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Patience
Exits come in all shapes and sizes in the venture capital business. There’s lots of focus these days on the quick flip which isn’t usually the preferred route for the venture capitalist, but you can’t complain too much when you make three, five, seven, or even ten times your money in a year or two. And of course there's the YouTube quick flip which anyone would be ecstatic to have in their portfolio.
But one thing I’ve learned about the venture capital business is that if you are patient and stick with your best companies for the long haul (and it can be a very long haul), you are often rewarded with some great exits.
I am on the board of four companies that were started in the mid to late 90s and I have a significant investment in one other. All of them are Flatiron Partners portfolio companies. We have had our capital invested in these businesses for seven or eight years now. And we’ve had our time invested in most of these investments as well. The time and money are significant and finance theory teaches you that time works against you when you are in the rate of return business.
But I am always a bit mystified by the focus on rate of return as the measure of performance in the venture capital business. It’s not like you can turn around and invest your money at that rate of return so easily. So if your capital is tied up in a company that is building significant value for its shareholders, it’s often best to let it stay there.
I am much more fond of the return multiple and also total gain numbers as a measure of performance. Time doesn’t work against these numbers. In my experience, times works for you when you are in the return multiple business.
The key thing about patience is that you have to see that value is being created to be patient. It’s not always a quantitative exercise either. It often takes a company five years or more to start producing positive cash flow and it certainly takes time to produce the large high growth operating margins that produce the big valuations upon exit. So in the meantime, you have to have other proxies for value creation.
The most common proxies we use in the venture business are customer adoption, revenue ramp, the development of a strong team, the emergence of a strong brand, the creation of a robust and scalable technology platform, and strategic partnerships with other important companies in the target market.
But even if you achieve all of these, there are other things that will impact how patient the management team and investor group will be. Does the company have a strong supportive and constructive board? If it does, it's often easier to be patient. Does the management team have the desire to slog it out for close to ten years? That's not common and getting less so.
I attended two ten year anniversary parties in the past six months. Both were for companies that I was a lead investor in from Flatiron Partners. It's something special to see a company last that long as an independent entity. Both of these companies are thriving and I suspect the next ten years will be even better for them than the first ten years.
We have a company in the Flatiron portfolio that is looking at a financial transaction in which stock would be sold at 15x the price we paid in 1999. That's a 40% annual rate of return, which is good, but not fantastic by VC standards. But 15x is a great number on a deal no matter how long (within reason) it takes to get there. I'd happily wait 10 years to get 15x.
It's hard to be patient. You can't pay a mortgage or the kid's college tuition with your private company stock. It's even harder on the founders and management. At least VCs have a portfolio which makes it easier to be patient. But I have found that patience is often rewarded handsomely in the venture business. This is and always will be an asset class that requires a long term horizon. The quick flips we get in markets like the one we are in don't change that fact at all.
Comments (13) | Posted February 21, 2007 in Venture Capital and Technology
Comments
I like to see companies that build a real business model... Not some widget that they hope to flip. If a founder starts off with a "quick flip" as their goal, that's a pretty low goal... I think everyone should set their sights high, and adjust as needed.
Posted by: Robert Dewey | Feb 21, 2007 9:49:39 AM
Thanks, I needed that message. I think it's a good lesson. Patience and not over reacting.
Posted by: Ada Stein | Feb 21, 2007 10:29:37 AM
I do think that it is important for any investor to view time passage as an important negative factor in determining the potential or success of an investment. The longer it takes to achieve your return, the less valuable the investment is (5x in one year always beats 5x in 10 years).
That doesn't mean that time should be the ONLY factor (and this is the point I think you are making).... Time and patience are often necessary for a business to achieve its goals and grow into the types of returns that VC investors are after.
Posted by: Andy Swan | Feb 21, 2007 10:39:31 AM
my bank manager keeps telling me he's being VERY patient .... ;-)
Posted by: carl rahn griffith | Feb 21, 2007 11:31:52 AM
this is all very nice. and hopefully you are the exception to the rule. but having been on the other side of the fence i can only say, "trust but verify."
Posted by: ming666 | Feb 21, 2007 12:27:49 PM
Fred,
This is your best post in a long time. I really appreciate these types of posts and hope you do more like it.
Chilisoft was a 12x return for investors over 2 and a half years. I'm proud of that, but it could have been a great company, and was good but not great. I'll blame me for that one.
40% is pretty sweet--rule of 72 tells us your money will double by the remainder of 72/40, or every 1.8 years. We're currently growing at 10% a month (hope that continues) so we should double revenue, customers, and valuation every 7 months if we continue to take it slow and steady. Not bad. But I do have the inclination to hit this thing with a hammer, really break out.
