Bill Gurley: startups seeking funding are starting to lower their expectations(wsj.com)
wsj.com
Bill Gurley: startups seeking funding are starting to lower their expectations
http://www.wsj.com/articles/venture-capitalist-sees-signs-of-caution-in-private-tech-arena-1445366864
5 comments
We're not talking about a binary choice. Rather, low Treasury rates influence the risk-interest demand curve across the broad market. People are pushed into low yield on low risk investments, which pushes yields lower on marginally more risky investments, &c.
Furthermore, leverage allows you to make portfolios that mimic the risk of other portfolios of riskier/less risky assets. In a theoretically perfect market where the replication can be exact, this fact alone can generate the entire risk curve.
Furthermore, leverage allows you to make portfolios that mimic the risk of other portfolios of riskier/less risky assets. In a theoretically perfect market where the replication can be exact, this fact alone can generate the entire risk curve.
What Gurley is referring to here is actually a level higher up than VCs. He's talking about the people who give VCs their money - Limited Partners or LPs.
LPs are usually very high net worth individuals or funds who invest a portion of what they have in venture funds. VCs are the people who get paid for managing those funds.
If you're responsible for managing the Harvard Endowment Fund (which is larger than the GDP of most nations) you're going to be investing large chunks of capital, and you're going to try and diversify the way you invest it. Say you put 20% into commodities, 30% into real estate, 40% into mutual/hedge funds (the stock market) and 10% into tech via VCs. (Of course, these numbers are complete bogus.)
If the market shifts and all of the sudden you expect really low returns from some parts of the economy, you may shift that money into other parts. So instead of putting 10% into tech you might bump that to 20%.
If that happens across the board VCs will be flush with cash, but unless there's a systemic change in how companies are starting they'll still be responsible for dumping that cash into companies. Remember: if you're a VC it's literally your job to invest the money the LPs give you.
All of the sudden every VC has tons of cash and there aren't enough good companies to invest it in. You might as well invest at really high valuations in the quickly growing companies: It's either that or taking bigger risks on lower quality companies. (Gurley has argued that both of these things are happening, but in this article he's more specifically arguing the former.)
The assertion Gurley makes is that now the market is starting to correct itself a bit. That correction takes place when either the returns are low enough that LPs stop investing as much of their capital in VC or if other investment opportunities heat up and LPs abandon VC to some extent.
Interest rates haven't gone up, so it's not like there's money moving out of VC to make other particularly great investments, but companies aren't being bought very quickly or going public. This means VCs aren't able to give cash money back to the LPs. Therefore the LPs can't reinvest this cash in new companies, and there's still some level of skepticism around whether these companies will return what they're "worth" on paper at the end of the day. If they put less money into VC the companies raising money will have a harder time doing so. Gurley is arguing that this is happening now.
Overall VC is a minuscule part of the overall economy - it's basically a rounding error - but how much money is in VC is very much dependent upon how other parts of the economy are doing.
LPs are usually very high net worth individuals or funds who invest a portion of what they have in venture funds. VCs are the people who get paid for managing those funds.
If you're responsible for managing the Harvard Endowment Fund (which is larger than the GDP of most nations) you're going to be investing large chunks of capital, and you're going to try and diversify the way you invest it. Say you put 20% into commodities, 30% into real estate, 40% into mutual/hedge funds (the stock market) and 10% into tech via VCs. (Of course, these numbers are complete bogus.)
If the market shifts and all of the sudden you expect really low returns from some parts of the economy, you may shift that money into other parts. So instead of putting 10% into tech you might bump that to 20%.
If that happens across the board VCs will be flush with cash, but unless there's a systemic change in how companies are starting they'll still be responsible for dumping that cash into companies. Remember: if you're a VC it's literally your job to invest the money the LPs give you.
All of the sudden every VC has tons of cash and there aren't enough good companies to invest it in. You might as well invest at really high valuations in the quickly growing companies: It's either that or taking bigger risks on lower quality companies. (Gurley has argued that both of these things are happening, but in this article he's more specifically arguing the former.)
The assertion Gurley makes is that now the market is starting to correct itself a bit. That correction takes place when either the returns are low enough that LPs stop investing as much of their capital in VC or if other investment opportunities heat up and LPs abandon VC to some extent.
