Super LP (www.superLP.com)

The Suburban in the Garage, Or Big Investors and Their Funds

About 15 years ago, I learned a lesson I’ve carried around ever since: when I was a rookie consultant visiting an industrial firm in the Midwest I got in a discussion with our client-side project leader about why people sometimes buy things that don’t make obvious sense.  “For instance,” my client asked rhetorically, “why do you think the Chevy Suburban [the only extra-large SUV at the time] annually tops the owner loyalty and re-purchase rankings when there are so many great cars out there?  You'd think every once in a while some other car would topple the 'Burban, no?  And who wants to drive such a behemoth, anyhow?"  Before I could whip up a smart-sounding, yet hollow textbook answer about key buyer purchase criteria or some such noise, he answered his own question, “what the heck else are they going to buy, though?  If you've got four kids or three dogs or a snowmobile you have to tow, there's just no other choice.  What’s the alternative?  Buy two cars and split up the family when you go out?"  

I’ve thought a lot about that story lately, as it offers an important metaphor for investors.  After all, like large SUVs, big venture and private equity funds have been getting kicked around a lot lately.  (And I think I can credibly say that I’d been an early and consistent (and sometimes unfair?) fist-shaker in the direction of some large funds.  Sure, there are some big funds out there that will be successful -- and to be clear, I don’t root against anyone; that’s bad karma -- but the arithmetic facing sizable funds is daunting.)  Yet, despite my ever-mounting cynicism and some good research and analysis that bolsters the small-fund argument, I’ve actually started to feel some sympathy for big funds and their investors and I’ll (not-so) secretly express a hope that larger investors stay focused on bigger funds.  After all, they’re like the Suburban buyers of the story: if they must go out for a spin, it just makes sense for them to find larger vehicles.

See, if you have a gazillion dollars to put to work, it’s actually pretty hard to execute a smaller fund-oriented program, even though many large investors are currently fetishizing such a strategy.  And to those investors thinking about jumping on the small fund bandwagon, I’ll note that such funds tend to be hard to find, challenging to diligence, difficult to “sell” internally, expensive to monitor (at least in terms of time), and catalytic of insomnia.  Indeed, I love my managers like I love my children -- all equally but differently -- yet the younger ones tend to keep me up more at night.  For sure, the rewards can be great and I’ve got high hopes for all the kiddies, but people never let me forget that I’ve taken a lot of career risk . . .

And then you get to the practical challenge: if an institution is deploying a ba-jillion bucks a year, it’s hard to do it in $10 million chunks.  Even if one could write a bigger check to a smaller (sub-$200M?) fund how much more would you want to do?  Would you want to be 25% of the fund?  40%?  Would the GP want you to be that big?  And if an institution is writing a bunch of $10 million checks, are they writing too many of them and seeding a whole bunch of competitors in a space?  Are they ruining the experiment by participating in it?  Stretching our tiring metaphor, if everyone’s trading in their Suburbans for a pair of roadsters and taking two cars out on family trips instead, all those incremental cars on the road will snarl traffic, no?

So let’s raise a glass to big funds with a toast of sincere best wishes for their success . . . of course, I’ll be explicit about my ulterior motive: keeping the small fund space the preserve of the nimbletons.  If big players continue to focus on big funds, it’ll be more beer for us.

Raisins in the Sun

Memo to self: check in with the crystal ball repair joint.  (That blasted crystal ball of mine's been in the shop for way too long!  I do have to admit that that it never really worked all that well, but I'd hoped that they could've tuned it up by now.)

In the meanwhile, I've been trying to avoid daring forecasts.  But here's a prediction that's not too saucy: exits of venture-backed companies will continue to be modest for as far out as the eye can see.  Sure, a company or two might ring the bell every now and again, but I suspect that we'll continue to be disappointed with the number of start-ups that crack the hundred million dollar exit mark each year.  And in a bloated overcapitalized world, that just can't be enough return to keep the teeming masses of lottery players interested.

But they continue to play and show no signs of letting up.  And hey, everyone's got a strategy – or at least a rationalization.  Who am I to say that my play's better than anyone else's?  I've got no monopoly on wisdom (and a broken crystal ball, too!)

Here's what I do know, though: markets are price discovery mechanisms and right now things seem a bit out of whack since different markets are sending us wildly conflicting signals.  In exit markets, the stats are daunting: no venture backed IPOs in Q2, M&A volume down considerably, sophisticated strategic buyers beating down valuations simply because they can, dwindling numbers of investment banks available to serve as public offering bookrunners, etc.  Meanwhile, private markets remain firm with round-to-round valuations up meaningfully, according to law firm Fenwick and West.  What's up with that?