Brand strength is a reflection of commitment and loyalty to customers. We have very loyal customers in most cases, because we are taking it a bit more slowly and not pushing beyond our means to serve them. It's so damn easy to get distracted in this industry, chasing deals that don't matter, chasing tech that doesn't matter chasing hype.
When we focus on our customers and their needs and attitudes, we do very well. Our DEMO success for launching the SalesWorks beta was great, but it feels like we took our eye off the ball with it. Hype feels great, but it doesn't serve customers.
So back to steady.
Posted by: Charlie Crystle | Feb 21, 2007 12:54:53 PM
People have a hard enough time being patient in traffic. Unfortunately, today, we live in an "instant gratification" society. Sure, we VC's understand patience with our investments - because we have seen how well some of them have done over the years. However, we will always have some impatient investors to deal with because they are simply not on the same page.
Posted by: TheBillfold | Feb 21, 2007 12:55:38 PM
Excellent post Fred!
Reminds me of the old saying "Rome wasn't built in a day", of course it wasn't built by lollygaggers either, and being able to identify the many factors involved is essential in any form of venture or angel investment. I liked this one a lot.
Posted by: Stephen L. McKay | Feb 21, 2007 1:34:20 PM
I liked this post a lot too. I think it's quite soothing. Maybe you'll become a minister later in life? Unitarians accept Catholics and Jews so your whole family could come to your services. They also accept Muslims, so my family would be included too. Your future: Unitarian minister. Except I also think you should be a Wharton professor. I like how you take quant concepts and tell great narratives to bring them to life.
Posted by: Karen E | Feb 21, 2007 3:13:28 PM
I really like this post, and it's nice to hear of institutional investors that value perseverance.
I remember a while back reading about a start-up that folded and put itself up for sale due to what one founder called "concept fatigue." It really pissed me off, on a couple of levels. I don't know how, in good conscience, an entrepreneur can raise seed money, most likely from friends and family, and then get concept fatigue. You either believe in the idea or you don't. Concept fatigue is bullshit.
The real stress test for an entrepreneur's commitment is the existence of other opportunities. Out here in SF, I'm seeing a number of talented enterpreneurs that are start-up hopping, due primarily to the number of really cool opportunities. All I can say is that as entrepreneurs, we need to choose our start-ups wisely - the quick flips are the exception, and as Fred says, you need to be prepared to grind it out.
Posted by: lawrence | Feb 21, 2007 6:19:37 PM
Hello, I'm writing book about VC for startup companies. And I would like to know your opinion.
Title:
Venture Capital! Best way to fine mega-investor!
Plot:
1. Problem: where to get money to start?
2. Venture Capital - that is the answer.
3. Venture Business - investor point of view.
4. Venture Market conditions
5. How to calculate necessary summ?
6. Where to find Venture Company and how to choose right.
7. Secrets of writing success business-plan.
8. How to spend money correctly.
9. Resume.
What do you think of the plot?
Are there uncovered questions or themes?
A will appreciate your help.
You can answer to
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art.pugachev at gmail.com
Or contact me via ICQ: 331-121-217
Thank you very much.
Posted by: art | Feb 21, 2007 7:37:36 PM
On further consideration I think that as part of the Venture Capitalist licensing process (what? there is no professional license?) should be a mandatory Hubris Anonymous clinic. In fact it could be required course work at HarvardStandfordWhartonMIT B schools. It would cover that insidious and chronic syndrome that afflicts many VCs who believe they know all and have seen all - this is especially virulent in newly minted mba(s) and venture partners.
apologies for the sarcasm its based on experience - both good and bad.
Fred - i certainly take you at your word. but i think what you are saying is truly the exception and not the rule. The VC/Entrepreneur relationship is rarely an equal power relationship. Because people are involved (specifically smart people with opinions) it can devolve into dysfunction. Agendas on both sides tend to intrude. But the system is like the Churchill quote on democracy - its not pretty but its better than the others that have been tried.
I have no answer other than advice - the VC/Entrepreneur relationship is like a marriage. for better or for worse, in sickness and in health. anybody who is taking money had better take the same care that they would/should give to the marriage contract. chosen unwisely, they can both cause misery, hardship & loss.
Posted by: ming666 | Feb 22, 2007 8:00:29 AM
Great post.
I think it is also good to look at the patience required by an entrepreneur. Sometimes the process of trying to raise money and adoption can take years, but once one hits the process can speed up dramatically.
How many entrepreneurs tell stories of how they came up with an idea x years ago, only to now persue it?
I think patience is an important trait on both ends of the investment, and your post clearly shows the importance from the VC side of things.
Posted by: Eric | Feb 22, 2007 12:58:09 PM
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