Ben Horowitz: Capital market climate change
finance.fortune.cnn.com
finance.fortune.cnn.com
Valuations are high by historical standards, which means at some point they'll probably fall, but we're not seeing evidence of a fall yet.
It does seem to be getting harder to raise later rounds. But I think that is a secular change, not a market fluctuation. VCs seem to be shifting toward a strategy of spraying money at early stage startups, and then ruthlessly culling them at the next stage. This may well be the optimal strategy, but it's tough on the late bloomers.
pg - do you have any stats around how many more recent YC co's are profitable & have not secured/pursued Series A?
A bunch of the companies we've funded are profitable and haven't raised a series A round yet, but it looks like there is only one that is way past the (now much later) series A stage and yet didn't raise a series A: Weebly.
Looking at this from way outside: I think this is because they're much more aggressive on product-market fit. Pivot once or twice, then give up when you're not the next instagram.
Ideas have consequences; here it's the concept of startups as early-terminating simulated annealing search algorithms that has been consequential.
I know, I know, too cynical. But looking at the exits that way skews the numbers.
Of the two acquisitions where I had good visibility into the terms, in both cases the original Investors were cashed out at approximately 2x their total investment and the rest put into an earnout/retention package for the people that were coming on board. It was a haircut to be sure, but it wasn't actually a loss for anyone with preferred stock. I would have thought with smaller starting chunks that would be easier rather than harder than it was after the dot-com debacle. I certainly defer to your greater experience here as it is much more current than mine. I made the mistake of figuring those were more typical than I guess they actually are.
At face value, an investors buy shares at price X and the HR acquisition happens at value 2X. A naive conclusion is that (X - legal costs - time)= profits.
Do you mean that these acquisitions don't make enough to pay for the failed startups? That the cost associated with investing in that startup are more than the revenue? That something about typical deal terms makes (reported) valuations at buy and sell time meaningless?
What happens in practice is that the acquiring company effectively recaps the startup on the fly. This takes a bunch of different forms but a common method is that a big part of the purchase price takes the form of restricted stock grants or signing bonuses to the employees, as opposed to cash or stock that gets processed through the cap table.
From the acquiring company's standpoint, this is logical behavior because the acquirer wants the people to be well motivated to work hard at the big company, and doesn't care whether the investors get their money back or not.
But this has the effect of putting a startup's founders at cross incentives with their investors. It's very important for everyone to act like adults in that circumstance, which often but not always happens.
Of course acquirers can overdo this and burn their relationships with angels and VCs in the process.
in general, most companies with similar progress are being valued less highly than last year.
which isn't to say they are either cheap, or a bargain -- just not as high as last year.
First, corporate earnings are at all time highs. Looking at P/E ratios as a measure of if we are in a "normal" sentiment environment is kind of a bad idea, since the P/E ratio captures two cycles at once: the sentiment cycle (higher P for less E), and the earnings cycle (higher E overall). At P/E of 15 when the earnings cycle is at it's peak (as it is now) may still be reflecting extremely high (read: irrational) relative sentiment towards equities, even though the ratio itself sits only slightly above average. And, in fact, there are many indicators that point to the fact that the public is more bullish on stocks now than they have been since before the 2008 crisis, even though the P/E ratio is only 15-16.
Second, the consensus right now is forming that we may have finally turned the corner in the 30-year bond bull market, and interest rates are on the rise again. If this is true, it represents an important change for asset managers, and will trickle all the way down to private equity and startup funding. As rates rise, particularly if they rise not just due to inflation but due to tightening monetary policy, investors will need to deploy less capital to reach for yield to places such as private equity, so you can expect deal terms to get more "investor friendly." (I am not sure if we are actually at the beginning of a bond bear market, but many people believe so.)
Why do you think earnings are at a high?
It's no guarantee profits won't go even higher, of course, but they are quite high now.
so sentiment shouldn't really have peaked unless earnings already did too?
wonder if anyone else has seen this, and when he wrote that, if it was during the Fed scare correction that seems to have been succeeded by the Fed relief rally.
http://stockcharts.com/h-sc/ui?s=%24spx&id=p33407302522&def=...
Nothing in efficient market theory suggests constant PE ratios over time. Nothing in efficient market theory suggests that your stock will be higher if you double your bookings. (If the initial price assumed 3x bookings, you'll tank even if the market is the same) PE ratios revert over long time horizons (many years) but even what is considered earnings changes over time.
That said, his conclusion is true. If you raise money in great times, you may need to take a hit in bad times. Better not to overpromise.
One of the bloggers I host gave a very good explanation of what the EMH is and what it actually implies: http://skepticlawyer.com.au/2013/05/29/bubble-trouble-all-in...
Having particular bearing on the Horowitz post is this remark:
Commentary often seems to presume that EMH,
or notions of market rationality generally,
provide some implicit or explicit guarantee
that current prices will be sustained, which
is false. No guarantee against asset price
volatility follows from either.Is this something that actually happens or is he being hyperbolic? I thought there might be some legal issues around making claims like that.
Many software engineers have read a few finance books and will understand that preference provides a large premium in preferred stock.
It's a ticking time bomb not just in terms of employee morale but also 409A (tax law).
It would be interesting to look at the trend for EBITDA multiples over time instead: https://cloudup.com/cHNL3Wcy5yH [1]. In this view, you can see that TEV/EBITDA ratios are very similar today to what they were in 1995 even though they took a very circuitous route to get there.
1: S&P Capital IQ (exported just now)
Sure, it is not 1999 or even 2002. I don't think anyone thinks it is.
Focus on the last 4 years. It looks pretty flat with a blip in 2010.
3/31/2009: 14.5 3/31/2010: 18.8 3/31/2011: 15.4 3/30/2012: 15.5
Of course, Ben could be (and probably is) right but the P/E ratio does not look like evidence to me.
That works as long as the potential investors aren't comparing notes: "I heard Moneybag Ventures only offered you $180 million valuation..."
I mean if you did your job right as CEO, you are the dumbest person there. You spend all your time being upbeat and optimistic in public (maybe horribly depressed in private?). Your engineers and managers, who are experts in divining information out of the smallest bits of data (single line bugs anyone?) are much smarter than you realize.
I have rarely seen a CEO that I completely respect. They just don't have the ability to aggregately integrate every detail in the company and tend to lead things to a crash and burn as a result.
A lot of the startup CEOs I have seen tend to have a "this is my company" sort of feeling. But by expressing that feeling to their employees, they crowd their employee's feelings in this regard. Everyone who works for a startup wants to feel like they OWN the company. That's why you join one. For that feeling of ownership.
But when a CEO talks with these "sole ownership" feelings, people GET it. Also if a CEO uses evasive or trivializing language or behavior about the state of the company, people's internal sense of dissonance causes a rift of trust AT THE WORST POSSIBLE TIME.
I have seen this pattern play out a few times as the "non CEO" position. Yeah it's a hard job, but if you didn't want the challenge of a lifetime, why take the job?