Wednesday, June 3, 2009
A massive shakeout of venture capital firms has been predicted for years but it is finally going to happen over the next year because of a perfect storm of timing.
There are countless books, a few movies and mountains of silicon valley gossip about the good times of venture capital. Huge returns from the internet bubble bred too many people who thought they were smart because they were rich and it seemed as if new funds were popping up all the time, staffed by VC wannabes from investment bankers to millionaires from companies like Netscape, eBay, and Cisco. As one of my investors said at the time "everyone wants to be a venture capitalist, even the landlord".
But that era came to an end 9 years ago now, and 10 years is the critical period for the venture capital industry because funds are 10 years in length so I predict the decimation will start by the end of this year (although some like Venture Beat are already counting the corpses).
The perfect storm will create an inability for all but the best firms to raise money - and funds need to keep raising money to stay alive - but they face a tempest:
- the 10 year look back will not look good for all but a very few by the end of this year. With the exception of a handful of funds, the great returns came off funds that started before the tech bubble burst. It burst in 2000 so by 2010 the lookback will not include liquidity events in 1998 and 1999. Even some of the best firms don't have great returns over the last 10 years.
- major LPs (limited partners like pension funds and endowments) are having to balance their portfolios away from alternative investments. Imagine you manage an endowment or pension fund that has a restriction on what percentage can be invested in alternative investments (like venture capital) . But the equities portion of your portfolio has dropped by 40% so now your venture capital portion is over your limit. You can't invest more in venture capital even if you want to participate in a new fund.
- for years now about $2B a year in new money was flowing into the venture capital world from new LPs. This was new family money diversifying, or countries bringing a portion of their sovereign wealth fund into venture - but now if you are a newly wealthy South American land owner and have a $100M that you are being advised to invest in higher risk/higher growth you'd look back at the 10 year returns of venture capital and say "no thank you".
- the IPO market is broken so smart investors know that the rates of return for venture capital will continue to be depressed. Being acquired just doesn't carry the same multiples as an IPO - especially now when buyers are taking advantage of the difficulties small companies have raising money in a recession.
Even the best funds are working harder than they have every worked before to raise their new funds. NEA has closed on over $2B of their $2.5B raise, Oak Investments has attracted some negative press but they'll succeed in raising their $1B+ fund because the same small group of partners has been repeatedly successful over more than 20 years - as will the best of the best like Sequoia, Benchmark, Sutter Hill, Kleiner-Perkins et al when their time comes.
But we're seeing a flight to quality as the funding so far in 2009 is down almost 40%. LPs will be ruthlessly selective and this will weed out the new, the small and the weak.
The coming contraction will cause the startup industry to return to fundamentals. Good ideas into vibrant new markets that take 6-8 years to bloom not 2-3. Some in the valley think this will lead to less innovation but I disagree. I think we'll get a higher quality of company because great new companies don't come from the spray-and-pray approach - they come from creative, hard working entrepreneurs working hand in glove with nurturing investors and customers over a considerable period of time.
There are about 700 venture capital firms in the US according to the National Venture Capital Association. I readily admit I'm opinionated and think that probably less than 10% of these are really valuable to entrepreneurs (my friends who are partners in the best firms listed above would say the quality list is less than that!). As I've posted before - all venture money is not equal - pick your investors very carefully.
I predict decimation - but I realize as I conclude that I am not using the word correctly because it comes from the Latin for the destruction of one tenth - but I wonder if one in ten will be left standing? Will there be as many as 70 US venture capital firms two years from now?
Monday, February 9, 2009
In the world of running a public company one of the critical skills a CEO/CFO team used to have to have was the ability to set guidance for the "Street" - that is the sell side analysts who cover their stock and publish research and guidance to investors.
Guidance was typically top line and bottom line, revenue and earnings and the street would come up with a consensus on what EPS (earnings per share) the company would earn in the following quarters - often based on complex models developed in the wee small hours of the night by hard working young analysts.
