Krassen Dimitrov
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3 weeks ago
in A Secondary Market For Private Company Stock on A VC
I see nothing attractive in a world that rewards elaborate scammers. Markets that are based on trust and integrity are much more efficient and they require strict regulation and severe penalties for abusers.
1 reply
3 weeks ago
in A Secondary Market For Private Company Stock on A VC
Fred,
most companies have ROFRs with their founders. If the company has a problem with a corporate acquirer of stock, all they have to do is match the offer.
I like your idea of a liquid market, it can be great for founders like myself who are well removed from employment in the company. I am just perplexed how employees can sell unregistered stock. The company has no obligation of disclosing material events; the employee, though, most likely has insider knowledge of how things are going in the company. It seems like an extremely asymmetrical information balance between buyer and seller.
I appreciate the notion of qualified investors, but still, securities laws apply. The seller has to disclose material information on one hand, but he/she is likely under confidentiality agreement with the company on the other. Perhaps the buyer waives their rights under applicable laws, I guess...
most companies have ROFRs with their founders. If the company has a problem with a corporate acquirer of stock, all they have to do is match the offer.
I like your idea of a liquid market, it can be great for founders like myself who are well removed from employment in the company. I am just perplexed how employees can sell unregistered stock. The company has no obligation of disclosing material events; the employee, though, most likely has insider knowledge of how things are going in the company. It seems like an extremely asymmetrical information balance between buyer and seller.
I appreciate the notion of qualified investors, but still, securities laws apply. The seller has to disclose material information on one hand, but he/she is likely under confidentiality agreement with the company on the other. Perhaps the buyer waives their rights under applicable laws, I guess...
1 reply
fredwilson
It's not a great outcome for the company to be using their cash,
particularly if they don't have a lot, to buy back founders stock just
because it's being bought by a corporate purchaser who is or may be
unfriendly. Craigslist certainly didn't have $25mm to buy the founders
shares that went to eBay.
I think what we may need to do is change our stockholder agreements to put
restrictions in on selling to corporate purchasers
particularly if they don't have a lot, to buy back founders stock just
because it's being bought by a corporate purchaser who is or may be
unfriendly. Craigslist certainly didn't have $25mm to buy the founders
shares that went to eBay.
I think what we may need to do is change our stockholder agreements to put
restrictions in on selling to corporate purchasers
3 weeks ago
in Venture Fund Economics: When One Deal Returns The Fund on A VC
This is why like this site, you get such stimulating cross-perspectives from other industries. Very interesting comment!
My perspective is that of an avid NBA fan. There a lot of similarities between drafting players and betting on startups.
For example, tt must be hard for some of these GMs to see a 17-year-old kid who has no idea how to play the game and say "you know, his length-agility-athleticism is tremendous, let's draft him and give him guaranteed money that is ten times more than what his entire family would make in their lifetime and hope that he would learn and develop into an All-Star player." Sometimes it works, sometimes it doesn't. I guess that's the equivalent of your home-run.
Then you have the conservative types: "This guy is 24, has had four years in college and led his team to a conference title. He's a bit too slow and a bit too short for the pro game, but you know what you are getting". you rarely ever get a home-run out these situations, but the stink-bombs are fewer.
Then you have this famous expression that says "You can't teach 7ft". Most NCAA 7-footers get drafted under the assumption that even if they don't develop at all they would still be useful for their size alone. Some of the biggest mistakes in NBA draft history have come from this logic: Sam Bowie was drafted before Michael Jordan. Michael olowakandi was drafted #1 in 1998. Frederick Weiss did not play a single game in the league.
What would be the equivalent of that mindset in the venture world? The fire-proof CEO myth? "This guy has made us money before; even if the technology fails, he'll figure out a way to save the company"? I don't know...
Then you have all these fads and copy-cats. Once Nowitzki proved that he can be a star in the NBA, for a few years a whole bunch of Euros were drafted very high and labelled the "next Nowitzki". Then you had a string of Chinese players all labeled as the "next Yao Ming"... It seems that this approach is very common among VCs.
