Long time scales in venture investing: a feature, not a bug
Tough venture markets, as evidenced by difficulties in getting companies financed, lengthened IPO timelines and slowed M&A activity cause LPs and GPs alike to stress out — hard. The conversion of TVPI into DPI, always elusive, becomes an even more distant fantasy. Firms with deep in-the-money portfolios, even when marked against current valuation realities, might consider continuation funds to give their LPs some cash during lean times and GPs a measure of hard-earned carry. But other (seemingly) unfortunate market participants might be stuck with the notion that any hope for portfolio realizations have been pushed back many, many years. This is how investments in illiquid, long duration assets work: you don’t always get to choose precisely when you want to exit, and that moonshot you backed might be coming of age at precisely the wrong time to secure the anticipated rewards. But is this necessarily a bad thing?
As I’ve written on numerous occasions, markets, portfolios and, in fact, many systems in life take the shape of barbells. It’s tough to be in the middle — are you artisanal, built for scale or stuck in between? Are you risk taking, risk averse or a combination of the two? My personal approach to venture investing has been to use the powers of illiquidity, convexity and the willingness and ability to withstand extreme pain and delayed gratification for maximum compound returns. This is why I’ve generally invested at the very beginning of a company’s life when these factors are at their maximum, a point at which most investors are loathe to make a concentrated bet. In addition to the factors above, perhaps the most important from a psychological perspective is that I’m not afraid to look stupid, lose money or feel concerned about “losing face” or damaging my reputation. Some might say “How could such a historically good investor make such a dumb bet?” as one of my companies flames out. Others might think “After all these years, wouldn’t you think that Roger would know better than to make [x, y or z] mistake?” as another does a sharp layoff. The bottom line is that if you want to be in this business and to have the chance to make exceptional returns, taking these risks are part and parcel of doing it right. This also means having the temperament to execute this strategy, and to have LPs and partners who understand this and share the same degree of zen that you do (and must have). If you don’t have the time, the patience, the steely nerves and the conviction to play the game this way, my advice is not to play it at all. But if you do, leveraging these unusual factors for your benefit constitutes a true superpower that will help you in both the venture business and in life. Who wouldn’t benefit from more patience, perspective, equanimity and confidence? In the realm of “steel sharpens steel”, I feel that my adaptation to being a seed stage venture investor has truly made me a better, more effective human.
Funnily enough, I saw this question on Quora a mere two years into IA Ventures existence and had to answer it immediately, and then to follow up five years later. The question: Has IA Ventures exited any of its investments?
Nope. And given our life-cycle approach to investing, I have to say that I’m deeply thankful.
We invest as a traditional venture firm (albeit investing earlier than most established firms), in the sense that we are building a relatively concentrated portfolio of investments and reserving very heavily for follow-on investments. We are working with founders who are seeking to build very large, profitable, truly differentiated businesses, for whom an “early exit” is not the goal. Many of our founders even have a “chip on their shoulder” about not selling out before they feel their companies have reached their full potential, as if it would be an injustice to their customers, their mission and themselves. I personally love this attitude.
Sometimes selling early is the best thing for both the founders and the investors, and I’m not the guy to say “don’t sell” if the founders have already crossed the mental rubicon. However, these outcomes are not going to drive the kind of cash-on-cash returns we want as investors or as stewards of our LPs capital. So we actively push on the founder’s true mind-set prior to investing, to make sure that we are mentally aligned at least at inception. As we all know, attitudes change with time and circumstance, but having an active discussion about the founders’ goals in conjunction with our own at the outset has been incredibly valuable for deepening relationships and avoiding surprises in times of stress, e.g., when an acquisition offer is on the table. Because if the first time this is being discussed is in the heat of an M&A offer, it is frequently a painful and frustrating experience for all.
I hope this helps.
EDIT 4/18/2017
Over five years have passed since I first penned this answer, and two significant exits have occurred: (1) the 2/20/2014 sale of Simple to BBVA for $117M; and (2) the 9/21/2016 IPO of The Trade Desk. While the Simple sale was not notable for its scale in light of our investment objectives, it played a critical role in The Trade Desk story: the sale proceeds enabled IA Fund I to recycle significant capital, a large chunk of which was invested into The Trade Desk Series B round. And given that TTD now has a market cap of around $1.4BN, the $3M invested out of our $50M fund is now worth more than $15M or 30% of committed capital. IA Fund I was able to convert part of our TVPI into DPI in the wake of the 2/28/2017 secondary sale, where we sold 2.5M shares of our 6.6M share position and returned more than $75M — or 1.5x committed capital — to our Fund I LPs. And our residual position, at current prices, is worth another $150M, or 3x gross/2.4x net Fund I. Suffice it to say, we are thankful and proud to be a part of such a great business, and working with such wonderful entrepreneurs and co-investors.
These intervening five years were necessary for the IA Ventures strategy to play out — even just one time — for our founders and for our LPs. Given that we invest so early, in the case of TTD before a single line of code had been written, we are necessarily playing a very long time-scale game. And when we are aligned with founders who themselves are self-motivated to build businesses of such scale, even acknowledging the many, many years necessary to do so, magical 50x outcomes intersected with significant ownership can change the lives of founders, employees, LPs and GPs. We are now a firm that has “done it” — been lead investor in a company that has gone public, and where we’ve returned significant capital to LPs with the promise of much, much more. But I couldn’t have written this 5 years ago, because after only 2 years in business our institutional seed strategy didn’t have enough time to gestate. But after 7 years, we are now seeing not green shoots — but actual trees — resulting from the seeds planted those many years ago.
We still have a long way to go, with many more seeds to plant and trees to pick, but I am now happy to provide the overdue update that IA VENTURES HAS ACTUALLY EXITED INVESTMENTS.
Fast forward ANOTHER seven years and here we are. Seeds were planted during this time period resulted in four IPOs (TTD/DDOG/DOCN/WISE) and a host of interesting companies that more than 13 years later STILL have room to run. While some periods during this almost decade and a half have been great for listing strong performing high growth companies, there were very challenging times as well. But what we did not do is to force it. If a company is great, it’s great and compounding capital at rates that both we as GPs and our LPs are excited about, so what’s the rush for liquidity? The best institutional investors and family offices manage liquidity smartly and put early stage venture into a “do not touch” bucket and forget about it from a liquidity perspective. It’s all about long term cash on cash returns, and the cash will come eventually. Liquidity can be deployed from other buckets: early stage venture represents a portion of the “swing for the fences” part of their portfolios. Early stage venture investing and liquidity concerns don’t mix and, in fact, dampen the very superpowers that give top performing investors their unfair advantages. So the next time you read about early stage investors bemoaning the fact that the IPO market is closed, M&A markets stink and LPs are breathing down their necks, you can be assured this is due to either of two reasons: (1) they don’t have very good companies and are looking to be bailed out by easy money markets or profligate acquirers; (2) they have the wrong LPs; or both. Don’t let competing narratives fool you. This is the straight deal. Illiquidity is a feature, not a bug, and don’t let anyone tell you otherwise.
