When Is a “Mark” Not a Mark? When It’s a Venture Capital Mark
a16z.com
a16z.com
If AH wants to be able to sell any LP interests in the next 12 months they are going to be very, very careful not to state any performance figures, particularly the trumpet-able kind.
(Exception: there do appear to be firms who are cavalier about this kind of thing, mainly seemingly new or nontraditional firms. But if you have DLA or Gunderson or Proskauer or whoever it is these days advising you, they are not going to be cool with you possibly blowing your Reg D in order to have a twitter feud with a reporter.)
The industry already has standard measures for talking about performance of a fund from different perspectives. I fear that HN is reinventing several wheels here.
For example, TVPI, Total Value to Paid-In, includes "marks" (which the VCs strongly influence, but ultimately have to be signed off on by auditors). But every savvy industry person would also look at DPI, Distributed to Paid-In, which includes only actual cash (and marketable securities) distributed to investors, and as such is much less susceptible to gaming.
It would be the scalar fallacy to believe that you can reliably compare any two funds' mid-life performance with a single metric. A high DPI fund is much more certainly a performer, but might have less residual value in the portfolio; likewise, a very high TVPI fund (but with low DPI) might have a ton of realizable value or it might just have unrealistic marks. (Finally, neither of those measures accounts for time value of money.)
For financial services the equivalent would be either talking your portfolio or your returns. In this case, the mark-to-market portfolio looks bad and the returns look bad, so they've resorted to arguing with newspapers.
That's basically a backend way of figuring out how much of their returns are pie in the sky. One other thing to keep in mind to give a16z the benefit of the doubt is their funds are MASSIVE. Putting that amount of capital to work is hard- and relatively harder than Bessemer and the other funds they are compared to.
That said, the % of Fund III in particular that is non realized is fairly scary. I'd take a wager that it does not return capital. Note also A16z pretty quickly raised a new fund before a lot of these returns for 3 become clearer. That's just guessing on my part but I'd def bet III is not gonna be good. That said I still love a16z and the partners and their approach...I actually hope I'm dead wrong.
Just so I'm clear, the idea here is to look at all funds that started in the same year, average the non-realized gains, then compare that to the non-realized gains of the fund you're evaluating? How do you know whether the difference is how they mark vs. actual alpha?
1) Realized Returns/ Total Size of Fund 2) compare above to prior vintage years of same partnership/ similar funds 3) Look at unrealized returns as a percentage for this vintage across funds and for same partnership for prior funds for same years out.
The bulk (like 80%) of unrealized gains can disappear in a quarter if you have a large market correction.
Some of the variance is going to just be market conditions but in general the weaker those numbers that's a pretty bad sign.
Unlike the blog states, it seems that WSJ is, in fact, using "actual, realized returns" as evidence.
http://www.wsj.com/articles/andreessen-horowitzs-returns-tra...
* How did Sequoia end up as the only VC that made money from Whatsapp? It certainly wasn't an accident.
TL;DR: Sequoia didn't get that deal just by random chance.
Jan and Brian were uninterested in VC or business relationships to the extent that they were impossible to contact. There was no address on their website. There were no contact details. They ignored inbound emails. There was no signage on the building. They ignored press emails. But Sequoia knew they were in Mountain View and literally had partners walking the streets doing a physical search for them in order to initiate that contact. That's a pretty amazing effort.
Additionally, Sequoia have an internal tool called Earlybird they wrote themselves that monitored mobile app stores, which is how they noticed that WhatsApp was doing so well despite the fact that it had not taken off in the USA specifically. They relied on hard data collected systematically, rather than waiting for hot Bay Area startups that the VC's friends were using to turn up on their door.
And finally Sequoia had a great name that Koum associated with success.
There's a lot of great info in this video. I love WhatsApp partly because it violates so much received valley wisdom and yet has been so successful.
Accounting should be done in a way that maximizes the usefulness of financial reporting for strategic and management decisions. In some cases, firms are required by regulators to adopt specific practices, but there is a fair bit of freedom given to the CFO.
VC firms must make wise financial decisions and satisfy their LPs with some degree of transparency. The accounting strategy chosen must accomplish both goals.
In many cases, it makes sense to be very pessimistic about valuations, and doing so often reduces tax liabilities.
On a side note, the whole "mark to market" scandal from the 2008 financial crisis was a case where firms typically marked assets in a way that matched their management goals, but at times failed to reflect short-term price fluctuations.
Regulators thought that forcing firms to mark assets to a known market price would result in better financial reporting. The problem was that the balance sheets containing those assets were also used as underwriting capital. So a market price increase (or bubble) in the assets was suddenly leveraged into a lot more risk capital by the firm (whereas before the rule, the CFO would not likely have wanted to mark the assets that high).
This resulted in industry-wide increases in risk capital for "free" because of asset price spikes, and following that it led to increased investment. The problem was, when the price fell back down, the firms were over-leveraged. It's generally a bad idea to use highly volatile assets as underwriting capital.
So while "mark to market" sounds good, it can enhance natural fluctuations (minor boom/bust cycles) in a destabilizing way.
The art of being the CFO of a VC firm is likely a very interesting thing, and it would be fascinating to learn more about how this happens across the industry.
Top hedge funds are known for 2 & 20, and Berkshire Hathaway doesn't charge anything.
30% is murder. Scrutiny is justifiable.
I find the OPM method interesting. Has anyone here used this? Is it always more conservative? Is it a better predictor of realized value?
http://repository.upenn.edu/cgi/viewcontent.cgi?article=1035...
But isn't it that it just needs to better than other methods?
"nothing" is the wrong word here. My experience is that the "marks" are indeed quite helpful and for the most part, reasonably accurate.
My experience is also that many portfolio company valuations are not particularly sophisticated.
The hedge fund comparison is odd since many hedge funds investments are as illiquid or more.
zing!