Then you have the "specialists". This guy will not be an All-Star but he is a good shooter and he will help us. This company has a nice niche technology and will be the perfect acquisition target for Big Company X.
Then you have the "psychoanalysis" or "chemistry" experts. I don't know a lick of basketball and cannot tell a pick-and-roll from a post-up, but this kid has a "great character, no ego, great work ethics, great teammate" etc. The Orlando Magic GM from a couple of years ago was like that, he came from hockey. Complete disaster. Tons of VCs are like that.
What I find very interesting is that in the NBA world there is a clear shift towards quantitative analysis and other sophisticated analytical techniques. A good example is Daryl Morrey , the Rockets GM, a true whiz-kid from MIT. His drafts the last few years have been absolutely spectacular! Many VCs (not all obviously) are much less sophisticated. Many invest in technologies that contradict the laws of physics, are completely blind to market trends, and keep reciting superficial cliches like "we invest in teams with strong leadership" or "technologies that address unmet needs" as if these mean anything... It's amazing how much capital is controlled in such spurious manner...
My perspective is that of an avid NBA fan. There a lot of similarities between drafting players and betting on startups.
For example, tt must be hard for some of these GMs to see a 17-year-old kid who has no idea how to play the game and say "you know, his length-agility-athleticism is tremendous, let's draft him and give him guaranteed money that is ten times more than what his entire family would make in their lifetime and hope that he would learn and develop into an All-Star player." Sometimes it works, sometimes it doesn't. I guess that's the equivalent of your home-run.
Then you have the conservative types: "This guy is 24, has had four years in college and led his team to a conference title. He's a bit too slow and a bit too short for the pro game, but you know what you are getting". you rarely ever get a home-run out these situations, but the stink-bombs are fewer.
Then you have this famous expression that says "You can't teach 7ft". Most NCAA 7-footers get drafted under the assumption that even if they don't develop at all they would still be useful for their size alone. Some of the biggest mistakes in NBA draft history have come from this logic: Sam Bowie was drafted before Michael Jordan. Michael olowakandi was drafted #1 in 1998. Frederick Weiss did not play a single game in the league.
What would be the equivalent of that mindset in the venture world? The fire-proof CEO myth? "This guy has made us money before; even if the technology fails, he'll figure out a way to save the company"? I don't know...
Then you have all these fads and copy-cats. Once Nowitzki proved that he can be a star in the NBA, for a few years a whole bunch of Euros were drafted very high and labelled the "next Nowitzki". Then you had a string of Chinese players all labeled as the "next Yao Ming"... It seems that this approach is very common among VCs.
Then you have the "specialists". This guy will not be an All-Star but he is a good shooter and he will help us. This company has a nice niche technology and will be the perfect acquisition target for Big Company X.
Then you have the "psychoanalysis" or "chemistry" experts. I don't know a lick of basketball and cannot tell a pick-and-roll from a post-up, but this kid has a "great character, no ego, great work ethics, great teammate" etc. The Orlando Magic GM from a couple of years ago was like that, he came from hockey. Complete disaster. Tons of VCs are like that.
What I find very interesting is that in the NBA world there is a clear shift towards quantitative analysis and other sophisticated analytical techniques. A good example is Daryl Morrey , the Rockets GM, a true whiz-kid from MIT. His drafts the last few years have been absolutely spectacular! Many VCs (not all obviously) are much less sophisticated. Many invest in technologies that contradict the laws of physics, are completely blind to market trends, and keep reciting superficial cliches like "we invest in teams with strong leadership" or "technologies that address unmet needs" as if these mean anything... It's amazing how much capital is controlled in such spurious manner...
1 reply
fredwilson
Ahh. The sports analogy. that's a good one!
3 weeks ago
in Venture Fund Economics on A VC
Thanks, Fred
I have a couple of questions:
1. What happens to private shares at the end of a fund's life? I assume they get distributed, correct? How would this impact the carry? Are they at all counted in calculating the carry? Can you reallocate your distribution, where for example you take out your carry only as cash/public shares and stick the LPs with all the private shares? That would really suck for the LPs. This issue is probably very relevant in today's "scarce exits" environment.