Setting, and then making guidance worked well for high quality companies - they earned investor trust and were rewarded in the stock price - and the process could also create controversy when, for example Google said it would not provide guidance because the founders did not want to ever sacrifice the long term for a short term reporting need. If you're Google you could get away with that, but only the rarefied few could, and in the past most would have been crushed by such arrogance.
So what happens now? As reported by MarketWatch, an increasing number of companies like GE and AMD are stopping guidance in the current downturn because they have simply lost good enough visibility to be able to provide it with integrity.
It's an ethical and practical dilemma. If the CEO doesn't provide guidance he's not supporting his investors - one of his key constituencies - and their need to understand the company's expected performance in order to value to stock. If he does provide guidance and he really doesn't have enough visibility then he could be misleading his investors (and setting himself up for shareholder lawsuits).
I'm a big believer in transparency and over time that companies will be rewarded for it. Many institutional investors are investing for the long term - more so now than in the recent past - and want and need companies to share the metrics that drive their businesses in order to build their models and understanding. Transparency may not be EPS guidance, but it should be the best information the company can provide to share the outlook management sees. Companies withholding information or being coy about it infuriates investors, as well it should (and even worse is when they miss lead investors by manipulating revenue, as does still happen).
It takes courage for CEOs and CFOs to be transparent and help their shareholders really understand what's happening to their businesses, but I believe that in the long term - and following the downturn - the CEOs that figure out how to stay transparent will be rewarded.
Monday, November 17, 2008
Wall Street will be facing a talent retention challenge very shortly unless the bonus issue is elegantly handled this year.
Over the past week the news has been full of "outrage" and questions about whether bankers should get their bonuses this year. Talk of large chunks of the bailout going to top bankers and class-warfare type language.
But unfortunately this problem is not as simple as the government, or the "public" controlling the pay of an industry they don't understand. I'm a pretty hard-core democrat and yet when I hear talk of the US taxpayer wanting zero bonuses on Wall Street this year - per a Bloomberg article today - it concerns me that the public doesn't understand how talent works.
Our best companies are very, very competitive. In all but a very few rare cases, a company is only as good as it's people. And companies, like fish, rot from the head. It's a common adage in my world that A players hire A players and B players hire B and C players. Talent is everything. So, in the competitive world of banking it is essential for the long term health of our institutions that they keep the talent, within the institution if at all possible, and definitely within the country. Our best deal-makers will go where the money is and that had better be in the United States and at the institutions that make our financial systems work.
So while I understand that taking public money and using it to pay bonuses may be optically obscene - and it is certainly a good idea for the very top management of the institutions to not take bonuses - if that action is taken too far down there will be a negative backlash - and the talent which is so critical to long term health will leave. There are too many other firms, and countries, that will be happy to hire them.
Friday, September 19, 2008
It's obviously sad and sobering to watch the financial crisis unfold, but for me it is at a human level not at an institutional level. I don't respect all the media rhetoric and blame about "short sellers" and "greedy executives", and especially not John McCain calling for the firing of Chairman Cox (great editorial today in the most-conservative of papers - the WSJ - calling him "un-presidential").
The rhetoric shows a lack of understanding that markets move, and people behave, the way they are paid to by their shareholders (who elect the board after all). The blame game (read Paul Kedrosky this week - great commentary) is naive.
No question the men running the major institutions are smart and aggressive, and as a result they take risk and sometimes it doesn't play out - that's why it's called risk. But it's bad for the country and the economy when it plays out at this scale and affects as many people's lives as it is this time so sadly a bailout is needed.
New York Magazine puts it in perspective though, with the article Bank on it this week - Why Lehman Brothers wasn't too venerable to fail. It tells the story of how Lehman is not an old and venerated institution (as the media has described it) but instead the result of a revolving door of mergers, failures and spin outs reaching back to 1867.
Tuesday, September 16, 2008
It would seem that we experienced yesterday differently than our silicon valley brethren. I was surprised to see a Valleywag post that the discussion of the day was self absorbed as usual - about user interface and how tech can make money, not about the impact of the meltdown on the lives of people on both coasts.
