Urgent Speed

More Networked than Cisco? Angel and Venture Syndicates

I like the thinking behind Yael Hochberg, Alexander Ljungqvist, and Yang Lu’s research on predicting venture investment return.  Their study, “Whom You Know Matters: Venture Capital Networks and Investment Performance” shows how, historically, Angels and VCs that make a habit of co-investing outperform funds that tend to participate in more limited syndicates.   As TechCrunch explains:

A venture firm’s network in the study was defined as being made up of all the other venture firms who co-invested with it in funding rounds. The more co-investors a venture firm has, the better its network. The better its network, the better its overall returns. The correlation between the size of a venture firm’s network and its returns may have something to do with better access to deal flow, talent, advisers, potential customers, and potential exits.

If this is true, then who are the most connected venture firms and angel investors today? Vijay Dondeti , a graduate student in bioinformatics, applied the analysis in the Hochberg paper to about 2,700 investors in CrunchBase  who participated in over 3,300 startup funding rounds between 2006 and 2008. He scored each investor based on how well connected they are to other investors as well as how well-connected their co-investors are to other investors. “In summary,” says Dondeti, “to get a high score, you need to co-invest often with others that also co-invest often.”

In my experience, larger more-connected syndicates are more likely to be able to help a start-up as it grows. As an Investor, I like having other smart heads looking out for my Angel investments, as an Entrepreneur, I like having a diverse group of minority investors I can turn to for guidance and perspective.   I agree with the study’s hypothesis that the outperformance of networked VCs is due to the increased likelihood that the syndicate can also contribute relevant intellectual capital.

But I think the “Whom You Know” study is missing an important correlation. Networked investors tend invest earlier, often at the seed stage, and seed investments, on average outperform the VC investment class.  Small funds and Angels need to co-invest, because they don’t have huge funds. Without a huge fund, an investor runs the substantial risk of being unable to meet the needs of the portfolio company. This is why small investors ban together to make sure they can invest a meaningful amount, while still keeping funds in reserve.   Small funds make their money on the upside; large funds often make substantial money on their management fees.  The result is not a big surprise; small funds tend to obsess on helping their portfolio.   Don’t get me wrong, I respect several large funds. There are several great large funds that have a proven track record both participating at all stages and also adding value beyond simply writing a check.  DFJ and Sequoia are good examples, and are ranked high on Vijay Dondeti's ranking.

So I salute Yael Hochberg, Alexander Ljungqvist, and Yang Lu.  I hope there is a next version of their study where they try to statistically separate Alpha from “stage” from Alpha from “network” (a hard task given the opaqueness of venture returns).  As for Vijay Dondeti, I salute you also…your analysis was excellent. I don’t claim your ranking of me (at 63) above Cisco (at 65) is perfect, but if someone knows a better statistical predictor of venture/angel performance… please speak up.

BTW, when reviewing the "Whom You Know Matters" study in the Journal of Finance I noticed an outcome tree for 16,315 venture investments from 1980 to 1999, following their outcome through 2003.  For my own edification, I created a pie chart showing outcomes. 

Only 18.5% of all deals resulted in an exit over the course of the dataset. So the takeaway for Angels: if you can't see at least a 10X+ return on investment, don’t make the investment, unless you have some method of avoiding the other 81.5%.  If you have a method of avoiding exitless investments… please speak up. 

Perhaps the folks at Sharespost will help create exit opportunities for early shareholders? Til then I am sticking to co-investing with a 10X+ hurdle.

These charts put recent market “adjustment” in perspective

more at: http://dshort.com/articles/2009/four-bad-bears-alternate-real.html

The Next Bubble – Alternate Energy

Eric Janszen does a masterful job articulating the conditions needed for a massive innovation bubble.  His article is required reading for any entrepreneur looking change the world.     The move away form oil will be as big as the transformation from animal power to steam, or transformation from steam to oil.  
 

Publish at Scribd or explore others: Business economy crash

There are two types of bubbles; asset bubbles and innovation bubbles.  The Asset bubbles are a zero sum game that doesn’t offer anything new to society, but innovation bubbles are critical to rapidly deploying new technology.  

