VC Cliche of the Week

This week's cliche is one I hadn't heard until we went out to raise money for our new firm, Union Square Ventures, last year. It's a cliche more common among limited partners (LPs) who invest in venture funds than among the VCs themselves.

But its used to talk about an important topic. When VCs, who've done well with a particular style of investing, start to adopt a new style, the LPs call it style drift. And it's not a compliment.

I know style drift as I've done some drifting myself. And I agree with the LPs, its not a good thing.

I spent almost 10 years doing early stage technology venture capital at Euclid Partners and did very well with that style of investing. In 1996, I formed Flatiron Partners with Jerry Colonna We raised $150mm and decided to focus on early stage technology deals with an emphasis on the Internet which was just emerging as an investable theme at that time. For the next two and half years, we did nothing but early stage deals and had great success with our approach. It was possibly one of the all time best periods to be making early stage investments and we benefited as did everyone else in the early stage venture capital business.

In late 1998/early 1999, we got a much larger commitment from Chase Capital Partners which was our financial partner. This time we committed to invest $500mm. We decided to broaden the scope of what we were doing. We staffed up from the two of us plus an admin to almost 25 people. We went multi-stage. We did much bigger deals, sometimes as much as $10mm on the first round. We invested in hardware and mobile technology, two areas we hadn't had prior success or experience investing in.

The results were predictably poor. With a lot of work in the 2001 to 2004 period, we've been able to turn that portfolio around and will most likely produce a decent return on our 1999/2000 investments. But style drift wasn't a good thing for us and its generally not a good thing for any investor.

When we formed Union Square Ventures in 2003, Brad and I decided to avoid style drift at all costs. We invest in early stage opportunities in the applied technology sector. That's all we do and as much as we'd love to profit from China or energy or something else, we won't do it.

We are in a period of intense competition in the financial markets. That is not limited to venture capital. It's true in buyouts, hedge funds, real estate, even international markets.

The best way to make money in these super competitive times is to find a sector and a style that distinguishes you from your competition, stake it out, and make it your own. Be the best of breed in that specific style. And stick to it, even when the market moves away from you for the time being.

Because consistency and focus are rewarded over time. Chasing the style of the moment is not.

So if you are a venture investor, its best to avoid style drift.

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Posted September 7, 2005 in Venture Capital and Technology

Comments

Sounds kinda like 'if it ain't broke, don't fix it' to me.

Posted by: jackson | Sep 7, 2005 11:25:57 AM

Very interesting post on the most fundamentally important of topics and one can't help but have a reaction to it.

The whole thing kind of reminds me of the ongoing "value" vs. "growth" name game with institutional fund managers (ouch).

At one end, it doesn’t matter whether you're a "growth" or a "value" fund manager - you still can't beat the index- so who cares?

But the again, it's important to market your self, get a degree of differentiation and find anchors in the minds of customers.

So it is a strange thing...in my trivial experience....any other business, but money management, benefits from self stylization and marketing rhetoric (these are very important and valuable things)- but in financial markets, no matter how and what you call your self, rhetoric fails to make an impact on IRR unlike it does on other venture capital metrics.

Alas, we're back at square one to debate thesis driven investing, of which I am starting to think of as good old, contrarian money management because after all- what's supposed to happen when thesis driven investing becomes the dominant style, other than people starting to diversify again? That said, there is a lot to note about contrarian investing and going against the grain.

And, hell, all said and done- I sure would hope Bill Burnham would expand on his original post, seeing that Celsius is following the money and going East…and I don't mean New Jersey.

Link: http://billburnham.blogs.com/burnhamsbeat/2005/05/deal_flow_is_de.html

Posted by: Daniel Nerezov | Sep 7, 2005 2:57:10 PM

Fred;

Thanks for this fascinating post - you seem to always dish up the good stuff exactly when I need it. I appreciate your candor, there wouldn't be much to learn here if you only ever succeeded.

Question on early stage opportunities - with the growth in peer-production & social ventures, my theory is that most new online b-models are going to require less working capital to be launched than ever before in history. Add that to the rapidly declining cost of software development and the increase in solid open-source frameworks and it looks to me that we're headed for an even better time for early-stage investment - do you agree? In fact it looks as though many of the new ventures online won't even have to bother to look for "round 2".