Interest rates haven't gone up, so it's not like there's money moving out of VC to make other particularly great investments, but companies aren't being bought very quickly or going public. This means VCs aren't able to give cash money back to the LPs. Therefore the LPs can't reinvest this cash in new companies, and there's still some level of skepticism around whether these companies will return what they're "worth" on paper at the end of the day. If they put less money into VC the companies raising money will have a harder time doing so. Gurley is arguing that this is happening now.
Overall VC is a minuscule part of the overall economy - it's basically a rounding error - but how much money is in VC is very much dependent upon how other parts of the economy are doing.
But if LPs are targeting a certain return, then their capital allocation could swing towards including more Treasuries when their interest rate goes up.
Of course that's in a vacuum. In reality I expect many of the asset classes in their portfolio to have some dependence on Treasury rates, which perhaps would result in wider capital reallocations (or change in relative allocations going forward).
Of course that's in a vacuum. In reality I expect many of the asset classes in their portfolio to have some dependence on Treasury rates, which perhaps would result in wider capital reallocations (or change in relative allocations going forward).
Low interest rates are forcing asset allocators who have high (7-8%) nominal return targets into PE/VC
I go over the logic of this here, many seem to miss it: https://medium.com/@emad/asset-allocation-not-share-prices-w...
(my background: hedge fund manager/strategist with clients like those mentioned in article)
I go over the logic of this here, many seem to miss it: https://medium.com/@emad/asset-allocation-not-share-prices-w...
(my background: hedge fund manager/strategist with clients like those mentioned in article)
In your experience is the risk of the real money managers unconstrained? It seems odd these guys have to hit these rates of return, no matter what.
This same type of behavioral nuance comes up when looking at low vol strategies: empirically, low vol outperforms per unit of risk than high vol due to managers seeking high rates of return in combination with being unable to leverage.
This same type of behavioral nuance comes up when looking at low vol strategies: empirically, low vol outperforms per unit of risk than high vol due to managers seeking high rates of return in combination with being unable to leverage.
Yes, the returns are set due to actuarial liabilities to repay the pensioners. Only other option is to hugely increase premiums for current workers & most of these funds are already hugely underfunded.
As they follow Swensen's endowment approach risk theoretically diminishes as they "diversify".
As they follow Swensen's endowment approach risk theoretically diminishes as they "diversify".
> Mr. Gurley said the root of many of Silicon Valley’s problems is a resistance to taking companies public. By staying private for longer periods, startups have eluded the scrutiny of public-market investors that is needed to help companies mature and become sustainable, he said.
A lot of Silicon Valley's high-flyers are not yet great IPO candidates. Of those that could be taken public, many would face much lower valuations in the public markets, forcing them to raise less capital or sell more of themselves to raise equivalent amounts of capital to what they're raising in the private market.
As such, one could argue that the startups have been acting completely rationally by taking advantage of the willingness in the private markets to invest at exorbitant valuations. Sure, the late stage valuations are all engineered and companies will pay a hefty price if they can't deliver the returns they're increasingly having to promise late-stage investors, but I think a lot of these startups have made a calculated decision to raise as much capital as they can selling the least amount of equity, and worry about the consequences later.
It's not surprising the traditional VCs aren't thrilled with this.
A lot of Silicon Valley's high-flyers are not yet great IPO candidates. Of those that could be taken public, many would face much lower valuations in the public markets, forcing them to raise less capital or sell more of themselves to raise equivalent amounts of capital to what they're raising in the private market.
As such, one could argue that the startups have been acting completely rationally by taking advantage of the willingness in the private markets to invest at exorbitant valuations. Sure, the late stage valuations are all engineered and companies will pay a hefty price if they can't deliver the returns they're increasingly having to promise late-stage investors, but I think a lot of these startups have made a calculated decision to raise as much capital as they can selling the least amount of equity, and worry about the consequences later.
It's not surprising the traditional VCs aren't thrilled with this.
You wrote: "As such, one could argue that the startups have been acting completely rationally by taking advantage of the willingness in the private markets to invest at exorbitant valuations."
In the words of Clay Davis from The Wire: "You think I have time to ask a man, 'why he givin' me money?' Or 'where he gets his money from?' I'll take any motherfucker's money if they givin' it away."
Many VC's encouraged startups to raise as much money as they could while the getting was good. That is a good move for the VC's (raises the value of their shares) and the entrepreneurs (they get more money). But everyone should have known that interest rates were going to rise in the future, and that's the one trigger that will truly change the capital market.