And Kara Swisher at Boomtown who said "Last week, one of the things that struck me about the coverage of the two main tech conferences devoted to start-ups, DEMOfall and TechCrunch50, was the almost complete lack of discussion–or, more appropriately, worry–about the troubled economy."
I agree with the path she takes in the post - that the woes of Wall St will indeed affect the Web 2.0 economy, with no path to liquidity in the public markets and the economy slowing there is no question the "ad driven" business models will slow - yet again tech entrepreneurs need to be patient and stay the course. Either weather through with the cash they have, find an acquirer, or (the more fun path) find a VC who will invest for the long term gain and wait the markets out with the company.
But there will be direct impact on tech companies who were selling product to traditional Wall St - specifically to the big banks and broker dealers like Lehman and Merrill, and Goldman and Morgan Stanley. There indeed we'll see a dramatic slowing of spend as the market shakes out and we may see this fallout affect large IT suppliers like Oracle and Salesforce.
At FirstRain we made a strategy decision not to sell to the "sellside" - not to sell to sell side analysts and investment bankers and instead to focus on the buyside portfolio managers and analysts so our exposure today is distraction not a loss of customers.
The personal loss this week will be painful for many thousands of people, and so very sad and unnecessary. Much has been written about the causes leading up to this week's events and I'm not going to add to the chatter. I'm going to be there for my friends who are affected and stay focused on our business. And today we're talking to our buyside clients and they are in the market making money as they do every day - there's a job to be done.
Friday, September 12, 2008
Guest post by Marty Betz, VP of Technology
This week saw the stock of United Airlines (UAL) drop by 75% in a single day because of information posted on the web. In this case, it was because 6-year-old content seemed ‘new’ to a user of the web – and that user pushed the ‘news’ into a major tool (Bloomberg) used by professional investors, and the markets reacted.
I thought I’d share my thoughts from a technical perspective on what happened, and how it can be avoided.
Quick (simplified) review of the chain of events:
1. Something lead to higher than usual clicking on an old news story about United going bankrupt
2. That spike in clicking made the story appear on a newspaper’s “Most Viewed Articles” list on their web site
3. Google News crawled that list and article, and sent it to Google Alerts users who track UAL
4. An investment advisor posted it to a public forum on Bloomberg
5. A Bloomberg editor pushed it up into the closely watched flow of Bloomberg ‘headlines’
So, how could this have happened? From a technology/product perspective, it’s because one very specific type of user (a professional investment researcher), doing a specific task (investment research) used a tool designed for a different user with a different task (plain old consumers like you and me keeping up on the news).
Re-purposing is a good practice. It’s often how investment professionals as well as tech startups move the ball forward, but it comes with a requirement that you get disciplined about making trade-offs between the added value and the costs and risks. In this case, there are a few aspects of a) the web and b) investment research that boost the risk of that mismatch. Let’s start with the web.
Finding what’s “new” on the web is hard. Old content makes up 99.99999…% (you get the picture) of the web. Because of this, you need to make a number of significant technical specializations to use it as a source of news. Add to that the fact that the web wasn’t designed for news delivery, so there is no reliable time stamp on a web page, much less the kind of “I’m new” flag that we would like.
Second, consumer search engines were not built to find news. As search engines have done the work to build this capability, they’ve had to make hundreds of technical choices. In the case of Google Alerts, to give their consumer user a great experience by sending them news to “keep up with what’s going on,” Google very reasonably chose to crawl a given web site’s “Most Viewed Articles” list. And even when the assumption is wrong, the worst possible consequence is old (but popular) content showing up in your Google Alert. That is, at worst, a little annoying.
Investment research is a very different animal. The investment firms and hedge funds that manage the majority of money in the market earn their keep by being careful and thorough about deciding when to buy or sell stock, but along with their deliberative research process, they are also required to pay attention to the news. It would be reckless, and potentially illegal for them to ignore news – because news moves the stock’s price. Many of the professionals who do the research at these firms have re-purposed Google Alerts to track news, and they’ve simply gotten used to some level of old stories coming in.