I know, I know: we invest for the long term and today's public market gyrations should not affect start-ups that just begun securing reference customers or whatnot.  Yes, yes, I know there's a haves-and-have-not financing market where some companies get multiple term sheets while others go hungry.
Now back in the day, when I was trading public securities, the oldsters would extend a craggy finger our way and admonish us that, "there's a fine line between being right and being early".  Yet, what I've always loved about VC is that you get paid for being early.

All that said, isn't it bizarre that there will likely be aggregate mark-ups in many LP portfolios while liquidity markets are (and will likely continue to be) so bad?  The year-over-year benchmarks keep chugging along in VC; sure, many start-up companies are progressing, but progressing to what?  It's almost as if the train is accelerating into the oncoming wreck.  Cue the surging violins: there's . . . just . . . so . . . much . . . tension!

And at some point, this tension needs to get resolved.  Or does it?  Are the mark-ups a portent of good things ahead or just a snooze bar that allows us to pull the velveteen covers up over our heads and momentarily ward off the pearl-gray chill of morning?  Without an effective price discovery mechanism, it's tough to tell if one's throwing good money after bad.  And in that kind of environment, folks can seek out (selectively) whatever data confirms their hypotheses.

And that’s what keeps the Dollar and a Dream guys coming back.  It can be easy to overlook a lack of distributions when the quarterly reports look rosy.  Like a late-inning rally that energizes those fans that haven’t yet started making their way for the B, D, or 4 trains, there might even be a distribution every now and again to ignite the bonfire of hope.  But that fire needs dollars to keep burning – not just paper – and eventually, the flames will burn down to smoldering embers.  Will investors bail out before we get to that point, or will they continue waiting, watching, hoping?  

"What happens to a dream deferred?" asked Langston Hughes.  "Maybe it just sags like a heavy load / Or does it explode?"  Given the disconnect between public and private markets, I'm betting that the Dollar and a Dream guys are going to get just enough positive feedback that the former of Langston's possible outcomes will be true, not the latter.

Good Advice I've Gotten

I’ve gotten a lot of good advice over the years . . . it’s really unfortunate that I’ve forgotten most of it.  Two nuggets, however, keep rattling around inside my otherwise sparsely-populated skull. 

First, in my younger and more athletic years I played baseball.  Back then, I was a pitcher, although not one of those fireballers-in-training that got all the attention from the hotties and Division I-A coaches.  Nope, I was a dependable – but less flashy – finesse pitcher with a tragic flaw: whenever I started getting roughed up (which was often!), I always tried to overpower the opposing team’s hitters with fastballs.

Unfortunately, when your three pitch speeds are slow, slower, and slowest, trying to blow the ball past someone can become a dicey proposition.  Whenever this madness set in, Coach C. would come out and say, “don’t compound your mistakes . . . you’re in a hole; stop digging.  Get back to your game plan.”

The second chunk of wisdom was imparted in the early part of this decade by an LBO pro who was reflecting on the just-past ebullience in Venture World:  “Always remember that any form of value-added, hands-on investing works best when time is cheap and capital is expensive.  Unfortunately,” he continued, “in frothy environments time becomes very dear and capital becomes very cheap.”

Implicit to this statement was an assertion that a pendulum swings between ebullience and sobriety, between spirited overextension and thoughtful focus, between openhanded wagering and miserly risk aversion.  Here’s my question, though: whatever happened to the swinging of the pendulum?

Despite a hiccup here or there (including the recent mega-cap buyout world lock-down,) the velocity of money has been accelerating across PE world.  Sure, the deal pace has slowed lately, but transactions are still getting done and double-digit billion dollar funds continue to get raised.  And all those dollars will have to go somewhere.

At the same time, we hear tales of woe about slouching return expectations and I’ve lost countless hours of sleep worrying about compressing risk premia.  It’s a prisoner’s dilemma, of course.  Returns are going down because too much money is being put out, but a sizeable number of GPs (and LPs for that matter) don’t want to stop putting money out because they don’t want to sit on idle cash.

And why not sit on idle cash?  Because that prevents people from going out and raising their next fund which in turn postpones the augmentation of their fee stream.  Maybe I’m painting with too broad a brush, since I know plenty of managers who are still capital gains motivated and not just W-2 focused, but it just seems that a handful of folks are enjoying robust enough fee streams that they can look at their carry as a nifty free option owned at their limited partners’ expense.

Since all economic analysis is done on the margin, it’s these current income focused cats who are inverting the time and money equation.  You can’t begrudge them, though, since their incentives are clear: get the money out fast, get involved in too many things, see what sticks, and raise the next fund.  As long their investors allow them to keep raising subsequent funds, there’s no disincentive to stop.

I just hope that along the way – when times inevitably get tough – we all have the wisdom to know that we’re in the hole and should stop digging.  Compounding your mistakes is the worst thing you can do when trying to compound capital.