In the words of Clay Davis from The Wire: "You think I have time to ask a man, 'why he givin' me money?' Or 'where he gets his money from?' I'll take any motherfucker's money if they givin' it away."
Many VC's encouraged startups to raise as much money as they could while the getting was good. That is a good move for the VC's (raises the value of their shares) and the entrepreneurs (they get more money). But everyone should have known that interest rates were going to rise in the future, and that's the one trigger that will truly change the capital market.
This seems so odd to me. It's like working the odds to stay as VC-funded as possible and basically avoid growing up - and most of them must understand that profitability simply doesn't exist in their model (before they pivot to being another advertising billboard).
The first step is admitting you have a problem, and as long as people keep giving you money, there's no need to admit anything.
Heck. As long as people keep giving you money, is there really a need to make money in another way?
The first step is admitting you have a problem, and as long as people keep giving you money, there's no need to admit anything.
Heck. As long as people keep giving you money, is there really a need to make money in another way?
The flip side of that coin is that some companies, under pressure to "grow up", become misguided—destroying their core product and user base in the process.
I would argue some business models aren't necessarily suited to generating significant or otherwise self-sustaining levels of revenue. However, that doesn't preclude these businesses from being incredibly valuable to larger, more established corporations with sizable cash reserves.
Of course, publicly admitting you're building for an exit is tantamount to suicide in the present climate, so it's no wonder the current situation is what it is.
I would argue some business models aren't necessarily suited to generating significant or otherwise self-sustaining levels of revenue. However, that doesn't preclude these businesses from being incredibly valuable to larger, more established corporations with sizable cash reserves.
Of course, publicly admitting you're building for an exit is tantamount to suicide in the present climate, so it's no wonder the current situation is what it is.
>The flip side of that coin is that some companies, under pressure to "grow up", become misguided—destroying their core product and user base in the process.
If your core "product" is massively unprofitable, it's not really a product at all.
If your core "product" is massively unprofitable, it's not really a product at all.
There is sellability and there is profitability. Two entirely different things, but ultimately that which is sellable will be exploited for financial gains, and often it is pro`fit`able
>If your core "product" is massively unprofitable, it's not really a product at all.
Tell that to Instagram or Snapchat.
Tell that to Instagram or Snapchat.
> Tell that to Instagram or Snapchat.
This is no longer true for Instagram. It should generate $595 million in ad revenue this year, and is expected to reach $2.81 Billion in annual ad revenue in 2017. (Remember: this company was purchased for $1 Billion.)
So, to recap, Instagram was "massively unprofitable" for five years, after which it started bringing in revenue most easily measured billions.
In other words the notion that a product isn't "a product" until it's profitable is farcical.
This is no longer true for Instagram. It should generate $595 million in ad revenue this year, and is expected to reach $2.81 Billion in annual ad revenue in 2017. (Remember: this company was purchased for $1 Billion.)
So, to recap, Instagram was "massively unprofitable" for five years, after which it started bringing in revenue most easily measured billions.
In other words the notion that a product isn't "a product" until it's profitable is farcical.
"However, that doesn't preclude these businesses from being incredibly valuable to larger, more established corporations with sizable cash reserves"
A business that's burning 100's of millions a year and has valuations in billions of dollars is rarely going to be "incredibly valuable" to a bigger company.
A business that's burning 100's of millions a year and has valuations in billions of dollars is rarely going to be "incredibly valuable" to a bigger company.
Like it or not, this is part of the game that's played in Silicon Valley. It's a high-stakes game to be sure and a lot of companies (perhaps most) are not going to make it.
But I suspect many wouldn't have made it if they tried to build a profitable business anyway because they're operating services that probably can't be run profitably (or very profitably).
But I suspect many wouldn't have made it if they tried to build a profitable business anyway because they're operating services that probably can't be run profitably (or very profitably).
Easy money is not necessarily all that it seems: It drives salaries up and creates an arms race for scarce talent that is crippling to many startups. It also creates a hype/hockeystick contest which is also largely unhelpful.
I agree. The strategic need for startups to exist in the Bay Area combined with the cost of living/cost of talent has caused costs to soar, necessitating more funding. Combined with easy money, this has been a tinderbox waiting to blow for some time.