2. How are the LP's protected from fund managers that optimize the risk profile of the fund towards their own interests. Here is a hypothetical example: you have a venture fund (let's call it hypothetically OVP) that is way underwater. They get a buyout offer for a portfolio company of $100M, which would still keep them underwater (no carry either way). The GP's interests are to hold out for a better deal, say $500M, even though it is very unlikely, which would put the fund in the black and allow them to collect some carry. The chances of the company being bought for $500M are super-small, but since there is no downside for the manager, their incentive is to hold out for this lottery shot. On the other hand the LPs would like to at least get some of their money back. What are their recourses?
Thanks again for this series!
I have a couple of questions:
1. What happens to private shares at the end of a fund's life? I assume they get distributed, correct? How would this impact the carry? Are they at all counted in calculating the carry? Can you reallocate your distribution, where for example you take out your carry only as cash/public shares and stick the LPs with all the private shares? That would really suck for the LPs. This issue is probably very relevant in today's "scarce exits" environment.
2. How are the LP's protected from fund managers that optimize the risk profile of the fund towards their own interests. Here is a hypothetical example: you have a venture fund (let's call it hypothetically OVP) that is way underwater. They get a buyout offer for a portfolio company of $100M, which would still keep them underwater (no carry either way). The GP's interests are to hold out for a better deal, say $500M, even though it is very unlikely, which would put the fund in the black and allow them to collect some carry. The chances of the company being bought for $500M are super-small, but since there is no downside for the manager, their incentive is to hold out for this lottery shot. On the other hand the LPs would like to at least get some of their money back. What are their recourses?
Thanks again for this series!
1 reply
fredwilson
The answer to the first question is ³it depends². There are secondary share
buyers who often will pay cash for the remaining illiquid shares in a
venture portfolio and I believe that is the best way to liquidate a fund.
But yes, LPs sometimes do get illiquid stock. It's not a good idea in my
mind though.
The answer to the second question is that will only work once. If you do
that, you'll never raise another fund from LPs. It's a small world and
reputations last a long time.
buyers who often will pay cash for the remaining illiquid shares in a
venture portfolio and I believe that is the best way to liquidate a fund.
But yes, LPs sometimes do get illiquid stock. It's not a good idea in my
mind though.
The answer to the second question is that will only work once. If you do
that, you'll never raise another fund from LPs. It's a small world and
reputations last a long time.
2 months ago
in Where To Go For Inspiration? on A VC
That's really not the point. The issue is lying and misrepresentation. A drop in asset values may be viewed sincerely as a "dip" rather than a "blowup", in which case the "awesome opportunity" pitch would have been sincere and the Feds would have no case.
A VC manager pitching to lps by making misrepresentations about portfolio companies in his/her previous fund, or future prospects, while at the same time knowing that to be false is as odious as these Bear guys...
A VC manager pitching to lps by making misrepresentations about portfolio companies in his/her previous fund, or future prospects, while at the same time knowing that to be false is as odious as these Bear guys...
1 reply
fredwilson
I am not saying it won't happen. I am just saying it's not as likely to
happen.
happen.
2 months ago
in Where To Go For Inspiration? on A VC
It's the other way around: when your track record sucks is when the need arises to lie about everything else ."We have hot new dealflow" "Things are looking great in the last fund, exits are around the corner", etc. etc.
1 reply
fredwilson
Right but there's one essential difference
VC's raise funds when there is noting in them
The bear guys were raising money when the assets in their fund were blowing up
VC's raise funds when there is noting in them
The bear guys were raising money when the assets in their fund were blowing up
2 months ago
in Where To Go For Inspiration? on A VC
Fred,
when do you think are we going to see some VC fund managers taken away in handcuffs, like the two Bear Stearns guys yesterday? It will be a highly educational visual on how not to lie when raising a fund...
when do you think are we going to see some VC fund managers taken away in handcuffs, like the two Bear Stearns guys yesterday? It will be a highly educational visual on how not to lie when raising a fund...