The impact of the repurposing shows up in the lopsided consequence of Google’s assumption being wrong.
- For the consumer user, annoyance
- For the investment professional, a $1.16 billion intraday loss
- For United Airlines, the kind of attention that hurts when you’re already under stress
- For Bloomberg and the researcher who posted the link, a big hit to their credibility.
What does it take to avoid it?
In contrast, we make our hundreds of technical decisions with the investment research user in mind. These include:
- Carefully understanding each site’s structure and publishing patterns. For example, we generally don’t look at the “Most Viewed Articles” pieces of a web site, because widely known information is the least valuable to an investment researcher
- Analyzing the words and phrases in the article to place it in time
- Sampling small pieces of every article and compare them against our database to detect stories we’ve crawled before
A lot of the hand-wringing in the press and on blogs has been about “machines gone wrong,” but the right machine/technology actually works well for the portfolio managers, analysts, CFOs and CMOs it was built for.
The Bigger Picture
While this news tracking piece of what we do is valuable for our clients and technically challenging for my team, the more compelling impact of the web for financial research comes from recognizing that the web is a comprehensive reflection of reality – the biggest investment research database that has ever existed.
Every other data source is relatively limited – and very picked over. We began releasing new capabilities in FirstRain earlier this year that mine this ‘database’ for unique insights, trends and patterns over time. The reaction from our users tells us we’re on to something big.
Monday, August 11, 2008
Back on line after a much needed week in Maui...
I wrote about the risk and impact of auction rate securities back in February and how young VC backed firms who had put their precious cash into ARS were suffering. By March Merrill, Citigroup and Morgan Stanley were being sued.
Now finally the SEC is getting involved and has "issued a formal order of investigation into whether various provisions of the federal securities laws have been violated over the sale of ARSs" and is responding to various subpoenas from state agencies.
Small comfort to the companies who faced a liquidity crunch as a result of listening to an ARS pitch.
Tuesday, December 18, 2007
I'm in New York this week, but on my way home to England for Christmas - and one of my staff sent me a great article in Hedgeworld (which needs a subscription) on the ongoing debate of London vs. New York.
Per this article, the battle is now on for hedge funds and the British Government is working hard to attract them. On the positive side, London is much closer to the broader investor market and the FSA, while highly regulating the market, is considered predictable. On the positive side for New York though, it's cheaper to do business there and the US savings market is supportive of alternative investments. But while New York still leads the hedge fund market today, the London growth rate is 63% vs. the New York growth rate of 13%
I think the trend is a challenging one for New York, although the weak dollar may turn the tide back. At the base of New York's problem, as was much reported in Jan this year, are two issues: the litigious environment and geography. The stranglehold of regulation on US public companies is not going to go away soon, and while some of it was good to correct for the issues of the past, some of it is ridiculous (for example the way accounting firms now behave during audits - it's hard to believe until you live it).
And the perfect location of the British Isles has been an advantage for England for 500 years. Money can flow in from the West and the East with ease, into a large, modernized airport with fast rail to London (unlike arriving at terminal 7 at JFK).
The best thing about what's happening is the fun of the healthy debate. Whether it's semi serious about the financial markets or amusing about lifestyle, the press (for example this running commentary) is now documenting the debate that has been active at my family's dinner table for 20 years, ever since I left England for California.
My personal observation - London will always have the emotional pull of "home" for me, the streets are the streets I roamed as a romantic teenager and the theatre is hard to beat. But New York offers an unbeatable combination for me now: exciting work, building a new company, fantastic entertainment and a place my teenage kids love to come to and roam around while I am working.
Thursday, December 13, 2007
I’ve been watching the increasing pressure hedge funds have come under since August (following the sub-prime meltdown). Pressure like:
- MAN Group’s Peter Clarke said he expected 1 in 10 hedge funds to fail, up from the 5-7% historical attrition rate;
- it is becoming clearer that many hedge funds are inflating their reported size by including borrowed amounts, where a “$2 billion” fund turns out to have had less than $100 million;
- institutions like universities are starting to feel/fear their exposure to hedge funds;
- and European politicians increasing their agitation for regulation of hedge funds.
