While skimming through my twitter stream I came a across a quote from the BizTech conference this morning attributed to Naval Ravikant which said “VCs doing seed deals are price insensitive”. This seems to be a common refrain these days in startup land. I think Ron Conway put it most succinctly in a recent letter in which he said
“These startups are binary …they succeed or fail so why waste time on deal structures, terms, vc’s, and valuations etc and just help entrepenuers build their companies.”
Those who subscribe to this theory argue that a company is either going to be the next Google or it isn’t. If it is, it won’t matter what price you paid for it because you and the entrepreneurs will all have a massive financial windfall. And if its not Google then, again, price really doesn’t matter because it was a failure of an investment regardless of what price you paid for it.
Its certainly true that the companies who generate the lions share of returns in our business are at the scale of Google. But does that mean that all companies that aren’t the next Google are failures as investments? Or that even if you had invested in Google that it really wouldn’t have mattered at what price you’d invested because that single investment, regardless of price, would be such a winner that it would return your fund many times over?
I would argue that its not quite that simple.
Let’s take Google as an example. Its well established in Silicon Valley lore that Andy Bechtolstein and Ram Shriram were some of the very earliest angel investors in Google. Its also well established that Kleiner Perkins and Sequoia, who lead the first institutional round for Google generated massive returns for their funds based, in large part, on their Google investment. But there is a scenario in which you could have invested in Google and not made the same massive returns for your fund. I’ll now quote from an old Silicon Beat article from 2005:
Conway’s investors will have gotten back slightly more than half of the money they invested in that fund — even though Conway invested a small amount from it in Google too (the amount, in this case, was too small to compensate for the other losses in the Angel II $150 million fund, and also Angel II made the investment in Google later than the one made by Angel I, meaning it bought at a higher price).
Similarly, I had a conversation with a good friend this week who was an early investor in what is now a very large public company. To the outside world this looks like an absolute slam dunk of an investment, but because they took the attitude that price didn’t matter, it only ended up returning 2x their invested capital. Hardly a slam dunk. In both of the above cases, too little money was put to work at too high a price to have a material impact on either of these funds.
I don’t bring these up as indictments against any individual, fund or strategy. I do bring it up because I think the talk of binary outcomes and price insensitivity needs a little perspective thrown on top of it before its accepted as truth.
The reality is most companies aren’t the next Google. In fact, FLAG Capital reports that the average median exit valuation in 2010 is around $70M, with the larger transactions this year being the acquisitions of both AdMob ($750M) and ITA Software ($700M) by Google. Hard to be the next Google when you’re being bought by the current one. Does it matter to the funds who backed these companies at which price they invested? You bet. In many cases its the difference between 1000x, 100x and 10x which is also the difference of returning 10% of your fund, returning capital or returning many multiples on capital.
So when does price actually not matter? I’d suggest there are two scenarios in which price doesn’t matter or, at least, doesn’t matter as much.
First would be when a fund is paying a very high price but has the ability to put large dollars to work. A recent example of this would be the spinout of Skype from Ebay. There were a number of private equity investors in that transaction, but one that stood out was the venture capital fund run by Marc Andreesen and Ben Horowitz. Its reported that they put $50M from their $300M fund into Skype at a $2.75B valuation. Expensive? Yes. But, because they were able to put large dollars to work Skype doesn’t need to return 10x for them to return their entire fund.
The second scenario I see in which price doesn’t matter is when its a branding exercise for the firm. This is best summed up by a comment made to me by a very successful friend in the venture business. He asked “does anyone know how much of Oracle, Apple or Cisco Sequoia owned? No. They just know those logos are on their website”. For firms looking to establish themselves, getting into a few high profile companies can be a real boon. Depending on the price they paid or the dollars they were able to put to work these may not drive returns for the funds, but they can put them on the map in the minds of entrepreneurs.
So, does price matter? As with most questions related to the venture business I think the answer is a hearty- it depends. It depends on when you invest, how much money you are able to put to work and whether the investment is more about attaching your firm to a high profile company than driving overall returns.