The Tulips Bubble of 1637 is the classic example of an asset bubble.   More recently the assets of real-estate, oil, and gold have all had their bubbles.  I believe asset bubbles are a natural occurrence given our collective human nature.  (I wonder if algometric trading amplifies or dampens our human propensity for froth and panic.) 

But innovation bubbles are a different organism. Innovation bubbles are the markets (our collective intelligence) realization that technological change is afoot. Canals and Railroads are the classic example form the 1800.   More recent examples include Radio, Automobiles, TV, and the Internet.   Fortunes will be made and lost, but in the wake of the bubble a new technology will have taken root. 

I can’t wait to see what technologies replace oil and coal, and even more so; I can’t wait to see what entrepreneurs make it happen.  Will it be microbiologist hackers modifying algae to produce cheep fuel? Maybe nanotechnologists will invent cheep solar cells that are super efficient.  Perhaps some grad student is about to drop out of college to commercialize his ultra-capacitor thus ending the need for batteries.
  
Moving away from oil will take dozens of new inventions and business models; I am just glad Eric Janszen gives us a roadmap.

Dogbert, Math and Diversification

Looks like Dogbert also expounds the benefit of portfolio diversification.

Publisher Monetization Tools – Useful list for Angels

Steve Spalding's article “21 Great Advertising Networks For Publishers” is the best round up of services for publishers to monetize traffic I have seen in a long time.  I linked to the article because I thought it might also be useful for start-ups that need to advertise as well as Angels investors,  looking to better understand the (still growing) on-line advertising market. 

Bank Run on Wall Street - 1884

This picture looks West on Wall Street towards Trinity Church.  It caught my attention because:

1.) The Church is where my Great Grandparents were married
2.) The street is near the offices of my first start-up, and
3.) The picture is from May 14, 1884 when the sudden failure of the Grant and Wood Bank caused a panic. 

This run reminded me of the recent run on Bear and Lehman.  In 1884 business returned to normal within a few days.  As for Lehman…you be the judge.  It’s easy to forget that bank failures were common before the formation Federal Deposit Insurance Corporation in the 1930’s.  I am often reminded of this when I talk with business owners from former Soviet nations, as they see bank failures as a normal occurrence.   I wonder if the 2000’s will look more like the 1900’s or the 1800’s?  Hopefully neither; the 1900’s were hit by a huge string of failures in the 30s…and the 1800’s were even worse.  

1929 VS 2008 (Chart)

This chat does a good/interesting job of comparing the 1929 stock market crash to the drop in 2008. 

Market Crashes, Defaults, Urgency and the Long View

There is something about a market crash that makes me wants to write.  I guess it is a cathartic way to deal with loss. 

Given the huge drop in Japan and London, we might expect the US market to drop substantially this morning.  Though I weep for the NIKKEI, I fear for the DOW.

I think it is easy to lose track of the BIG picture…the long-term view.  This may seem ironic, given my obsession with speed and urgency, but I don’t confuse urgency with short-sightedness.  Rather, I think small improvements implemented urgently can have huge impacts on the long-term outcome.  

I guess you could say my long-term view increases my urgency.  Furthermore, a long-term view needs to be long…maybe 10 years, maybe 100 years, maybe even 1,000 years?  1,000 years really puts things in perspective.  Let’s look at these long-term views:

The 10 Year View:

Because growth compounds, decisions today impact the future in non-linear ways.   If, for example, you have a start-up that is growing 10% a quarter and you decide to invest $10,000, in 10 years your investment will have become $411,000.  If you decided to delay that investment for 180 days, however, you would only accumulate $340,000.  That lack of urgency would have cost you $71,000.

