Venture Capital, The Revenant

An unsettling milestone was reached last year, as quarterly venture capital investment rose to the highest level since Q1 2001, according to the MoneyTree Report from PricewaterhouseCoopers and the NVCA. The comparison to the bursting of first Internet bubble was too obvious to ignore, and the chorus began to rise that this cycle’s end, too, was near.

Well, we have a different view, one that is very much informed by our partnership with a media conglomerate, Advance Publications, a massively successful company that has survived and thrived for nearly 100 years. At this moment, the economic data is flashing signals that are entirely in the eye of the beholder. While there appears to be underlying confidence and buying power among the target US market for many consumer Internet companies, the world beyond our borders is not as strong. Conditions have caused many venture capital investors to begin to warn their portfolio company management teams that winter is coming.

Source: Pitchbook

We would like to offer some perspective.

When we read of such memos or board meetings, with founders being warned to “stop burning cash” because the funding environment is changing, we cringe. We believe that growth is rarely free for the great proportion of emerging businesses, so cash should be valued appropriately — always.

At what point did it become OK not to care about cash? In our view, cash is a permanent member of the start-up “security council”, along with talent, a defensible idea, and execution. Have less than all four for any extended period of time, and you’re out of business. When it comes to cash, we know of very few businesses that made a successful habit of selling dollar bills for fifty cents.

When an entrepreneur takes funding from an investor who encourages that kind of cash use, she is buying into the false premise that when the cash runs out, there will be more to be had, at a higher valuation to salve the dilution to the founders and employees. This premise is false because in the past 20 years, venture expanded beyond the hands of the true believers and experts, and entered the realm of the financier. VC as banker, banker as VC. When the going gets tough, this fast money crowd leaves town. Start-ups are being advised to conserve cash because the funding torrent enabled by these folks is drying up.

A Fundamental Misunderstanding

As venture capital became more sophisticated, more liquid, and more replicable, the focus moved ever so slightly from the business model characteristics and markets being funded to the security or asset itself. In doing so, venture capital became just another asset class, like fixed income, public equities, or derivatives. At the same time, after 2008, as central banks eased and continued easing right into negative interest rate territory (compelling investors to put money to work), risk appetites grew. VC became a suitable investment despite having multiple vectors of risk, and new entrants wanted in on the “game.” Some of the current generation of VC’s and founders became regular visitors to the sets of Bloomberg West and CNBC, which fed the bubble.

Credit: Pitchbook

We believe that venture investing is different. It isn’t the trading of assets, commodities or securities from one account to another, financed and pumped up by the Street to create fee streams until it all comes crashing down and the game has to start again with some other fad. Venture capital isn’t the same as private equity, which is used to move assets from public ownership to private ownership, or from one set of private owners to another. It is primary capital.

Credit: Goldman Sachs, CB Insights

Startup funding of this nature will of course become less available when conditions change (your first clue will be when the CNBC commentators start discussing the “risk-off trade”). The animal spirits will take over, and what was a great plan as of, say, your last board meeting, will need to be revised. Immediately. Your CFO will be directed to generate an operating plan that prioritizes cash conservation. Too late to hit the brakes, or you realize there are no buyers for your product or service at a contribution margin that covers costs? That’s when one of your directors suggests having a conversation with his friend at a boutique bank who “knows the sector well” or “can have some informal conversation with Oracle/Google/WPP/Alibaba/Nordstrom/etc.”

The Successful Startup

Startups are the closest we will ever come to survival of the fittest in today’s business world. There’s a reason only a handful of companies emerged from the first consumer Internet bubble and crash a generation ago. Many were interesting ideas, but ahead of their time. It cost many of them too much to generate demand with unclear long-term customer prospects. A few were either extraordinarily well-designed and managed (Amazon), or fortuitously in the right place at the right time (Yahoo), and survived, only to demonstrate the importance of all four components of the security council.

It’s true, as Marc Andreessen famously pointed out, that there’s a world of difference between the immature, narrowband internet of a generation ago, and today. Yet business models still matter. Many companies financed within the past few years as the “Uber of ____” will see their demise in the next 12–24 months; some will deserve it, some sadly will be babies thrown out with the bathwater. That’s what happens when panic sets in. The last in are the first out, as the realization hits suddenly that they are beyond their depth, that a dollar-bill-for-50-cents business model is unsustainable in a market that reprices cash, or that finding leadership talent to build their ideas into working businesses is harder than they thought.

For those companies who never expected unlimited access to cash, whose vision encompassed the combination of talent, a great idea, protective moats and executing to generate growth AND profit — those are true venture capital companies, companies who will survive the onset of Valley Winter. They will get no warning PowerPoints, no emergency board meetings suggesting it’s time to retain bankers. Such companies will be the example for the next generation of founders, once Winter passes and the green shoots of the consumer Internet’s next phase appear. In the early days, they will be backed by the true believers, who invest in companies and not asset classes. They will be the latest in a line that started with Intel, then passed through Apple and Google. They will not be measured by the amount of capital they attract, nor the valuations they achieve in private rounds, nor the non-paying viewers of their content on others’ platforms. They will have business models, and their customers’ lifetime values will far exceed their acquisition cost. There will be no Winter for those companies.

These are the kinds of companies that Advance Vixeid Partners seeks to back.

Now, check our latest post here: https://medium.com/@Vixeid/the-paranoid-87d75cbda668#.tctmsztsq