Year-end musings: Fear of missing out (FOMO) and the danger of being a Monday morning quarterback
The Accolade team completed its last trip west during the closing weeks of 2013. During the course of our meetings we learned of a new term, FOMO, to describe behavior that some venture capitalists were exhibiting. FOMO is the fear of missing out on the next “big thing,” or perhaps more appropriately, the next venture-backed company that gets “heat” and will hopefully result in a billion dollar exit. Examples of FOMO behavior are founder-friendly term sheets submitted in haste at lofty valuations, often as a result of a bidding war by eager investors who have had little time for due diligence. These Series A or B rounds are at times “preemptive,” where companies are offered funding when they are neither raising nor in need of capital.
As we have learned over the years, building a billion dollar company is hard, rare and takes a long time! Aileen Lee of Cowboy Ventures published a terrific post entitled “Welcome to the Unicorn Club and Learnings from Billion Dollar Start-Ups.” Since January 2003, there have only been 39 U.S. based software companies valued at over $1 billion by public or private investors. On average, four are “born” each year and take seven years to achieve that valuation. One third of these companies is still private. So the point is that while the press focuses on the most successful companies, arguably, they are statistical outliers given that thousands of companies are funded each year (only 0.07% of venture backed startups have joined this Unicorn Club). What might be perceived today as “hot,” will not necessarily produce a great outcome.
While these conversations reinforced our impression that the environment is frothy (not bubbly!), we are reassured because our managers were open in both characterizing and criticizing this behavior. Many have learned important lessons as a result of investing in the bubble and know better than to follow the herd. As fund managers, we are reminded that it is not our job to be a Monday morning quarterback. Rather we are charged with identifying managers uniquely capable of being early in identifying teams that have the passion and drive to solve a large problem or identify a greenfield opportunity. We are delighted that to date, Accolade’s managers have participated disproportionately in unicorns having invested in 6 of the top 10.
We know that investors can be fickle and that sectors often go in and out of favor quickly. Facebook is a great case in point. When Accolade’s manager Accel Partners invested in the Series A at $100 million in April 2005, their judgment was called “in question.” That is being charitable! The same held true for those investors who participated in the $500 million Series B. The last private round in January 2011 was completed at $50 billion and institutional and individual investors clamored to invest. This behavior repeated itself in the short span that Facebook has been a public company. At the end of 2012, Facebook closed the year at $27, after falling as low as $17 earlier in the year, and its market capitalization was $65 billion. The stock appeared to have little support and many would have said it was headed lower again. At the close of 2013, Facebook’s market capitalization was $133 billion, the stock hit an all-time high of $58 a share and was one institutions had to own. Today, many companies are benefiting from Facebook’s success. Twitter’s market capitalization is over $30 billion or 30x forward revenues. “Hot” enterprise software companies like ServiceNow, Splunk, FireEye and Workday, sell at 14x forward revenues. Great technology companies are never cheap so long as they maintain their growth rates. Nonetheless, these are heady times and we are mindful that one day these companies will also fall out of favor, but probably not for sometime until their growth rates moderate.
The IPO market is doing well because the equity markets have performed spectacularly in 2013. Last year was the best year for venture-backed IPOs since 2007. There were 82 venture backed IPOs that raised $11 billion. Interestingly there were more IPOs for biotechnology companies than technology companies. Many companies that went public had terrific business models as well as strong, seasoned management teams. Most importantly, investors made money on these IPOs. That, combined with the consensus that the domestic economy is strengthening, should enable additional venture backed companies to go public in 2014. At the conclusion of our trip, it was difficult not to be excited about the prospects of many of the companies in Accolade’s portfolios. Marc Andreessen, another of Accolade’s managers, was quoted in the Wall Street Journal stating that the rise of valuable new software companies is a fundamental economic shift, and that “franchise” companies are going to win big. We are excited to see where the next unicorns are in Accolade’s portfolio.