Daniel - I battle to understand how thesis-driven investment dillutes focus. Please explain - here'a my totally uneducated perspective: Surely you need to be focsed to develop the thesis in the first place - if you're not an expert in the area of your thesis, it's not a thesis, it's a "brain-fart" and should be avoided no matter how much the "farter" is prepare to invest to see it happen.

The problem with thesis-driven investment is probably that it is a lot more difficult to write 10 good thesis' than to read 10 good business plans - a good thesis-driven investor is probably an entrepreneur who doesn't want to sit in the same office every day.

more great debate and insights at A_VC - thanks again Fred

Posted by: David Gibbons | Sep 7, 2005 6:19:41 PM

There's a big difference between a trade and an investment, right?

Wrong.

That's just a Wall Street mantra that needs to be uprooted.

Why is it that growth is associated with risky techs and semiconductors; why are buying shares of mega caps "not trades?"

I buy Home Depot (HD) -- America's 2nd largest retailer -- and pick up 3 quick points after the Katrina debacle -- did I trade or invest?

Can you "flip" stalwarts like HD, PNG, and KO?

The answer is yes.

"Value" and "Growth" are not opposites -- they're two sides of the same coin.

The bottom line is this: the trader/investor distinction makes little sense, if any at all.

Like good Derrideans (French philosopher Jacques Derrida was a former teacher of mine), we need to deconstruct Wall Street's most insidious binary.

Derrida, arguably one of the 20th century's most important philosophers, was concerned not so much with exposure of error but with an investigation into how we produce truth.

The contradictions of language were Derrida's silly putty.

If you stay in a position that no longer seems attractive just so you can stick to your philosophical guns and remain "value-oriented," the only thing you're doing is insuring your losses.

Capture gains as they come.

Pay the taxes.

And avoid dogma -- recalcitrance kills.

Dogma is for politics, not the Street.

Markets are fluid, mutable, and elastic beings -- our mentalities should mirror the same things we study.

Posted by: Catablast! Media Group | Sep 8, 2005 4:20:37 AM

This is regarding: "The bottom line is this: the trader/investor distinction makes little sense, if any at all."

Thank you for posting and maybe it's the financial planner in me talking, but I think a brief distinction between "trading" and "investing" is in order, for no other reasons than a bit of unsolicited advice on financial literacy.

"Investing" as a verb, is a largely misunderstood and abused bit of terminology, given way too many complex definitions which it doesn't deserve.

In essence, "investing" has little to do with financial instruments, markets, tickers, analysts, asset classes and/or different types of transactions. It's a lot more straight forward than that.

"Investing" is just a synonym for planning. That's all it is, good old planning. "Investing" starts with you figuring out where you are, where you want to get to and how you want to get there, and the kind of issues you're gonna be facing.

Trailing along on your financial journey, you might bump into all sorts of creatures like tax, estate planning, education, real estate, penny stocks, high tech private equity, blue chips, vintage wine, gold, oil and even bear put straddles for the more adventurous types.

With these financial instruments like common stock, warrants, CFD's, beach side condos and the like you'll have a whole bunch of procedures at your disposal like short term trades, indefinite longs and the occasional shorts.

So yeah...no mystery. "Investing" is just a bit of planning, an “Investor” is simply a planner and "Trading" is one of several procedures which you can do with financial vehicles that people drive to get to where they are going. Not all financial vehicles are any better than other financial vehicles- they're just different, made for different people who have different travel plans.

In Fred's case, Union Square wants to go to the stock exchange or an M&A bid within 5 years. The question is, whether traveling with China bound private equity is a good way to go about it, in which case, I don't know and my opinion is probably unwelcome.

I hope more people think about "Investing" because I can bet you; the average reader's financial itinerary is pointing no where but South. It's a national problem. People grossly underestimate their retirement needs and face a severe decline of lifestyle having left full time work. One of the reasons for it, is the same reason why having read this post the average reader will do nothing more than say “Yeah…I should get that checked out”, and quickly forget about the whole thing. It’s called myopia.

Unsolicited plug: See your CFP!!!!!!

[I sound like geek...eeep]

Posted by: Daniel Nerezov | Sep 8, 2005 9:38:20 AM

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