1 reply
fredwilson
I don't know about that
What would lie about when you raise a fund?
Your prior track record? Maybe, but that stuff is checked pretty well by lps
Fred
What would lie about when you raise a fund?
Your prior track record? Maybe, but that stuff is checked pretty well by lps
Fred
4 months ago
in We Need A New Path To Liquidity on A VC
I am an enterpreneur who has tried desperately to sell his private equity stock and let me tell you, it's not easy at all. What information do you disclose, so that you don't breach any securities laws? How do you value the shares? How do you get around the company's or existing investors' ROFR? How would the sale price compare to the exercise price on the options that the company is still doling out?
Speaking of this last one, question for Fred: in your companies how do you set the exercise price for stock options? Different people answer very differently to this question, despite there being published quite clear U.S. Private Equity Valuation Guidelines...
Speaking of this last one, question for Fred: in your companies how do you set the exercise price for stock options? Different people answer very differently to this question, despite there being published quite clear U.S. Private Equity Valuation Guidelines...
1 reply
fredwilson
we strongly suggest that our companies get a third party valuation at least once a year and ideally several times a year. it's expensive ($5k to $7.5k). but its worth it for a whole host of reasons.
5 months ago
in Hitting The Reset Button On Mortgages on A VC
This seems like a highly extreme scenario: the property was liquidated for 28% of the purchase price! I wonder how typical this is. In the current housing situation, if foreclosures can recover 75-80% that obviously would be a much better solution for the banks/lenders than a workout that includes a haircut of 25%, without getting the full proceeds, and being stuck with the same (unreliable) borrower for another 30 years, albeit federally insured... At what point a workout becomes the more favourable option? Say, if foresclosures run at 60% of pruchase price, and the workout is 80% of the loan, the banks may be enticed to keep the owner in the house, on the terms of fred's proposal...
I am mostly rambling here, sorry...
I am mostly rambling here, sorry...
1 reply
BW94941
Krassen.....My example may have seemed extreme to you, but it happened. To a friend of mine. "Value" is always a subjective amount, and this shows you what can happen when value is suddenly radically altered by often arbitrary outside forces.
The bottom line of any lending decision should be "Can the borrower make the payments outlined in the loan docs?" In an investment property you look at the operating income. In a person's home, you look at that person's job income. Beyond that, how much real money (cash or equivalents) do they have in reserve, in case they lose a big tenant or lose their job. Pretty simple, really.
The lenders got way too fancy (greedy) for their own good, and started creating products that jacked up their returns, but introduced an element of danger into the situation. Due in 5, 7 or 10 years? ("Bullet" loans, as they were called, 'cuz if you couldn't refi them when they came due you might as well put a bullet in your head). Hybrids, where the rate was only fixed for a few years, then started to ratchet up. Liar loans, where you could tell the bank you made $150,000 a year, when you really made $45,000. Just lots of bad lending. Result? What we really have in this country is a reset problem, more than a value problem.
And all these percentages people are tossing around? They really don't matter. It's all a paper loss until someone forces you to take a real loss. If the folks in Washington can figure out how to slow down, take a deep breath, and stop kicking over the first domino, we could get out of this mess with far less pain than we've seen so far, and I fear is coming.
One way to do it would be for this new Super FHA to say to a home borrower in trouble, "Show us your tax return. Tell us what you really make. We'll then tell you how much you should be spending on your mortgage payment. And just like the IRS, we're going to make it easy on you to make that payment. We're going to take it right out of your paycheck. Your employer can send it straight to us. Then we'll apply it on an interest only basis to your outstanding balance at the base, true interest rate on your loan (not some teaser rate), before any resets started to kick in. At that interest rate, we'll figure out what your max loan amount should have been. If you owe more than that amount, then the differential gets paid back down the road when you sell, to whatever extent possible. Kind of an "equity sharing" arrangement.
