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VCs give their thoughts on the market, and how it affects their long-term investing thesis
One of the most valuable things about going to Vator's Splash events are the number of amazing venture capitalists we are able to gather on stage in order to pick their brains about the market, and how investing is evolving.
For over a year now we have been running our Meet the VC series, in which we profile early-stage investors and ask them their thoughts on, among other things, where they see the investing market going. That includes whether or not we are in a bubble, and how that affects their long-term investing strategy.
Here are the answers from some of the investors we will have on stage with us on May 12.
- "Given all the money moving into the private sector, I believe there's more money going into late-stage deals in 2015 than there was during the heyday, back in 2000, do you think we're in a bubble?"
Matt Oguz, Founding Partner at Venture/Science: "It's not a bubble. The way it looks, it resembles more of a wave function. The wave starts building, and, at some point, it crashes. A wave behaves a certain way. In the beginning the wave starts early on, the wavelength is not that high, that's the earlier stages, that's the seed stages. More and more, the wave starts getting bigger and bigger, it's really a function of how much capital you have overall available versus how capital started much going to that particular deal. It’s a function of how much overall capital is available in the asset class vs. how much capital is deployed on a per deal basis. The wave breaks when you run out of capital."
Paul Martino, Managing Partner of Bullpen Capital: "We are in a late stage private equity bubble. In the public markets, companies get priced lower than last round. This late stage private market is going to end badly when companies go public at lower prices. Something like seven of last 11 IPOs priced lower than their last round."
Jim Andelman, co-founder and Managing Partner of Rincon Venture Partners: "There's certainly some irrational behavior on a case-by-case basis, with some companies getting valuations that are higher than they deserve. Some companies receive massive amounts of capital to deploy, and that that can be problematic. For the investors providing that capital, sometimes it works and sometimes it doesn't. But it also creates externalities: one competitor raises a ton of money, and that presents a conundrum for other companies in that space. How do they respond to that? In days gone by it was easier to ignore competition, and to focus on your product and your team, your business. Increasingly it feels like B2B markets are seeing increased concentration of enterprise value ('winner take all' or 'winners take most'), as has historically been the norm in consumer. Take Slack, which is an example of a SaaS business with strong network effects, where perhaps the value of the business increases geometrically as the user base increases linearly. It has raised so much money, it sucks all the air out of the room for its competitors.
It's absolutely true that some companies are getting over-funded. In the first eight months of this calendar year, the late-stage market was definitely overheated. Practically anything that had potential to be a rocketship got richly funded. Now the pendulum in my opinion has swung too far the other way. Whereas earlier this year the dominant fear was the fear of missing out, now the dominant fear is fear of loss. This means that many solid expansion- and growth-stage companies are actually having a hard time raising. The most common state of the market for VC investments is 'over-reaction.'"
Wes Selke, co-founder and Managing Director of Better Ventures: "It certainly feels like the bubble has deflated. It started to happen in Q4, or even late Q3 and I think the writing is on the wall now. It's happening in the public markets, it's happening with Fidelity putting out their report on the markdowns in their portfolio of unicorn companies that they're invested in. We've got a company right now that's looking to raise a Series B and I've just heard anecdotally from them that all the VCs that they're talking to are just talking doom and gloom. So it certainly feels, anecdotally, that there's a slowdown happening.
Personally, I'm happy about it, so long as it doesn't screech to a halt, of course. I think everybody would love to see a soft landing of all this, and not a huge bursting of the bubble, and I guess that remains to be seen. But a healthy correction could really benefit us all. It's just been lots of capital sloshing around in the later stage deals, and there's been very lofty expectations among early stage founders as a result, which then, frankly, makes our job harder to do. There's been this sense, at least there was in 2015, among entrepreneurs, that you kind of roll out of bed in the morning, write down a business plan on the back of a napkin, and it's worth $5 million bucks. They say, "Well, my buddy just went through YC and they raised at $8 million so I think I should get that valuation." So there's been a lot of that loftiness, and frothiness, going on, and I think, obviously, for our business, we would love to see that come back down to earth a bit.
Of course, if VC funding is really drying up, that could be really challenging. It's already hard enough to raise an A round and now if these A investors really start applying the brakes that could be tricky. I haven't seen that happen yet. Talk to me in six months, or maybe in three months, it could be a different story. I would say, so far, it feels like a healthy correction and not necessarily a popping of the bubble."
Paul Willard, co-founder and General Partner at Subtraction Capital: "There was over supply for a while but we are seeing it correct now. That has been catalyzed by public market valuations of comparables falling as well as a lack of liquidity in late stage secondary. A macro drop may accentuate the correction more."
