Bubbles, Markets, Planning, Things That Go Bump In The Night

Big Red Car here on a lovely ATX day. Hope you are at your best today.

The Boss was reading a great blog post over at AVC.com which is Fred Wilson’s fabulous blog about the venture capital business.

Fred Wilson is a brilliant commentator and an even better investor. Fred gets the blame, in part, for inspiring the Big Red Car to write The Musings of the Big Red Car as BRC was spending too much time commenting on Fred’s blog and didn’t want to take up too much of his space.

Fred’s musings today were about the subject of “bubbles” and, in particular, the prospect of the recurrence of an Internet bubble similar to what happened 1999-2000.

Bubble or no bubble?

While many suggest that “this time it’s different” and therefore there is no bubble the plain truth is of course there is a bubble. The bigger question is will the markets and investors be able to ride through the bubble without being destroyed? The answer to that is: MAYBE, MAYBE NOT.

The evidence there is a bubble is clear:

1. Valuations for startups are off the chart. Accelerator and incubator graduates are commanding valuations of approximately $8-12MM. These valuations are not liquidation values mind you but still they are very generous. The venture capitalists are validating these values by embracing them in their investments. You cannot correct the direction of valuations by pissing gasoline on the fire.

2. There is a ton of money chasing a lot of deals. The world is awash with money for the venture and, in particular, the seed slice of investing. Venture capital continues to be a business in which arguably 75% of all investments will be failures.

3. It is not just seed stage venture capitalists, it is also angels and syndicated angels. The distinction being that syndicated angels are imposing venture capital style deal structures, deal making and due diligence on their investments mimicking the best practices of venture capital seed investors.

4. Angels are by their very nature emotional investors so as more money is guided by emotion the frenzy of the market is reflected in what deals actually get done. Emotion accelerates the current trend. Bubbles are often a product of emotion and sometimes emotion alone. More emotional investors is not going to calm down the markets.

5. There is a huge explosion of incubator and accelerator and formal mentoring programs which are codifying the process and providing funds to their enrolled companies. The process is being streamlined which puts more opportunities in front of more investors.

6. Incubator and accelerator programs are coming with money attached as part of the process.

So yes, Virginia, there is a bubble.

Are bubbles always bad and what does this say about the market?

A good analogy for discussions about markets is the ocean.

1. The ocean has tidal variations which create high and low tides. Markets are similar, they vary. They are in constant motion. They are rarely stable.

2. Rarely is there equilibrium — slack tide — when the water is not moving and yet this is what we are constantly looking for in the discussion of markets, some sense of normalcy when the market is at equilibrium. In fact, the constant movement of the water is the norm. Equilibrium is the head fake. The tide is either coming in or going out constantly. It is only momentarily at slack tide and then it immediately changes.

3. This sense of whether the tide — markets — is moving toward a high or a low tide is often what is missed in a sound discussion of markets. It is the flow of the markets.

4. This sense of the velocity of markets or the flow of tides is one of the parameters that investors must incorporate in their investment philosophy. It cannot be ignored.

This is a simple concept — the Great Gretzky said to skate to where the puck is going not to where it is. Easy for him to say, right? This is made even more difficult by the realization that the life cycle for most seed stage venture investments is arguably 5-7 years long. That is a long time to see the puck let alone figure out where it’s going to be.

How long is the business cycle? You may be investing at low tide and liquidating or monetizing at high tide. Who really knows? Still a responsible VC has to make some assumptions in order to maintain their sanity and to speak intelligently to their suppliers of capital, their LPs.

If you don’t know where you are, it is difficult to assess where you’re going.

So what is an entrepreneur and a VC to do?

The pressure that is created by the acknowledgement of this reality can be relieved by two basic thrusts:

1. Intense planning which anticipates and accommodates changing conditions; and,

2. Building not just great products but great companies — sustainable, strong, well led companies which are sound engines of commerce regardless of the market forces at play.

The Boss has been advising startup CEOs, SMB CEOs and VCs with a deal in the ditch for two years after 33+ years of CEOing. He has developed a methodology of helping CEOs sort out their Vision, Mission, Strategy, Tactics, Objectives, Values and Culture.

In every failure he has stumbled upon, there has been a failure to plan adequately. As a CEO Coach it is not his inclination to take a CEO to task but in the craft of calling balls and strikes, failure is almost always a failure to adequately plan. Let me be clear — sometimes the inadequacy of the underlying hypothesis would have been smoked out by more detailed planning so this is not a recipe to make chicken salad out of chicken excrement. Sometimes ideas stink. Good planning would bring that realization to the fore more quickly.

On the other hand, The Boss has seen CEOs and their companies blossom when they undertake even a “small ball” approach to planning. A bit of planning, some good communication, an offsite meeting and suddenly the forces that make a great company — clarity of vision, mission and alignment — are unleashed. It is a wonder to behold and it shows up in the bottom line.

The exciting thing is to see how much better the CEO becomes at their job and how much stress is relieved. This planning, success and alignment allows the CEO to focus on BIG issues with less friction. BIG issues like growing the company, marketing and raising money. It is all connected.

Even in the absence of a bubble the seed investment business will continue to be a 75% +/- failure rate business with almost all of the returns being provided by the top 10% of the portfolio. You only need 1.5 successes to make an entire portfolio get up and sing.

There is nothing wrong with a bubble, as there is nothing wrong with the ebb and flow of the ocean, as long as you know where you are, where you think you might be in 5-7 years and you have accommodated those thoughts in your investment thesis.

Good hunting. Good luck.

But, hey, what the Hell do I really know anyway? I’m just a Big Red Car.

 

 

 

  • Yup. On the angel side, I think a lot of the money floating into startups is uneducated money. Everyone thinks this is just picking winners and losers. They don’t realize the amount of work that goes into it. It’s also not like the stock market: just because you invest at $3M pre money doesn’t mean you can cash out if the startup hits $20M on its next financing round. By the way, if that’s your strategy you will go broke.