VCs and Mega Late Stage Investments, or how to corner a market



The crossover fund has finally arrived.  Liz Gannes has done a great roundup of the latest trend, with Zynga, Facebook and Groupon taking money from the likes of KPCB, Battery, Greylock or Andreessen Horowitz.  There are few too many smart guys doing this to dismiss it as hype, so let’s think about what’s really going on.  [I was engaged in a great conversation about this on namesake and am recycling some of the content]

 

VC’s are offering Access

VC’s have paymasters too: LP’s. LP's can struggle to get into the best VC funds, even today, and now the best VC funds are offering them access into the winners of tomorrow.   Which LP is going to give you trouble for getting into facebook, really ?  How about google pre-IPO ?

 

VC’s are offering Brand

Assume EVERYONE wants a piece of facebook and think, for a second, from the company's standpoint: with the valuation being huge and hence irrelevant, who will be best for them as incoming investor ?  Having a cool VC brand (if there is such a thing) says to the market:

  • We’re still a startup and we have savvy insiders backing us, not some faceless mutual funds or hedge fund
  • The VC’s are giving us their money rather than funding new early stage competitors, we’re officially declaring game over on our segment !
  • We get Mary Meeker to do our IPO roadshow slides for us Smile

Compare and contrast with the negativity hitting the Wellcome Trust for its investment in Wonga.  Umair Haque is giving them a beating on twitter right now: “You couldn't find a more perfect example of the ponziconomy if you tried. Future health benefits? Traded for ultra high interest rate debt”.  No one would have batted an eyelid if it was KP coming in…  Although arguably a real coup from Wonga in buying cred !

In any event, the halo effect is mutual; call it “branding congruence”.  As @cdixon nicely put it, the VC’s are coining a new VC phrase: "buying posters" = VCs buying late stage shares of hot companies to put the company's logo in their lobby”.

 

The risk / return profile is not bad

Deals are surely often structured, though probably not facebook. At face value the price looks huge but a guaranteed return is baked in. Hence the financial logic is easy to defend. zynga at $7bn with 1.5X preference or similar. The company gets a great headline number, the VC gets a reasonable return on a big wad of cash and everyone is happy

 

Ecosystem in resonance

LP’s are concentrating their investments in the best name.  Now these franchises are all doing each other’s deals.  They’re owning the sector; it’s every money manager’s wet dream of a crossover fund coming true, but in collaborative mode.  Fund me, fund you.   Oh, and think about the relationship with the acquirors and the future startups created by talented leavers. Remember the Sequoia / Intel conveyor belt of startup / acquisition / startup.  The ecosystem is entering a form of perfect resonance.  Even Union Square Ventures’ Opportunity Fund is a perfect example of this.

Remember, resonance is a powerful thing, it’s also been known to destroy bridges Smile

Questions

  • Are these deals best for the GP’s because they put fund in the black at the expense of great IRR’s ?
  • Are VC’s really qualified to do momentum late stage investment ?  Is access all there is to it ?
  • Do I really need to get billion dollar companies built to feel good about myself ?  Back to work then, PriceMinister and Dailymotion are both in a different class Smile with tongue out)

 

I could go on but my arm is hurting.   This continues to be a fun market…

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7 Responses to VCs and Mega Late Stage Investments, or how to corner a market

  1. Gentschev says:

    Like most financial niches, it’s probably safe to assume that the early money will do fine. Six months or a year from now, either this trend will have died down since there are a limited number of Facebooks out there, or people will be making really bad investments. But at the moment it seems everyone’s happy.

  2. Sean says:

    So I like how you remained highly ambiguous as to what you think of all this, although perhaps the final bridge scene gives it away!

    Fwiw, I think this – like the recent mega-exchange mergers, like the pass-the-parcel wave of private equity “secondaries” (you buy my company, I’ll buy yours) – is one more example of a fundamental flaw in our economy’s current systemic asset allocation model which simply stated, concentrates too much capital with too few people. And if the returns were good, you could say so what? But they aren’t really.

    Study after study shows that smaller, more focused pools of capital are where the really interesting returns are to be found. But finding the gems in the coal is hard (and a problem not yet solved strangely enough) and there is no incentive for the folks allocating most of the world’s long term capital to try that hard. Just give it to Blackstone, KKR, KP, Sequoia, NEA, etc. – they’ll probably do a decent job and even if they don’t I won’t get fired (or even questioned) for chosing them. Interesting, the one segment of “alternative” investments where market diversity, innovation (ie new managers) and discipline has been a bit higher is the hedge fund world. I think this is a timing thing in that performance horizons are shorter than the career cycles of the LPs and so (some) creative destruction happens.

    It’s been said thousands of times before, but the vast majority of folks simply prefer the comfort of herds. Throw in 200 years of conditioning that bigger is better (which as a heuristic was pretty much true in the industrial economy) and you get a run-away reaction that takes the pendulum way past optimal… (how’s that for garbling metaphors!?)

    Don’t get me wrong, I think I understand why LPs throw money at the same big investors, who then in turn throw the same money at the same big trades (sorry, companies) – “no one gets fired for buying IBM” right? It’s actually worse for the LPs though when all their managers start buying the same companies, syndicating every deal to death as they ultimately just end up with huge positions in aggregate on the same handful of companies. Maybe these are good investments, but I’m not sure if I’m an investor and I give funds to 10 funds that I’m really only looking to own 10 companies…or if I am, couldn’t I cut a better deal by cutting out the middleman?

    So none of this surprises me and looks “rational” for the various players in the chain (except of course the ultimate end owners of these assets) despite producing poor outcomes. What does surprise me however is that you don’t see the mega VCs and PE funds seeding new managers (whereas you do see at least a bit of this in the hedge fund world) when if you think about it, their biggest relative competitive advantage lies more in raising funds rather than investing them. My subjective view is that this is due simply to behavioral inertia – “that is not what we do” – rather than an objective analysis of the attractiveness/or not of this model but maybe I’m mistaken…

  3. alan p says:

    Fred – re Wonga – I think Umair is only the start. As I understand the business model, it can be easily be seen as online loan sharking. I would predict a very rough ride once the mainstream press get their heads around it.

  4. It’s true that six months to a year from now, that strategy could be as good as zero. Internet bubbles come and go, facebooks notwithstanding.

  5. Max N says:

    Do I really need to get billion dollar companies built to feel good about myself ?

    Depends on the level of money you’re managing. If it’s 100M+ fund, I think you need to be invested in one or more billion dollar companies to have the right to keep being a VC. It sounds harsh, but I really do believe that.

  6. Wow! Great info.Thank you for bringing the article into focus on your site.

  7. Facebook is booming. Its hard to say when the party will end.