But if there were no easy money then those startups would have less money to spend on salaries as well. If we believe that easy money benefits established companies more than it does startups (not sure) or funded startups more than bootstrapped ones (almost certainly) then the net effect might be bad.
But an 'arms race for scarce talent' probably benefits a large proportion of the readers here, and harms a much smaller proportion.
But an 'arms race for scarce talent' probably benefits a large proportion of the readers here, and harms a much smaller proportion.
It surely does benefit many HN readers, but overall the culture is harmed by so many people jumping into software development just because of the money. It has also lured many who would have chosen banking, etc.
And in spite of the better developer salaries, many startups can still not afford to let developers be makers and creators, and must instead focus on deadlines and other business metrics driven by fundraising.
If the runway for startups were longer, then longer-term thinking and strategy would be more prevalent. Easy money reduces the penalty of a failed startup, and makes it easier for anyone involved (including investors) to jump ship.
Since a startup is a stance about the future, this constrains startups who can get funding to those that are able to show traction after about a year, since there is little incentive to continue beyond that, and even a big series A won't pay for much talent in the valley anymore.
I think there is just an inevitable tension between investment as a visionary stance about the future vs investment as fuel for a machine that is hungry to grow. Both are essential aspects of the startup ecosystem, but inflated prices and easy money benefits the growth stage startup much more by crowding out the kind of environment needed for ambitious future stuff.
And in spite of the better developer salaries, many startups can still not afford to let developers be makers and creators, and must instead focus on deadlines and other business metrics driven by fundraising.
If the runway for startups were longer, then longer-term thinking and strategy would be more prevalent. Easy money reduces the penalty of a failed startup, and makes it easier for anyone involved (including investors) to jump ship.
Since a startup is a stance about the future, this constrains startups who can get funding to those that are able to show traction after about a year, since there is little incentive to continue beyond that, and even a big series A won't pay for much talent in the valley anymore.
I think there is just an inevitable tension between investment as a visionary stance about the future vs investment as fuel for a machine that is hungry to grow. Both are essential aspects of the startup ecosystem, but inflated prices and easy money benefits the growth stage startup much more by crowding out the kind of environment needed for ambitious future stuff.
"but overall the culture is harmed by so many people jumping into software development just because of the money. It has also lured many who would have chosen banking, etc."
You've got this backwards. People who would have chosen banking are the ones who are attracted 'just because of the money'. IMO most people who become developers do so because they're interested in software/tech, but most people who become bankers do so mainly/exclusively because of the money (and perception of prestige).
"...and must instead focus on deadlines and other business metrics driven by fundraising."
This is not an issue for bootstrapped startups. For funded/fundable startups, being beholden to funding cycles is the flip side of getting access to capital.
You've got this backwards. People who would have chosen banking are the ones who are attracted 'just because of the money'. IMO most people who become developers do so because they're interested in software/tech, but most people who become bankers do so mainly/exclusively because of the money (and perception of prestige).
"...and must instead focus on deadlines and other business metrics driven by fundraising."
This is not an issue for bootstrapped startups. For funded/fundable startups, being beholden to funding cycles is the flip side of getting access to capital.
"But an 'arms race for scarce talent' probably benefits a large proportion of the readers here, and harms a much smaller proportion."
In the short term, yes. In the long term, it can lead to crashes where a large number of the readers here may struggle to get jobs at any price for a period of time.
In the short term, yes. In the long term, it can lead to crashes where a large number of the readers here may struggle to get jobs at any price for a period of time.
"it can lead to crashes where a large number of the readers here may struggle to get jobs at any price for a period of time"
You mean because high salaries, over the medium term, may result in increased supply of developers?
You mean because high salaries, over the medium term, may result in increased supply of developers?
Doom and Gloom. Tech shorting cycle has been initiated by the Borg.
Gotta push the market down before the next round of buy-low-sell-high!
Thank you! Got hit with the subscription message.
I made an extension the other day (that does not ask for any permissions) that helps in these cases https://chrome.google.com/webstore/detail/news-paywall-acces...
VCs are investing in private tech companies expecting 10-100x returns on about 20% of their fund. Which works out to at least 20% return per year on a 10-year fund.
It doesn't make sense to me that an investor who would choose a VC fund as their vehicle would suddenly choose a Treasury note when interest rates go up 1-3%. A VC fund should still outperform that.