The 100 Year View:

Stock Markets fluctuate, but overall they have done fairly well over the last 100 years.  Despite my belief that the stock market in 2009 – 2010 will struggle due to massive debt and population demographic shifts (baby boomers are moving out of peak earning and spending), pulling out of the market does not make “cents” (bad puns for bad times).    Multiple examples prove that history is on our side… over the long term, including:

• In January of 1970, a bear market started that lasted until May of 1970, during which the market fell 35.4%. In May, a bull market began that lasted until January 1973 and brought a 124% gain in stock values.
• In April 1981, another bear market commenced that lasted nearly a year and brought a 24.7% decline. Then, in March of 1982, the market began to rise and continued doing so until June 1983, bringing an overall gain of 71.7%.
• July 1990 brought a downward market that lasted three months, until October 1990, at which point equity prices had fallen 22.4%. Then, in the same month, a new, now legendary, bull market took hold and lasted nearly eight years, until July 1998, delivering a 330.7% gain for the market.
• Since 1975, 8 of the last 15 bull markets have started in the autumn months of September, October, and November.
• Since 1957 there have been 15 bear markets, as measured from peak to trough, and on average they have lasted 10 months and brought an average decline of 29.4%.
• The duration and degree of these bear markets were significantly less than the duration and magnitude of bull markets. During the same period, there were also 15 bull markets, which lasted, on average, 30 months and brought average gains of 112.5%.

Markets could only drop to ZERO, but they have unlimited upside (the cup is not only half full, but it could overflow).

The 1,000 Year View

Given my long-term view of opportunities, you can imagine how pleased I was this morning to find an 800-year economic data set. 

Here’s the summary of from the study:

In a recent paper co-authored with Kenneth Rogoff, we introduce a comprehensive new historical database for studying debt and banking crises, inflation, currency crashes and debasements.3 The database covers sixty-six countries across all regions. The range of variables encompasses external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodity prices. The coverage spans eight centuries, going back to the date of independence or well into the colonial period for some countries.

In what follows, I sketch some of the highlights of the dataset, with special reference to the current conjuncture. We note that policymakers should not be overly cheered by the absence of major external defaults from 2003 to 2007, after the wave of defaults in the preceding two decades. Serial default remains the norm; major default episodes are typically spaced some years (or decades) apart, creating an illusion that “this time is different” among policymakers and investors. We also find that high inflation, currency crashes, and debasements often go hand-in-hand with default. Last, but not least, we find that historically, significant waves of increased capital mobility are often followed by a string of domestic banking crises.
The big picture

What are some basic insights one gains from this panoramic view of the history of financial crises? We begin by discussing sovereign default on external debt.

Default cycles

For the world as a whole (or at least the more than 90 percent of global GDP represented by our dataset), the current period can be seen as a typical lull that follows large global financial crises. Figure 1 plots for the years 1800 to 2006 the percentage of all independent countries in a state of default or restructuring during any given year. Aside from the current lull, one element that jumps out from the figure is the long periods where a high percentage of all countries are in a state of default or restructuring. Indeed, there are five pronounced peaks or default cycles in the figure. The first is during the Napoleonic War while the most recent cycle encompasses the emerging market debt crises of the 1980s and 1990s.

Serial default on external debt—that is, repeated sovereign default—is the norm throughout nearly every region in the world, including Asia and Europe.

Our dataset also confirms the prevailing view among economists that global economic factors, including commodity prices and centre country interest rates, play a major role in precipitating sovereign debt crises.

The Study goes on:

Another regularity found in the literature on modern financial crises is that countries experiencing large capital inflows are at high risk of having a debt crisis. Default is likely to be accompanied by a currency crash and a spurt of inflation. The evidence here suggests the same to be true over a much broader sweep of history, with surges in capital inflows often preceding external debt crises at the country, regional, and global level since 1800, if not before.

In the past few years, there have been massive capital flows as the US borrowed billions from abroad while simultaneously sending billions for oil and imports.  These old data sets provide useful insights into the likelihood of inflation. 

So in conclusion:

1.     Looking at markets/business from a 10, 100, and 1,000 year perspective can be helpful to reduce the panic over today’s markets.

2.     Urgency and an obsession with speed are complementary, not mutually exclusive, to a long-term view.

Aesop’s Ant and the Crash of 1873

Last night I read about the crash of 1873. Fascinating.  If you expect to live for 100 years, statistically you should also expect to experience one major bank run accompanied by a stock market crash.  Human nature has not changed since the tulip bubble of 1630.  I argue that modern communications do nothing to change the psychology of markets.