But in contrast, at the same time the “ultra-wealthy” continue to increase their investment in hedge funds – and where the smart money goes, so the rest of us will continue to follow.
(As a fascinating aside the same report says the over-$50M crowd are also, for the first time, getting more of their news online than from newspapers)
So while it’s been a tough environment, most of our hedge fund customers are managing well--employing discipline and the short strategies that they pioneered. What’s more, there are continued signs of innovation and growth across the community, with big moves out of Japan to the rest of Asia and new products for Russia.
Thursday, December 6, 2007
Being a small, nimble technology company, innovation has to be integral to our daily lives. For us to build a successful company we know that we have to constantly discover new ways to deliver our service, improve client experiences, and exploit needs in the marketplace.
When you innovate, however, everyone needs to be mindful of the risks and downsides. As the innovating firm: are you making a bet on a new feature that the market can’t support? Could the money spent on sales people be used to make the product better? How do you best support a growing client list and turn your customers into raving fans? As the customer: how will the new way of doing things positively impact your business? Are the implementation risks too great in relation to the upside the innovation can deliver? What if the product doesn’t work?
There was an interesting article in the NY Times this week about how we are currently experiencing the downside of innovation in the financial markets with the growing fall out from questionable sub prime lending practices and the housing bubble. It is scary to see how the lure of significant short term financial gains forced credit lenders to ignore the inherent risks in the system they were creating – they figured it was the responsibility of the buying public to know better. With hindsight this was, of course, completely irresponsible. The fallout has been dramatic, far reaching, and unfortunately it doesn’t look like we have seen the bottom yet.
The moral of this story: innovation can be truly great when there is a partnership between the innovators and the consumers of the innovation. One where everyone understands the upsides and the risks, and the customer understands that the value the new innovation is far greater than any downside associated with it.
Wednesday, December 5, 2007
It's great to see Christopher Cox, chairman of the SEC, evangelizing use of the internet for investment information. It's coming like a train down the tracks and it's refreshing having the official body trying to move the market ahead of the train. I've commented on whether CEO blogs can create inconsistency from management - but at least, so far, the SEC has been somewhat supportive of Sun's push to use the web as an investor communication medium.
The issue of the potential for this being a problem for the over-50 crowd (as raised by the AARP) is real though. We see in our own customer base that some of our most aggressive, creative users are younger and our older clients are definitely more comfortable with a push model (email reports) that with on line access, RSS, IM or - what is bound to come next - widgets.
Monday, November 26, 2007
The recent articles highlighting the anti-trust scrutiny by the EU of the pending merger of Thomson and Reuters have uncovered tremendous opportunities for growth and change in the investment research technology space. Here is some sub-text worth watching as the merger unfolds:
- Putting the bullseye on Bloomberg: From the beginning, it has been apparent that TF-Reuters were coming together to target Bloomberg’s desktop market share. The main speculation has been focused on how Bloomberg will react to a pending attack on its core business, but an under reported aspect of the story is that many opportunities will be created for the smaller niche players in the market. While the big players are preoccupied with one another, hungry nimble companies in the space could seize the opportunity and gain traction in their core areas of expertise. Firms that can deliver interesting and innovative solutions, especially in those areas of weakness by either the new TF-Reuters offering or Bloomberg, could easily make waves.
- A ramp up by platforms in the “second tier”: Similar to the very small niche players, “second tier” platforms like Capital IQ, FactSet and Factiva could capitalize on the channel noise above them to gain market share with material expansions of their offerings. The pending Dow Jones–News Corp merger makes the Factiva story especially compelling, as it is unclear about the direction Rupert Murdoch intends to take that service despite the tremendous amount of content under the News Corp umbrella. More so than at any time in recent history, this tier of services appears to have a real opportunity to expand their reach.
