VC Cliché of the Week

Matt Blumberg reminded me last week of a saying that my finance professor at Wharton taught me, “if you aren’t a buyer, then you’re a seller”.

The theory behind this cliché is that it’s impossible to be neutral in a market. Either you want to own something or more of it or you want to own less of it or none of it.

I don’t totally subscribe to this theory because I do think there are times when you should be happy to own what you own and not want less or more.

But this cliché comes in handy in the venture capital business. I think the time I laid it on Matt was in a discussion about the endgame once you’ve built a business. You either want to take your earnings and capital and apply that towards acquisitions and growth (being a buyer) or you want to find your exit (being a seller). It’s hard to do both at the same time.

This maxim is also useful when valuations get extreme in the positive or negative territory. You wanted to be a seller plain and simple in 1999 and 2000.  You wanted to be a buyer plain and simple in 2001 and 2002.

I am spending a lot of my time thinking about what you want to be right now. We are still making new investments (buying) in the Union Square Ventures portfolio and we have been sellers for the past couple years in the Flatiron portfolio and we’ll continue to be sellers for as long as that portfolio is around. Most successful VCs are buyers and sellers at the same time, building one portfolio while liquidating another.

But it sure feels like a sellers market right now. I’ve been meeting with a lot of entrepreneurs who have been successful in the past and are starting a new company. They could easily raise a couple million and not suffer a lot of dilution. But most are choosing to raise a lot more money right now, often $5 million or more. And I shake my head and ask them why. They give me lots of reasons that make little or no sense to me and I am left with the obvious conclusion. Because they can. Because it’s a sellers market right now.

So it’s a good time to think hard about whether you are a buyer or seller. I think most people are going to be both at the same time, but you need to at least have a bias because if you aren’t a buyer, then you’re a seller.

Comments

[steve]

Problem is, as you say, to know when to hold 'em and know when to fold 'em. Its certainly true that 1999-2000 was "plain and simple" a time to be a seller... but only in retrospect to most folks. When we did our deal and sold nicely, you and Jerry were easily in favor of doing so but many of the other investors weren't and instead wanted to buy (raise more money from private or public sources.) And they were/are as smart and sophisticated as we were/are, and it was a tough call. (Phew, we made the right one.)

Couple of maxims come to mind here:

"When other people get greedy, I get scared, and when they get scared, I get greedy."

--Warren Buffett

"The goal isn't to buy lowest and sell highest, its to buy low and sell high."

--My Dad

[al from chicago]

But that is just NOT a good reason. You don't get to keep the VC money!!! It is the same reason Staci wrote in paidcontent.org http://www.paidcontent.org/more-on-huffingtonposts-5-million-funding --why Huffington Post took $5 -- and how could you turn it down -- and here's my email to them (I couldn't get comments to work):

"ButI think it is easy to turn down $5MM — that is not a good reason to raise it. It becomes a bar you have to hit before you can participate in the upside; it forces you to spend more; and it dilutes you more. Taking $1MM or so — or in that range -- I can see and makes sense. But I know I could raise that amount for RCP if we chose to and it just doesn’t make sense for the business.

Figure it this way — to raise 5 – let’s say the VCs invested at a 10 pre money so they bought 33% of business. VCs want/model a 10x return on their money — so they are shooting for a $100MM outcome. To get that deal done, rationally, you need to be doing at least 10MM in cash flow. Let’s assume you can drive tremendous margins — maybe you can do that on $20MM in revenue? So $1.67MM a month. Let’s assume they can get an RPM of $15 — which is high btw, especially for politics — they need monthly page views of 111 MM — that is 111 million page views per month — that is a 8x (at least) over what they’re doing now if we assume all their page views are sellable (not sure that the comments are). In politics — not sure how much more runway they have. So they’re going to launch all of these other sites — in a competitive marketplace — why will they win?

So now — instead of having a nice business that they can maybe get to cash flow to $1-3M a year and sell for 10-30MM, they are aiming much much higher. And if all they do is get to a $20MM outcome, which would still mean they did a great job -- their share of it is now 67% x 15 or 10MM, vs 20MM — so on the low end, for a still highly positive outcome — they’ve cost themselves A LOT of upside for a lot more risk. And this is NOT the first round of capital -- so I really should have modelled the original preference in there as well."