Month: April 2009
Furqan Nazeeri put up a post titled 2009 Startup Executive Compensation Survey Opens. It in he points to a compensation study produced by J. Robert Scott, Ernst & Young, and WilmerHale in collaboration with Dr. Noam Wasserman, Professor at the Harvard Business School. CompStudy covers more than 25,000 executives at 5,000 companies and is the largest study of its kind.
I (Jason) get asked often how I got into venture capital and how interested folks may get involved as well.
I always tell them that I "fell" into the job, as most folks that I know who are VCs and that everyone has a different and unique story.
I then point them to my partner Seth’s blog post on the subject which I think is the best written authority on the subject.
Today, however, I received a paper that one of my students, Judd Rogers, wrote on the subject. He takes Seth’s thoughts and puts a little bit of analytical muscle behind the subject. It’s an interesting read for those wanting to know potential career paths toward VC.
Q: Can you please address the issue of estimating Addressable Market when the product or service is trying to solve an emerging problem and opportunity that is about to hit in the near future. For example, FeedBurner raised money long before bloggers were convinced that feed management could use some professional help and long before VCs saw that an advertising and paid model would emerge at some point. In other words, Dick Costello was not taking out an incumbent or providing a better solution than the market offered for a given problem. He raised capital on the belief that a market was about to emerge and FeedBurner wanted to be the first to address it. In this scenario how does one estimate addressable market (other than assumptions and forecasts) or in such cases can you be light on addressable market numbers.
A: (Brad) There are two schools of thought on this one: (1) measuring addressable market (or "TAM" – "total addressable market") matters or (2) measuring TAM doesn’t matter at all.
I’m in the "measuring TAM doesn’t matter at all" camp, especially in an early stage company in an emerging market. Almost every presentation I’ve seen has a market size section. Almost every market sizing presentation is incorrect – by a lot. Enough to make it irrelevant.
Most of the companies I invest in are in markets that are early in their life. I can assure you that if you are in year two of an emerging market, there is a slide somewhere at Gartner or Forrester projecting a $1.5 billion market in year 7 that compounds 75% year over year after that indefinitely (or at least until the X-axis runs out of room). Whatever.
Now, there’s definitely value in trying to articulate how the market you are playing in will develop. I’m usually more interested in understanding “proxy markets” (are there markets out there that are good proxies for what you are going after?) and “market drivers” (what has to happen for the market to grow big, and quickly?) While you can wrestle this information into a spreadsheet or a bottoms up powerpoint slide with a pretty triangle in it somewhere, anytime I see any number with two decimal points of precision, you’ll probably lose credibility with me.
Remember, at the beginning I mentioned that there are two schools of thought and I land firmly in one of them. There are plenty of VCs in the other (e.g. measuring TAM matters). This just reinforces a point we’ve made many times on this blog – make sure you know who your audience is and what they care about.
Question: You often hear to leave out the possible exit scenario when you pitch. Brad states that its because its usually wrong. I suspect most VC’s discuss likely exits with their partners before making an investment, what percent of the time do you guys generally "guess" the exit on the front side of the investment?
A: (Brad): I’m going to answer this from an early stage VC perspective. I’ve never been a later stage VC nor have I been a buyout guy, so I won’t try to answer for people doing those types of investments.
Back in prehistoric times when there was a tech IPO market, early stage VC’s used to want entrepreneurs to answer the question "Is your companies destined to exit via M&A or an IPO." I’ve always thought this was a stupid question, as the answer is "I’ll take either one!" As homo sapiens evolved, the argument about M&A or IPO raged on fiercely. Pre-Internet bubble, many VC firms (including mine) would often do extensive exit analyses upon each investment round, building complex models stacked on top of detailed assumptions about the future performance of the company, the future multiples in the market, and a range of execution of the company from "flawless" to "pretty good." These analyses usually had an IRR result and a cash on cash return result for each potential outcome.
Almost all of these analyses are total baloney. I suppose they give some people comfort that they basing their investment decision on sound economic analysis, but since there are so many variables that are outside anyone’s control, they tend to be meaningless. In addition, almost all of these analyses (at least the ones I’ve been exposed to, including many from other VC firms), have incredible bias in their assumptions which help support either (a) an affirmative decision to make the investment or (b) a justification for a particular valuation range.
In 2001, the IPO vs. M&A debate cooled for a while when the IPO market vaporized. It emerged again briefly in 2004 and 2005 with a new wave of IPOs, but almost anyone that had an exit in the 2004 – 2007 time frame preferred cash from an M&A transaction to IPO stock (with a few notable exceptions, such as Google.)
VCs fantasize about the day a vibrant small and mid-cap tech IPO market will once again exist. Let’s hope this fantasy becomes a reality. In the mean time, I expect more and more people – especially if they’ve read Nicholas Taleb’s Fooled By Randomness and The Black Swan – will realize that making early stage VC investment decisions based on complex forecasting exercises is – well – foolish.