Recently in the it industry, writes mark Suster, there is an ongoing debate about why the cost of some start-UPS and tech companies plummets — as it happened, for example, with game Studio King (the company in 2015 acquired gaming giant Activision for $5.9 billion, and the cost of the King after the IPO in 2014 reached $7.1 billion) or payment company Square (the companys capitalization after the IPO amounted to $2.6 billion, while pre-IPO investment round, the investors estimate the value of Square at $6 billion). It is important to understand that to value any company is a difficult task, as it is necessary not only to rate herself, but also to predict its further growth, competition in the market and the profit it can get. The mood of investors was affected by several major events, says the author of the material, — including a fall in the value of the it giants LinkedIn and Twitter, as well as the reduction of investment Fund Fidelity estimates some of its portfolio companies (for example, the estimated cost was reported by 25%). “Most venture capitalists, who have long been working in the technology business, foresaw such an event — in the narrow circles of conversations about this were in the past two years, explains Sister.
— I would like to share my opinion about what is happening in the tech world. Most of the judgments that I hear from entrepreneurs is not only wrong, but also remind me of what I heard from 1997 to 2000, before the bursting of the dotcom bubble”. Mark Suster interviewed about 150 of their friends involved in venture investing. He asked them to describe their own emotions regarding the situation on the technology market. 82% of respondents said that prefer to act with caution, while only 18% expressed optimism.
“I want to emphasize that this is a “blind” data — I dont know what kind of investor or the company have given a particular answer, says Sister. — None of the respondents had no reason not to talk about his true attitude to the situation”. “For such sentiment is the reason. Many of these people own large shares in private companies who are already looking for or planning to seek new funds in the near future.
Thus, it is likely that assessments will continue to fall — about 90% of investors believe me that trend will continue for the first six months of 2016,” explains Caster. According to the investor, he talked with colleagues on the topic of the fall ratings in the past couple of years, and published some notes on his blog. “It hurts me to see people write to me on Twitter. “Venture investors simply want to assess is down!”, “It will be just fine for investors but very bad for businessmen, mark is interested in projects for fall”, “fall Assessment, because venture investors talking about it”.
It is not true”. “I started blogging because I was inspired by the approach known investor brad Felda (author of “Attracting investment in startup”). When I was an entrepreneur, I could not find out how it works venture Fund, the investment treaties and so on. Brad wrote a whole book about it, which openly spoke about the processes in the investment Fund. I wanted to try the same approach,” writes Suster.
Almost every smart investor, with whom I talked in the last two years, talked about how ridiculous most startups, and that soon they will pay. Most of these investors, said Mr Caster prefer not to talk about their fears publicly, for two reasons. They own shares in such start-UPS, but also afraid to gain fame as people who want to hinder the success of entrepreneurs. “Let me be with you even more honest. I personally do 2-3 deals a year, and our investment company — about 10-15 transactions.
We invest approximately $40 million in new companies per year and about $40 million at a later stage. In 2015, the total investment in technology companies in the U.S. totaled $77 billion. Ill spare you the calculations and say that we have funded approximately 0,104% of the market”, writes Suster. “No, most investors dont want. However, there are several reasons (not what you think) for which investors would like that they fell,” explains the author of the note.
“Imagine that you own a property and would like to purchase another. You have 10 objects, and you probably will buy 1-2 more objects within the next 10 years. Real estate prices start to fall. You think “Excellent. Now I can buy more real estate at lower prices”.
In fact, everything in life is a little more difficult. You really think that was going to sell two of these objects, which seemed overpriced. Now nobody wants to buy them, and the status of your Bank account forces you to suspend investments in real estate.”. According to Castera, feel it and venture investors. Many experienced investors are 7-10 boards of Directors of companies, most of which need additional funds, and the first thing they feel at lower ratings — dissatisfaction and desire to help their portfolio companies with investments.
Yes, they understand that the more down-to-earth assessment will allow companies to obtain higher profits. However, right now it brings more pain than joy. “In short — no,” writes Sister. In 2010, the co-founder of the publication TechCrunch Michael Arrington accused a group of 10 investors in Silicon valley in fixing assessments startups. “This is complete nonsense.
Of course, 10 investors can fix the price in the investment market. During the last seven years of evaluation have shown a steady growth,” explains the author of the note. One person cannot manage the entire market — for example, to derail it — just because its the market. The head of the Federal reserve Bank is likely to disrupt the market, the head of the United States, China and Iran, also. But not a venture capitalist — neither I nor bill Gurley (have invested in Uber and Snapchat) cant do.
Sister gives three reasons for the assessment of technology start-UPS have become inadequate to their real value. Since 2009, says mark Suster, the volume of investments in the technology sector grew by 300%. In the boom of inflated estimates, the investor believes, is not guilty of a venture company, and the sources of “innovative financing” (hedge funds, insurance companies and others).
“10 years ago, for every dollar raised venture capital Fund, had a single dollar invested in a startup. Today, one dollar bought us $2.5 invested in a startup,” concluded Sister. According to the author notes, despite the widespread belief that the investor is not required to be an expert on your market, an important role in determining the value of the company is played by the understanding of the dynamics of the market.
“The basic macroeconomics of the graph — the curve of supply and demand. The demand represents the buyer, and the supply of the seller. In our case, the buyer is a venture capital Fund ready to acquire a stake in a start-up. If the market equilibrium of supply and demand will set the price of the product. Some products are “inelastic” — in the sense that at higher prices the demand for them falls.
There is also an “elastic” products — the demand for them rapidly decreases when the price starts to grow.”. Sometimes, I Sister, the demand curve shifts — this occurs as a result of some significant events. In the situation with venture capital financing this event was the accumulation of a large number of “non-venture” capital, the owners of which wanted to obtain their funds from more income, as well as the successes of Facebook, Twitter, LinkedIn and the expectation of huge profits Uber, Airbnb, Dropbox and so on.
About $50 billion of additional capital has suddenly appeared on the market, and prices shot up dramatically. The classical shift of the demand curve. The result. Estimates have tripled in just two years, and then began to experience a sharp drop.
“Most entrepreneurs believe that a high valuation for startups is good. Most reasonable investors, although do not advertise it publicly, I assume that its not good,” writes Sister. Such conditions attract people who want to earn quickly big money, and huge amounts of funding lead to massive inflation. When funding levels are lower, many potential entrepreneurs prefer to stay in a stable company (like Google) on a good salary, and the market consists of only “hardcore” entrepreneurs. Most venture investors such a situation more to their liking.
Investors in the later stages of funding (such as hedge funds), notes Caster, establish estimates on the basis of expectations about how the company shows itself on a public market. “And when the valuations of public companies falling, falling and evaluation at the later stages of financing, though it makes it slower”. “If you participated in the round and invested $50 million – $100 million, and 18 months after that other investors invest in the company more than $200 million, the rating bother you less. However, when you become increasingly difficult to sign new deals, you become more sensitive to price changes,” explains Sister. “If you usually invest in the round And $15 million in the company, but increased competition began to invest $40 million, so the problem was leaked on this level.
This happens even at seed level. In 2009, startups in this stage received $4 million – $5 million. Now they receive about $10 million and more.”. “Lets go back to my example with the real estate. If you are thinking about buying a house, and prices suddenly begin to fall, you are likely to wait some time before making a purchase — so will hope that the price will fall even lower,” writes the author of the note.
“Investors call it the “catching a falling knife,” and psychologically its very hard. Delayed transaction — the investors are trying to assess the situation and care about the state of their own portfolios”. “Many entrepreneurs dont understand what are the challenges of working with companies. “If last year you liked my company, why dont you just give me more money that a startup could survive for difficult time?””, I Saster. The first obstacle for the investor is financing policy.
“Sole investor may be willing to support the company and further, but if took part in the funding and other funds, or people, he does not want to allocate funds alone,” explains the author of the note. In addition, he notes that the portfolio company is often not one company that needs funds, so the Fund partners have to figure out which ones are “worthy” to receive additional funding, and which arent (Caster calls this process “sorting”). Now imagine. You “sort” companies from their portfolio, spend the time to negotiate with other investors and entrepreneurs themselves, who are not going to cut spending.. You still want to participate in yet another round of investment of the new company?.
“I dont even mention the internal processes in each Fund in any company we have 1-2 partners who enter into more bad trades than others, which means that any partner can deceive the other, trying to protect their own investments. As a result, the financing may get someone who doesnt deserve”. “Lowering the companys value is hard. A small reduction can survive, but massive reductions are given to investors is not easy. For a start, most new investors do not want to decrease the score — in the end, they have to work with those who have stopped by, and they dont want them to piss off.
Easier to give up and look for other options. In addition, a revision can upset the co-founders or top management and they decide to leave the company,” explains mark Suster. Also a revision can change the position of the investors themselves, says the author of the material. Some of them will become more respected, someone — less. To reduce the evaluation of a startup is really hard problem, writes Sister.
The decrease is preceded by long and complex negotiations. “That is why investors prefer to invest their funds together with those they know and trust. In difficult times we would like to count on their partners”.