- Anticipated divesting by TF-Reuters to comply with anti-trust concerns: One of the most obvious questions that arose after the announcement was regarding how the merged entity was going to manage the duplication of services between Thomson and Reuters (news desks, earnings estimates, trading platforms, etc.). As the two firms look to comply with anti-trust regulations both here and abroad, divesting of duplicative or non-core entities is increasingly likely (as Thomson recently has done with its TradeWeb platform). Because both Thomson and Reuters have such large, established footprints in the investment research technology space, sales or spinoffs of select business units could significantly alter the competitive landscape.
- Additional consolidation in the industry: There is a distinct possibility that all of the activity mentioned above could also lead to the large players (likely suspects are Bloomberg, DJ-News Corp, S&P, TF-Reuters, and Xinhua Finance going on a “land grab” -- buying the best of remaining firms available in the marketplace as a way to become the most robust platforms available. It is also feasible that new major players could enter the scene via merger of smaller firms. In the end, it wouldn’t take much, maybe one or two transactions, to start a domino effect across the industry.
Of course, all of the conjecture above is going to largely depend on the economy and the health of the institutional investment industry as a whole. Regulatory, economic, and geo-political factors could all play a part in how Thomson, Reuters, Bloomberg, and the rest of the industry adapts to the pending changes. Nonetheless, it is safe to say that the upcoming Thomson-Reuters merger brings with it a pivotal era in the investment research technology industry. Stay tuned!
Guest author: David Frankel, VP Business Development FirstRain
Wednesday, November 14, 2007
The departure of Charles Prince from Citigroup and Stan O’Neal from Merrill has started me wondering about the bigger risk-tolerance picture. To understand it better I looked at a quick cross-section of results in FirstRain, and was struck by how rapidly this shakeup has accelerated, from the occasional blogger highlighting an exception to the risk binge to weekly predictions of the meltdown (A Prescient Call on the Merrill Meltdown) to a daily deluge of coverage in the last few weeks.
In context, the significant moves by Citi Citi Buys Credit-Focused Hedge Fund make me wonder how the risky decision process works in such high stress situations.
Most reassuring is that many banks seem to be doing just fine so far including Deutsche Bank Deutsche Bank's Net Rises 31% and Lazard Lazard's Net Triples Amid Record Results; but, what I think nobody knows so far is when the other shoe can be safely considered dropped, both for Merrill and other big players like Citi where For Citi, Stakes Get Higher
Tuesday, November 13, 2007
The tumult in the financial markets is leading to an interesting side-bar around Bank of America’s Investment Bank. BofA continues to deny it but, with the CEO Ken Lewis having had “all the fun” he wants, everyone (including the league tables guys are getting into the rumor mill. As far as $675 million projects go, this seems like a big unwind to contemplate so soon, but with this coming in the context of the September departure of the CIO and more recent departure of the head of structured products, it’s going to be a tough turnaround.
Friday, November 9, 2007
Fundfire reports on a study, run by Greenwich Associates, that finds that finds that while "quantitative information like performance and risk management are still important, the qualitative factors are far more compelling in the due diligence process".
Fascinating for an industry where the results are so measurable and it's the amount of money you produce, and so make, that counts.
“We asked the portfolio managers what they perceive to be important in the process of evaluating them,” says Greenwich consultant Andrew Klebanow. “The managers…have their own point of view about what they believe manager research teams should focus on to effectively evaluate them as asset managers.”
The main finding: the qualitative factors – a firm’s investment philosophy, its trading practices, its ownership structure, its people – are more important than performance, risk and other quantitative factors. The study found 75% of managers feel the qualitative factors are “extremely important” in the evaluation process. Quantitative factors were called “extremely important’ by 51% of respondents, indicating that performance is not the most important.
When we discuss FirstRain with potential customers we discuss it in the context of their research process. The old salts, and the young turks, who produce consistently high results have a rigorous research process where a rich variety of sources of information is essential and they cannot tolerate missing insight on their markets and companies. As a result a service which discovers information and then detects patterns in the information significantly enhances their process.
"“At the end of the day, performance is the end result of the processes,” Klebanow says."