BILL GURLEY RENEWS OUR MISGIVINGS ABOUT VENTURE CAPITAL

Bill Gurley again made some internet waves with his recent post on the dangerous state of the Unicorn market.

His piece, like those of many others, questions the logic behind the unprecedented funding environment of Unicorns, and casts blame around to various parties: founders and their egos, “shark” investors with dirty term sheets, LPs, Angel/Seed investors, family offices, and practically everybody except traditional VCs like Benchmark.

In some ways, Gurley’s post was reminiscent of Mark Suster’s post, wherein he explained away irrational valuations as caused by early noob investors and late stage institutionals. Suster also never questions the potentially irrational behavior, FOMO, and herd-mentality of traditional VC firms.

The problem with this is that it simply doesn’t add up. As we noted, VCs seem to be the crux of the problem:

The average VC investment in 2012 was roughly $7M. In 2015 it was $15.2M. If we make a gross assumption that the average equity stake of each investment is the same over time, it means that valuations DOUBLED in four years for VC backed companies.

As we stated recently, traditional VC’s, which sit in the wide space between angel/pre-seed investors and late stage corporate/institutional investors, seem to function more as real estate agents than investors. Effectively they are traders, using ad-hoc pricing metrics to justify an ever increasing price for their asset.

Let’s look at Uber, which is an apt example because of Benchmark’s stake in the company, and Gurley’s membership on the BOD. In addition, as Matt Rosoff pointed out, the company really is the bellwether of the last eight years of VC behavior.

This does not include the latest fundraising round of over $2B, allegedly from Tiger and T. Rowe Price.

The first four rounds, of which Benchmark participated in three, were all VC driven, and subsequent rounds became more and more institutional and corporate.

The point is, the irrational valuation of Uber’s most recent fundraising round is a direct result of prior rounds, and the subsequent rise in valuation is driven by the trading mentality of VCs, where each batch of investors is simply looking to upsell and protect their stake.

To that point, Uber’s current valuation, estimated around $65B, is based on nothing more than the belief that Tiger and T. Rowe Price can sell their asset for $80B or more, probably via an IPO, leaving Joe and Jane Shareholder (via their pension funds) to deal with the ugly ramifications of public disclosure of financial records, and the harsh reality of things like profitability and free cash flow.

Those in the early investment rounds are rooting for this as well, as the cash windfall will eventually trickle down to them as well, even considering dilution.

Noticeably, Gurley does not mention the value-chain of the VC world and how that may be the root cause of the irrational “Unicorn Financing Market”. But all of this is not nearly as interesting as his final paragraph, where he states:

The healthiest thing that could possibly happen is a dramatic increase in the real cost of capital and a return to an appreciation for sound business execution.

This is clearly a call for more financial rigor and realistic business assumptions behind startup investments. We have heard this call before from numerous VCs in recent months, and yet nobody seems to be picking up the gauntlet to actually implement anything of substance.

This seems particularly ironic coming from Gurley for two reasons.

First, Gurley and Marc Andreessen allegedly have an ongoing rivalry, where each one likes to hint that the others Unicorns are nothing but donkeys. One way to put this contest to rest is by focusing less on media hype and more on actual portfolio optimization and performance, which requires financial scrutiny.

Secondly, and much more interestingly, is Gurley’s post from the summer of 2014 where he lashed out at Prof. Aswath Damodaran for daring to use financial modelling to call into question Uber’s valuation. The reasons behind Gurley’s argument ere typical for VCs at the time, and none of them actually referenced any numbers to prove points.

Ironically, Gurley’s reasoning did not come to fruition. Uber has expanded its services to delivery and car-hire services; two sectors that can fairly easily be estimated in much the same fashion as Aswath Damodaran’s original post.

Yet here we are, less than two years later, and Gurley, et alia are calling out for more financial rigor and better business practices.

As Bryce Roberts recently pointed out, the traditional VC model is beyond the point of structural change, and we can’t expect LPs to lead the revolution because, as Gurley states: “In a sense they [LPs] have already “banked” the gains.”

So instead of waiting for founders, sharks, or LPs to wise up, we are stuck waiting for some big-name VCs to put their money where their mouth is and show the larger startup ecosystem that the VC model can be more efficient and grounded in reality by incorporating more financial rigor in their investments-cum-trades.

In light of all of this, we have a proposal…

We will show you how to do this.

I’m assuming, like other brand-name VCs we know, that somewhere Gurley has an Excel that shows a target investment amount and subsequent dilution for a company you are invested in. This target is probably based on 3 things: Some pricing mechanism (7X Rev multiple for a SaaS company, for example), some targeted portfolio return, and some comparable perspective of “this is what we always do”, or “this is what Andreessen always does”.

Instead of just going along with the pack, we want Gurley, or anyone else for that matter, to pick a recent A or B round investments, we don’t care which one, and we will use our tools and methodology to assess the investment — maximizing the potential, accounting for all of the risk, and ultimately increasing potential returns for the portfolio.

Gurley said it best: “The numbers they [investors] are looking at on a PowerPoint deck are potentially erroneous.” If this is true (and it overwhelmingly is), why not do a financial gut check of those numbers and match them to VC internal metrics. You can even take this a step further and account for all the variance and risk with smart simulation analysis. This is exactly what Gurley, and every other VC, is clamoring for, yet not implementing.

The broken VC model will only change if a big-name insider leads the charge. According to practically everybody, the VC marketplace needs a financial kick in the ass. Business acumen and risk management can make money for everybody in the chain — the VCs, LPs, and founders. So contact us, one of you could have a first-mover advantage over everybody else.

Well, technically the second mover; we have been doing this for a while already.