A well-run market is a balance between Greed and Fear.  Sometimes balance gets out of whack.  Overall, I view market crashes as “nature’s way” of clearing out the dead wood, much like a forest fire.  Sure some good trees burn, but years later the forests emerge stronger. 

Professor Nelson’s article points out:

The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris. Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.

But the economic fundamentals were shaky. Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export trainloads of wheat to abroad.

Britain, the biggest importer of wheat, shifted to the cheap stuff quite suddenly around 1871. By 1872 kerosene and manufactured food were rocketing out of America's heartland, undermining rapeseed, flour, and beef prices. The crash came in Central Europe in May 1873, as it became clear that the region's assumptions about continual economic growth were too optimistic.

Europeans faced what they came to call the American Commercial Invasion. A new industrial superpower had arrived, one whose low costs threatened European trade and a European way of life.

As continental banks tumbled, British banks held back their capital, unsure of which institutions were most involved in the mortgage crisis. The cost to borrow money from another bank — the interbank lending rate — reached impossibly high rates. This banking crisis hit the United States in the fall of 1873. Railroad companies tumbled first. They had crafted complex financial instruments that promised a fixed return, though few understood the underlying object that was guaranteed to investors in case of default. (Answer: nothing).The bonds had sold well at first, but they had tumbled after 1871 as investors began to doubt their value, prices weakened, and many railroads took on short-term bank loans to continue laying track.

Sound Familiar?

Then, as short-term lending rates skyrocketed across the Atlantic in 1873, the railroads were in trouble. When the railroad financier Jay Cooke proved unable to pay off his debts, the stock market crashed in September, closing hundreds of banks over the next three years. The panic continued for more than four years in the United States and for nearly six years in Europe.

Correspondingly, if you are a start-up, you need to find a business model that is not dependent on massive cash infusion.  When we founded Mimeo in 1998, we were able to raise $20+ million to hire 45 developers and set up an integrated built-to-order manufacturing facility.  Today at scale, Mimeo is very cash efficient, but I don’t think I would launch a company that needs to burn through millions of dollars before hitting profitability.

I recommend start-ups that use invention and intellectual capital to create cash flow.  Software, web applications, and cleantech come to mind. Truly great start-ups are bigger than any temporary economic downturn. 

The article goes on:

The long-term effects of the Panic of 1873 were perverse. For the largest manufacturing companies in the United States — those with guaranteed contracts and the ability to make rebate deals with the railroads — the Panic years were golden. Andrew Carnegie, Cyrus McCormick, and John D. Rockefeller had enough capital reserves to finance their own continuing growth. For smaller industrial firms that relied on seasonal demand and outside capital, the situation was dire. As capital reserves dried up, so did their industries. Carnegie and Rockefeller bought out their competitors at fire-sale prices. The Gilded Age in the United States, as far as industrial concentration was concerned, had begun.

I guess markets are like seasons, sooner or later we will see winter.  May you be Aesop's Ant…I get the feeling there are more than a few Grasshoppers here in America. 

Oil Parity, Wall Street and Solar

Much like Gordon Moore’s chart that predicted chip performance, this Deutsche Bank chart and reflects Wall Street’s predictions for solar/electricity costs. 

There are about 80 known solar manufactures, all scurrying to increase capacity and drive down cost.  Plus, who knows how many stealth mode solar manufactures are coming on-line in China?  Costs will keep dropping. 

It reminds me of the hard-drive, processor and memory chip industry in the mid 1980s.   

The big question is this: if there is a global credit crunch, as some predict, how will it impact the dissemination of solar panels?  Solar ROI is directly tied to cost of capital.

If credit dries up, grid party will get pushed out and deployment will be slow.

If credit is free flowing, the force of capitalism will deploy solar on every available business roof.  

In August of 1858 Edwin Drake proved what I call “oil parity”,  the point at which it was cheaper to drill than hunt for whales.  Wall Street sprang into action and rammed money down the throat of the opportunity. By August of 1859 there were “oil wells as far as the eye could see in Titusville.”

Moore:

Drake:

Moore's Law:

CPU and DRAM charts: