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Scars From The Last Bubble
In general, I think entrepreneurs and VCs who lived through the last bubble and its burst are better off because of it. We’ve seen what can go wrong and what happens when it does go wrong. I think it has made us all better at what we do.
But there are some scars that may not be all healthy. For example, in 1999 we stepped on the gas and made something like 20 investments at Flatiron. Many of them worked out well and we booked a bunch of profits in 1999 and 2000 from those deals. Of course a good number of the 1999 investments we didn’t get out of before the bubble burst went bust or went through painful recaps which are actually now paying huge dividends.
Fast forward to 2006 and Union Square Ventures is going to make maybe 5 investments this year. We made 4 last year. We are taking a cautious measured approach to our investment pace. That was one of the lessons we learned from the last bubble. Stepping on the gas before the crash is a good way to get hurt.
But there are VCs who are stepping on the gas right now and are getting rewarded for it. Are we being too cautious because of the scars we carry on our back from the last bubble? It’s impossible to know. But hindsight will tell us the answer in a few years.
I was in a board meeting recently and the founder, who ran a different company during the bubble, was talking about his team. He said the team was getting a bit uneasy about all the new hires that the company is making. It reminds them of the time they bulked up in the last bubble. And that bulking up caused a lot of pain when the market broke.
Pattern recognition is human nature. When you’ve seen the movie before, you know how it ends. And so all of us who carry the scars from the last bubble are going to think twice before we make the same moves again.
But what if the same moves we made last time are the right moves to make this time? Then we are going to sub-optimize this current market opportunity. We are going to be too defensive. And someone else is going to step on the gas and pass us at the next turn.
It’s a challenge that we have to face. We cannot forget the lessons from that last bubble. But we cannot fight the last war either. As much as things look similar to the last time, they are not identical. This will play out differently. I am not sure how differently but I know that it won’t be the same.
So carrying those scars is both good and bad. Probably more good than bad, but not all good either. And it’s important to recognize that.
July 22, 2006 in Venture Capital and Technology | Permalink
Comments
Warrenn Buffett made more money than you or I will ever see by being highly selective in his investments. Seems to me, of all the things to worry about, not investing in enough companies is the last thing one should concern one's self with.
Posted by: Dave | Jul 22, 2006 11:04:13 AM
Every situation is going to be different in some way. History repeats itself and pattern recognition helps prevent big screw ups. However, it can be the little things that can completely make the situation turn a positive 180.
In the end, it's the quality of the management team and their ability to evaluate the situation that matters. If the team feels that more staff should be added, then do it. I would also have the team talk to the staff to explain the benefits of their actions.
"Measured Risk Taking"
Posted by: Jp | Jul 22, 2006 1:14:34 PM
I think the pattern recognition algorithm in our heads generally benefits from significant events like the last bubble bursting. It gives us an idea of what *could* happen so we can adjust our thinking accordingly.
Though there is a chance that we over-amplify a single event in future decisions, I think the big upside is we do begin to ask ourselves what makes this time around different.
As we look at new opportunities (both from the entrepreneur's perspective and the investor's perspective), I think it is helpful to ask: What are the things that make this particular situation different from last time? If the answer is weak, there is a chance that are are indeed reliving large parts of the prior pattern.
This is one of the big things that fueled the last bubble bursting. Too many people believed that "everything has changed" and responded accordingly. Now, the question is: "Has enough changed to make this time around different?"
Posted by: Dharmesh Shah | Jul 22, 2006 1:37:28 PM
difficult to be contrarian, and at the same time not wrong / stupid.
;)
Posted by: Dave McClure | Jul 22, 2006 3:13:27 PM
Dave(s) - I actually think it's more about "having a strategy and sticking to it." Some investors have been hugely successful making lots of investments (and setting up a structure to manage them accordingly); some have stuck with a strategy of making a few large investments. The challenge - in my opinion - is to believe in your strategy and not flop around based on what is happening exogenously to you. Buffett and Munger are great examples of this, but there are good counter examples of different strategies.
Of course, when a strategy fails, is a bad strategy, or becomes obsolete, you should revisit it. However, deciding a strategy is obsolete is very hard to do (correctly.)
Posted by: Brad Feld | Jul 22, 2006 5:26:23 PM
viewed in a larger context, it seems to me that venture capital is broadly cyclical -- that investing at the front of, or during, a significant technology platform emerging, pays off, and investing when no such transformative event is occuring or about to occur, is not always a losing idea, but a helluva lot more difficult
to wit, i'd argue that some (maybe all) the great platform shifts of our modern epoch are/were
steam engine
railroads
alternating current
telegraph/telephone
plastics/synthetics
commercial aviation
pennicilin/modern vaccines and pharmacology
film/radio/TV
transistor
microprocessor
mini-computer
micro-computer (PC)
internet (which includes all TCP/IP or packet based devices and uses)
mind you, VC hasnt been around all that long, maybe 50 years.
but in that time, you can easily observe the ebbs and flows of successful VC investing -- and the sometimes painful lulls between platforms emerging. most of the veterans are gone, but VC investing was in a long dry period prior to say 1993/94, as the micro- and mini-computer platforms became mature (so no more young fledgling Wangs, Apples, Oracles, DECs, Microsofts, et al to back) yet no commercial internet yet on the horizon
so whats the new platform now? mobile? IMHO NFW -- just more TCP/IP. Web 2.0? dont get me started. oh, the next big disruptive platform is out there, maybe just a half-baked brain cell in some 17 year old geeks tender cranium. but i think VC investing today is still largely hangover from last big boom. there'll be money made for sure (there always is) but the supply of capital (unbelievable amounts of VC funds sloshing around now) outweighs by far the supply of truly disruptive innovation and novelty needed to fuel enough VC-sized returns on that massive pool of dough. but LPs are way flush from the last boom (regardless of how much they maybe lost in the meltdown) and now are chasing the last boom, addictede to the possibility of outsize returns, and/or chasing Harvard's and Yale's endowments (they look bad lagging so far behind and cant admit that they are just inferior talent). and VC firms are happy to take it all in. who wouldnt be? fees are wicked huge and timelines are wicked long, and hell, despite protests to the contrary, it is a hit driven business and its not really clear that anyone is better than anyone else (with a few excpetions) at finding hits...
Posted by: steve | Jul 22, 2006 6:46:03 PM
Nice post, I think a few people aren't thinking the same way you are and that is unfortunate.
Posted by: David | Jul 22, 2006 11:53:58 PM
Gosh - this really rings a cord with me. I know a bunch of Web 2.0 entrepreneurs who like myself built Web 1.0 companies (most of which became profitable). We frequently discuss this issue of did we learn enough or are we over-learning. In dating paralance, overlearning is called getting jaded and it not good.
With our recent strategy shift to a search focus I can tell you that many employees at the company are more relieved as they can see a clearer path to money.
Munjal Shah
Riya.com
Posted by: Munjal Shah | Jul 23, 2006 12:23:31 AM
From down at the bottom:
1) The 1999 bubble was a mega-bubble that happens only every 35 years or so. We shall not see its likes again until around 2035 (probably biotech then).
2) We are now at or near a cyclic top, which is not the same as a bubble, but still a place from where things can only get worse. The sign is simple - a lot of people are chasing an unsustainable business model, eyeballs/advertising. That works as along as the economy is expanding. The next recession (which is close, given the Federal funds rate, and yield curve) will kill many of those companies, as the advertising budgets get slashed.
Posted by: Seth Finkelstein | Jul 23, 2006 2:18:47 AM
Incredibly Timely Post Fred --
As I sit here trying to figure out why in the world the Huffington Post is looking to raise $5MM dollars (http://www.privateequityweek.com/pew/freearticles/1152907879342.html)
...I wonder if I am so burned from the last bubble bursting that I am just being too conservative with some of my investments in online media properties? I understand the economics of her business; I understand they also just outsourced all ad sales to IAC; and I am just having a hard time with why the $5MM? Granted I know how to get things done technically much much cheaper than perhaps a more traditional media company, but how will that much cash actually generate the additional growth required? The whole point of these businesses is they are incredibly capital efficient and highly highly scalable. Raising additional capital just sets the bar that much higher for exit. Fred, I've discussed this with two other private equity guys - one Venture, one more of a buy out guy -- and they share my thoughts. What do you think? Even with a PR investment, its hard to get to $5MM and with her traffic she should be generating cash you would hope.
Interested -- this is completely spot on to your post -- am I being too conservative is exactly the question I am asking myself.
Posted by: Al From Chicago | Jul 23, 2006 12:06:47 PM
We know little about the way the brain works. But one of the things we do know is that it's extremely efficient at pattern-recognition...even to the point where it will "recognize" patterns that are not, in fact, there. This is the underlying driver of optical illusions, and the problem with stereotypes.
And many of these apparent "patterns" are self-reinforcing: if presented with an example that runs counter to our assumption (i.e. a fund that is aggressively investing in companies in a compressed timeframe, and experiencing success) the natural human tendency is to *exclude* that data point as an "exception" to the pattern we are attempting to establish (i.e. don't invest in too many companies at once).
I think broad conclusions like this have limited usefulness. Especially when there were so many other market dynamics leading up to the bubble and the burst. The sheer number of investments, IPO's and acquisitions taking place during that period established a herd mentality where quality bets were mixed in with substandard ones. However, the contrapositive is not necessarily true: that a multitude of investments over a short period of time is defacto bad business.
I agree with many of the commenters here, Fred, especially Brad Feld: you and your partners have a great track record, and a solid strategy. Hence, you should invest in as many companies as you identify as high-quality.
Megan Cunningham
Zoom-in.com
Posted by: Megan Cunningham | Jul 23, 2006 1:04:32 PM
And one more thing RE: the Huffington raise of $5MM. I couldn't agree more that the attractiveness of new media companies is in the minimal overhead and infrastructure required to get off the ground. However, the limitation of these companies is equally apparent: they rely on a tiny heroic team to produce content that competes with the big media companies, and rise to internet fame overnight. Witness RocketBoom, and their $40K/week in ad sales for a daily videoblog on the backs of a micro-team of people.
The question I would pose is: how sustainable and scalable are these new media companies? When Amanda Congdon (the one and only on-camera star) left Rocketboom, that almost meant the end of the whole shabang. The resulting blog flurry revealed a very overworked team lacking the basic professionalism that comes with an org chart, regular meetings, a product development plan that all were on board with, etc.
So without outside capital, I think the web 2.0 hits will be few and far between. Your question of how Huffington plans to spend it all, that's a good point. But I would recommend it go to 3 areas:
1. video and audio features (the future of syndication of A/V media is bright, and the CPM's it's commanding far outpace text-only blog ads)
2. sales and marketing (not outsourcing its revenue-pursuit, which is always a bad idea - no one cares as much about hitting your growth targets as you do, no matter what the comp pkg is)...and
3. support staff (like a cable TV production company, not a huge group is needed but there is a requirement for a core team that can keep the empire a float, and operate on its own when Arianna decides she needs a break.)
Posted by: Megan Cunningham | Jul 23, 2006 1:19:51 PM
Not to toot my own horn (too much) or anything, but you really should read this: http://www.dead20.com/2006/07/16/11-suggestions-for-not-being-a-dot-bomb-20/
Posted by: Skeptic | Jul 23, 2006 7:03:18 PM
I know that it is easier said than done but I think that you need to resist the urge to ramp up your investment activity.
You may leave some money on the table in the short term but I am sure that it will save you (and your investors) a lot of money and aggravation later.
Before becoming a venture capitalist, I worked at a hedge fund with two of the world's most successful traders.
They spent a lot of time analyzing their actions and the actions of other successful traders in order to better understand why the things that they did worked.
One of the things that they discovered was that it was the ability to stick to one's system that often led to success.
If you have a system that works, then stick to it.
Incidentally, one of the other things that they discovered was that traders who were part of a community performed better than traders who worked alone.
Without getting into anything technical (or confidential), the reason that this works is because the ability to talk to others engaged in the same activity can help fortify and reinforce you when your discipline (ability to stick to your system) weakens.
Hence the value of your blog--for creating the community--and Brad's post--for reinforcing your discipline by urging you to resist temptation unless your strategy fails, is bad or has become obsolete.
Posted by: Simon | Jul 23, 2006 9:29:08 PM
thanks for the post, fred. it is particularly relevant for me as i work to build a company, have memories of (though not first-hand experience living through) the tech wreck and wonder every day about the issue of over- or under-investment in the product. with so many degrees of freedom and with so much outside of one's control, i guess all you can really do is fall back on the one thing that separates the long-term successes from the short-term flash-in-the-pans - world-class process. for you, it is following the process of the multitudes of successful investments you have made over the past few decades. for me it is executing against a well-conceived plan built up by and bought into by the team, dealing with exogenous factors as they arise (i.e., changes in the competitive landscape, market conditions, etc.) and hanging on as the inevitable fears and uncertainties arise. i think w. edwards deming's focus of reducing variation in all you do is the right message, and will automatically yield the right answer for you concerning how often you should be pulling the trigger in today's environment.
Posted by: roger | Jul 24, 2006 12:19:19 AM
We are hiring and can afford to because of revenues & a decenlty managed net burn. We hire 2 months ahead of growth, so we can throttle back at any time and be two months from full sustainability. Our training curve is about 6 weeks, so we have a few weeks over slight over capacity in theory, but it never works that way; there's always more work to be done than bodies to do it.
But one thing we do every 2 months is review what we're doing and how we're doing it, and usually cut some things out and hone our focus. We hire for need. I know we need 3 product managers in the next 4 months, so we'll start recruiting and hiring now (hard to find the right PM around here).
If your company has enough buffer and hires for need a few months ahead of it, growth will be measured and comfortable, not speculative and nerve-wracking. it might be slower than your appetite for it, but at some point you have to reduce your speculative hiring and go more on what you know.
If you know you can add 4 salespeople, manage them well, keep them flush with leads, and get them up to average sales rate and ASP within a reasonable period (depending on your cycle), then that's not much of a risk and you should be doing that. If you have a hunch a product will sell if you just throw 10 people at it, you're not likely to get the results you want.
Posted by: charlie crystle | Jul 24, 2006 10:23:16 AM
I think Seth Finkelstein above has it right. This Web 2.0 thing is mostly just hype and doesn't represent any sort of true technological revolution.
If there is any lesson to be learned from history, it is that the next technological revolution that creates the new billionaires is not going to come from as predictable a place as "the internet". It will emerge rather suddenly from the most unlikely of places and only a select few will have been in the right place at the right time to have been able to profit hugely from it.
Posted by: Aran | Jul 24, 2006 12:13:03 PM
If only a fundamental strategy gave strong signals on TIMING.
A successful strategy will look seriously wrong at different times of the public equity cycle.
Like it or not realizing value from investments requires that the timing be right relative to the overall market.
Your Pattern Recognition might be RIGHT, and the TIMING slightly out.
Still, Warren Buffet seems to get it right practically every time. He dismissed the 2000 tech bubble completely.
Posted by: Paul Elosegui | Jul 24, 2006 4:13:10 PM
Hi,
To kind of sum up my opinion after having read your post and various other comments I would take help of this quote that I heard sometime ago somewhere ( will post when I track the source). "In these time of uncertainities what is needed is to have strong opinions but weakly held"
Posted by: Rajan | Jul 25, 2006 9:50:26 AM
If there truly is a wiser more pragmatic air to the VC crowd right know, what are the shifts in perspective they are brining to the table at Web 2.0 investment pitches?
What key points do entrepreneur’s need to be demonstrating about their company to differentiate their business model from a web 1.0 hype driven company?
We know the financials are key, as well as shorter term profitability. But the winners out there: Flickr, YouTube, MySpace, are viral to the core, which is what set them apart from the crowd.
Is the VC willing to overlook the balance sheet again in the quest for viral? Maybe the better question is, where is the middle ground between the two (Financials vs. Viral)?
We now Financials x Viral = Web 2.0 utopia
Posted by: Hasan | Jul 25, 2006 12:26:47 PM
A second dotcom bubble is indeed possible, but not with the same ferocity as the 1999/2000 bubble. VC firms are more selective the second time around. they are investing in larger scale, successful business models. the days of cutting checks stock options and rooftop parties are over. you are seeing more leverage, several VC firms co-investing. more control over the management team and setting hurdles that management must meet. very few dotcoms have gone public compared to the last bubble. investors want to see sustainable competitive advantages, strong management teams and earnings. there is quite a bit of VC money flowing into dotcoms, but less of a rush to go public. the problem with the internet is that there are virtually no barriers to entry. anybody can setup a website. to be truly successful you must have technology that are closely tied into the business model. i still believe that a brick-and-mortar and internet combination is the best way to go. investors can touch and feel. they can see the products, meet the people, it is not imaginary built strictly on some digital vision. i hope that vc's continue to be selective to avoid the errors of the past.
Posted by: Tommy Toy | Aug 13, 2006 3:26:58 PM
I think a lot of these experiences were felt across the board. When I was in Cisco 1999, we did large deals like Cerent for close to $7B, and Geotel around $2B. The reason is that overall market values topline growth. At P/E > 80 and market cap around $500B, almost all acquisitions for Cisco become a nice add-on. Man, that was painful to deal with in 2001 and 2002, the hangover took a long time to complete. We all learn those lessons from the past, nice blog...
Posted by: Ray | Sep 8, 2006 3:13:23 AM
steam engine railroads alternating current telegraph/telephone plastics/synthetics commercial aviation pennicilin/modern vaccines and pharmacology film/radio/TV transistor microprocessor mini-computer micro-computer (PC) internet (which includes all TCP/IP or packet based devices and uses)mind you, VC hasnt been around all that long, maybe 50 years.
as for individual or collaborative artists, well we have been around for thousands of years.
Maybe it is time to invest in art, for arts sake. Good god, it is staring you all right in the face that it has caused perhaps become so good that you think these people just live on love alone. In this day and age as every age before us, artists are the only people who digest probable possibilities on all things human and worldly.
You speak of investing millions... that is way too big.
How about investing it in smaller chunks. You have one million dollars to say invest anywhere you want, literally. And probably many of you do. Divide that $1,000,000 into 30 equal parts and giving $33,300 a year (middle class)to individual artists.
Art stands the test of time. And with the present technology as it is, in could last ad infinatum. That, I believe, is what web 2.0 is about. It would give the populace of the world art to view digitally, created 24/7.
Web 2.0 can't only be about a bubble. I think of it as a square, that spirally turns, expands and contracts like a fractal.
You guys are talented with money. Artists are generally talented at art.
Please read these definitions from:
art - http://dictionary.reference.com/browse/art
money - http://dictionary.reference.com/browse/money
Anyhow, this was a great read, post and comments both. I think sometimes we need to cross-polinate in the blogosphere... we all become a little more educated, tolerant, aware, understanding and above all, honest and trustworthy just by doing so.
This is collective conciousness. Money needs to be shared just as much as art does.
Posted by: Jessica Doyle | Sep 25, 2006 7:43:57 AM