The lending bank has to take a haircut on its return. The Wall Street house that packaged the loan for resale has to take a trim too. And the investment fund that bought the deal has to take less also. Tranches be damned. Everybody got caught with their hand in the cookie jar and chocolate all over their mouth, so everybody goes to their room for a while. Theoretically the smartest guys on the planet - Ivy League MBAs and quants working 20 hours a day for the big names on the Street - can't seem to figure out how to value these pools to date, so why try? You win some, you lose some. At least you won't lose it all if the right people can think this through..
The guy in the house gets to stay there, and doesn't have to move out. He won't be making any profit on the deal for a long, long time, but at least he's not in the street telling his kids he's sorry. The banks don't have to screw around with foreclosing on thousands of houses and getting 30-40 cents on their loan dollar at some auction at a Holiday Inn. Everybody loses a little, but that means everybody also wins a little. No more Bear Stearns meltdowns. No more self-fulfilling death spirals into the ground. It's a big bump in the road, but we'll all get through this if we just keep our heads and apply some crisis management skills and ingenuity to this whole situation.
The bottom line of any lending decision should be "Can the borrower make the payments outlined in the loan docs?" In an investment property you look at the operating income. In a person's home, you look at that person's job income. Beyond that, how much real money (cash or equivalents) do they have in reserve, in case they lose a big tenant or lose their job. Pretty simple, really.
The lenders got way too fancy (greedy) for their own good, and started creating products that jacked up their returns, but introduced an element of danger into the situation. Due in 5, 7 or 10 years? ("Bullet" loans, as they were called, 'cuz if you couldn't refi them when they came due you might as well put a bullet in your head). Hybrids, where the rate was only fixed for a few years, then started to ratchet up. Liar loans, where you could tell the bank you made $150,000 a year, when you really made $45,000. Just lots of bad lending. Result? What we really have in this country is a reset problem, more than a value problem.
And all these percentages people are tossing around? They really don't matter. It's all a paper loss until someone forces you to take a real loss. If the folks in Washington can figure out how to slow down, take a deep breath, and stop kicking over the first domino, we could get out of this mess with far less pain than we've seen so far, and I fear is coming.
One way to do it would be for this new Super FHA to say to a home borrower in trouble, "Show us your tax return. Tell us what you really make. We'll then tell you how much you should be spending on your mortgage payment. And just like the IRS, we're going to make it easy on you to make that payment. We're going to take it right out of your paycheck. Your employer can send it straight to us. Then we'll apply it on an interest only basis to your outstanding balance at the base, true interest rate on your loan (not some teaser rate), before any resets started to kick in. At that interest rate, we'll figure out what your max loan amount should have been. If you owe more than that amount, then the differential gets paid back down the road when you sell, to whatever extent possible. Kind of an "equity sharing" arrangement.
The lending bank has to take a haircut on its return. The Wall Street house that packaged the loan for resale has to take a trim too. And the investment fund that bought the deal has to take less also. Tranches be damned. Everybody got caught with their hand in the cookie jar and chocolate all over their mouth, so everybody goes to their room for a while. Theoretically the smartest guys on the planet - Ivy League MBAs and quants working 20 hours a day for the big names on the Street - can't seem to figure out how to value these pools to date, so why try? You win some, you lose some. At least you won't lose it all if the right people can think this through..
The guy in the house gets to stay there, and doesn't have to move out. He won't be making any profit on the deal for a long, long time, but at least he's not in the street telling his kids he's sorry. The banks don't have to screw around with foreclosing on thousands of houses and getting 30-40 cents on their loan dollar at some auction at a Holiday Inn. Everybody loses a little, but that means everybody also wins a little. No more Bear Stearns meltdowns. No more self-fulfilling death spirals into the ground. It's a big bump in the road, but we'll all get through this if we just keep our heads and apply some crisis management skills and ingenuity to this whole situation.
5 months ago
in Hitting The Reset Button On Mortgages on A VC
The "off with their heads" solution does seem a bit on the radical side, however, confiscating their bonuses should be considered. Obviously, the system is broken if they can take-in $74M and then proceed destroy 99% of shareholedr value... As another example, take a look at WaMu's bonus being shielded against losses:
http://www.bloomberg.com/apps/news?pid=20601087...