Zach Ware, Managing Partner at VTF Capital: "I actually disagree. I think huge sums of money are going into a select few companies while a lot of others face a cash crunch. I think that we're in a period of rationalization whereby investors are becoming more aware of the challenges of scaling a loss-centric company. Investors are looking at companies with little to no revenue and little to no plans to unlock it and questioning whether those companies can continue to scale or if putting more money in now simply kicks the can down the street."
Shruti Gandhi, Managing Partner at Array Ventures: "I think, bubble or not, everyone's very cautious this year. Not many firms have made investments in Q1 2016, a lot of firms are going out and raising more capital for the rainy day, so many of the firms are out fundraising."
Alex Rosen, Managing Director at IDG Ventures: "My perspective goes back to the mid-nineties. It’s safe to say there was a bubble in late-stage private company valuations through late last year. All you have to do is look at any of the graphs from PitchBook showing the average valuation or dollars per round for Series C and later and you’ll see a huge run-up in valuation.
We don’t live in that world very much. We like to invest in businesses that don’t require a lot of capital because that creates more options for founders as well as investors. For early-stage investing, I’m not seeing valuation change very much yet.
If you look at Q1 data, it will actually show that Series E valuations have not gone down but there are fewer of them. So the quality of deals getting done are higher because OK ideas (vs great ideas with traction) are having a harder time getting funding right now."
- "If we're in a bubble, how does that affect your investing?"
Matt Oguz: "I guess it's kind of like tennis. You're either playing on the baseline or you're on the net. Those billion dollar funds are right up on the net. We're sort of back on the baseline. We just want to make sure we don't get caught in no-man’s land."
Paul Martino: "That round is far enough away, since we focus on A round, that later stage bubble is largely outside my world view. We get them where they need to get to, but that’s not my world. You should go ask guys from Andreesen Horowitz or Seqouia who invest in those later rounds."
Jim Andelman: "It's kind of distant from what we do. We're investing so early, we win if a company grows from a toddler to healthy self-sustaining young adult. We hope they become $100 million+ revenue businesses, but more often than not they exit before that scale is attained. We do work with founders to help them see the benefits of staying independent longer.
We need to believe a company can be a $100 million plus independent company. We absolutely think about that, but we don't think about how T Rowe Price or Fidelity is going to be looking at it and whether it will be prematurely anointed as a “unicorn.” We are focused on helping companies build a scalable, repeatable growth engine. Helping them get from $30k in MRR to $200k in MRR before the next round. And then on toward that $100mm+ revenue scale."
Wes Selke: "It has. We're now looking at 18 to 24 months, rather than 12 to 18 months, in terms of how much capital our seed companies need to raise for how long they need to survive, or how long they should plan on it taking to raise a Series A. We're about to close a new seed deal right now that, initially, had targeted $800,000 to raise, and now we're bumping that up to $1.4 million. I feel good about them raising a bit more capital, and buying more time to build out the metrics, to get to that A round.
I think the good companies will still get funded, there's just going to be a slow down in more speculative investing. Obviously it's still going to be really hard to know at Series A, but maybe the me-too businesses, and the more speculative investing, will slow down but the fundamentally good, sound businesses with sound unit economics and growth trajectories, and LTB to CAC ratio, will still get funded.
We've had a number of companies in the past raise sub-$1 million seed rounds on a convertible note, then raise $1 million price-seed round, kind of as the primer round to get them to Series A. That seems to be fairly standard these days, but, if you can, go ahead and strike while the iron's hot, because the bar is a lot lower at seed than it is at Series A, and there's a lot of believing in the team and the market opportunity and buying into that vision. It's almost the audacity of zero, where it's like, "This could be really big," versus when they actually have revenue, and have something to poke at, the bar goes up. So try to maximize your capital that you're raising at the seed round, up to a certain point. Depending on the team, once you're hitting $1.5 million there can be diminishing returns beyond that, since if you raise the money, and have the money, you're probably going to spend the money. So there's a risk of getting sloppy if you raise too much."
Paul Willard: "I mentioned earlier that relatively high valuations in late stage are correcting. I also mentioned that I have been seeing Seed valuations backing down. Also, at the stage that we are investing, our investment cycle is longer than a valuation cycle like this. Both Jason and I have worked through two of these cycles, so we are pretty disciplined about investing in real value creation that is less sensitive to shorter term market volatility."
Zach Ware: "I don't think we're in a bubble. But recent market behaviors influences our investing by pushing us to question whether we believe a seed company will be able to raise a Series A down the road. We consider future potential investors more heavily than before."
Shruti Gandhi: "Enterprise companies, at their early stages, don't have such crazy numbers and valuations. I will still be investing in 10 companies this year."
Alex Rosen: "We’ve always had an explicit part of our investment thesis that we’re not going to rely on friendly capital markets to pump in hundreds of millions of dollars in our companies. We look at those businesses that can get to profitability on modest amounts of capital. So it’s not affecting what we invest in or how frequently we’re investing."
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