Obviously, the system is broken. Jack Bogle has been writing about this for a long time, see his brilliant book "Battle for the Soul of Capitalism". It is clear that in its current form the system is gamed by the management class at the expense of shareholders. This is neither a "citizen's society", nor an "owners society", this is a "management' society". I hope Obama will address this problem decidedly, or otherwise jackson's scenario may not seem so far-fetched at some point in the near future.
http://www.bloomberg.com/apps/news?pid=20601087...
Obviously, the system is broken. Jack Bogle has been writing about this for a long time, see his brilliant book "Battle for the Soul of Capitalism". It is clear that in its current form the system is gamed by the management class at the expense of shareholders. This is neither a "citizen's society", nor an "owners society", this is a "management' society". I hope Obama will address this problem decidedly, or otherwise jackson's scenario may not seem so far-fetched at some point in the near future.
1 reply
fredwilson
I love Jackson. I always have and always will. But extreme is an appropriate
word for his ideas. Thank god he takes the time to share them with us.
The problem is the boards. We board members (I am on something like eight of
them) must represent the shareholders and we must not let management get
sweetheart deals. It's not the government's fault, it's the boards and the
shareholders who elect them.
Fred
word for his ideas. Thank god he takes the time to share them with us.
The problem is the boards. We board members (I am on something like eight of
them) must represent the shareholders and we must not let management get
sweetheart deals. It's not the government's fault, it's the boards and the
shareholders who elect them.
Fred
5 months ago
in Uncertainty on A VC
"Skype, YouTube, Facebook created a lot of value for their founders and investors."
True... From your vantage point this may be irrelevant, but it is far from clear what these three did for EBAY, GOOG and MSFT respectively. In fact we know Skype cost E-Bay shareholders more than $1B in equity write-offs, as almost everyone predicted back in 2005. Now there is a rumor that Meg Whitman is groomed as a Treasury Sec in a future McCain Administration, which brought down my resepct for the guy by at least two orders of magnitude. Is this the type of fidicuary responsibility and fiscal prudence that the U.S. Treasury needs?
With respect to the other two, it still unclear what type of copyright liability YT carries, and it is obvious to everyone that MSFT's valuation of FB was in the realm of "ridiculous".
Next we have to see what kind of "value" will be created in the biofuels sector...
True... From your vantage point this may be irrelevant, but it is far from clear what these three did for EBAY, GOOG and MSFT respectively. In fact we know Skype cost E-Bay shareholders more than $1B in equity write-offs, as almost everyone predicted back in 2005. Now there is a rumor that Meg Whitman is groomed as a Treasury Sec in a future McCain Administration, which brought down my resepct for the guy by at least two orders of magnitude. Is this the type of fidicuary responsibility and fiscal prudence that the U.S. Treasury needs?
With respect to the other two, it still unclear what type of copyright liability YT carries, and it is obvious to everyone that MSFT's valuation of FB was in the realm of "ridiculous".
Next we have to see what kind of "value" will be created in the biofuels sector...
1 reply
fredwilson
Skype was worth a lot, just not to eBay. It was the wrong buyer. Imagine
what Vodaphone could have done with it if they wanted to really shake things
up.
I think YouTube will turn out to be another brilliant move by Google. They
have the balance sheet to fight the IP issues and win. And YouTube is
currently serving about half of all the web video right now. I bet that
number grows.
Facebook isn't worth $15bn, but it's certainly worth $5bn, maybe $7bn.
That's more than Skype and YouTube combined.
Fred
what Vodaphone could have done with it if they wanted to really shake things
up.
I think YouTube will turn out to be another brilliant move by Google. They
have the balance sheet to fight the IP issues and win. And YouTube is
currently serving about half of all the web video right now. I bet that
number grows.
Facebook isn't worth $15bn, but it's certainly worth $5bn, maybe $7bn.
That's more than Skype and YouTube combined.
Fred
I don't see any reason for government to add friction to the tools of society and the economy.