Another disfunctional and self-satisfied financial market?
I was pretty disappointed by the lack of insight and articulate views on finance that I heard sitting in on the “Entrepreneurship and Investing “discussion panel at the Supernova 2007 Challenge Day. The professional ‘VC’s’ on the panel were actually very articulate and - although I didn’t really think they said anything insightful - gave measured intelligent answers to the questions they fielded. Unfortunately, everything the two ‘angels’ on the panel said could at best be described as banal, and at worst was just a plain dumb amalgamation of platitudes, irrelevancies and inarticulate generalities, and did a huge disservice to an audience made up primarily of aspiring entrepreneurs.
Question from the audience: “How do you approach valuation in the companies you invest in?”
Angel answer: “I don’t worry about valuation, it’s around $2-5million for a start-up…”
Ummm… right man. THAT makes sense. No sense wasting time on valuation…it’s a couple mil, right?…btw what does the company do?
Everyone knows that valuing a start-up is not an exact science, but that doesn’t mean that there is NO science…there are many different approaches - based on option theory, discounted cashflow, discounted terminal value, etc. - that can be used to frame the discussion. Together with a probabilistic approach to outcomes, they can frame the valuation and the process of working through such a framework is helpful in terms of testing and adapting assumptions and building a more robust business case and execution strategy. As long as one doesn’t confuse precision for accuracy and over-engineer the process, a robust valuation discussion is the perfect vehicle through which to make sure the entrepreneur and the investor are on the same page.
One of the most ridiculous assertions to come from the (angels on the panel) was that the only place in the world where you could innovate and raise capital (for innovation) is Northern California. I’m not even going to bother wasting my breath deconstructing this idiotic and parochial worldview - and I’m going to try really hard and convince myself that this view is just one/two man’s opinion and not representative of a commonly held view - but all I can say is that I think there is a huge opportunity to connect smart (non-Valley) money to smart entrepreneurs everywhere.
There is a certain irony in the lack of innovation in the financing of innovation, don’t you think?
June 21st, 2007 at 2:56 pm
Yesterday I was discussing with a farmer serving on a cooperative board of directors the pros/cons of various methods of valuing a potential soybean crushing plant. He was reviewing financial models and was asking me what types of questions I would ask the folks doing the financial modeling. We discussed what the measure of value was, stochastic modeling, appropriate stress testing using both historical and created scenarios, etc. I find it ironic that this discussion I was having with a farmer was far more technical than the answer given by an angel at Supernova. That’s mind boggling. I guess I could have just said, “Oh a couple mill for a good crush facility feels about right.” Of course that would be more fertilizer than insight.
I’m surprised that VC is really functioning this way. Is this the result of excess capital looking for a place to go? These attitudes may rapidly change when liquidity dries up.
-JD
June 22nd, 2007 at 5:26 am
I suspect (ie ‘can-only-hope’) that most angels (perhaps even including the two that spoke on the panel) apply a more robust methodology when investing…also it must be said that it seemed that the two angels in question invested primarily (exclusively?) in ‘Web2.0′/variations-on-”social-media”/ community website start-ups and so with such a narrow scope, maybe their shorthand valuation metrics actually work (ish.) Indeed, the two VCs on the panel - when they could get a word in edgewise - were at pains to highlight that generalizations were hard as start-ups come in many many different sizes, shapes and flavours. And maybe it was just a question of the angels explaining themselves poorly: they seemed very happy with themselves - I imagine business is good - and slipped into a patronizing posture from time to time. It’s is pretty dangerous to generalize too much from one small panel discussion, however I suspect that however eccentric this particular discussion may have been, there is an underlying opportunity to improve on the status quo.
Anyhow, I hope you discussed the appropriate weather risk inputs in the soy financial model!
June 25th, 2007 at 9:19 am
This did make me laugh - good one Sean. Personal experience, and perhaps a bit of an over-generalisation, is that there are two “sorts” of “angels”:
1. Those that have a few quid and look at angel investing as something that looks good on the dinner party circuit and “buys them” status (sound like you had two of these on the panel).
2. Those that are passionate about investing and growing businesses, are happy to take calculated risks and follow a robust investment process - real pros in other words.
I keep bumping into “type 1s” in dinner/drinks parties. They are amusing to listen too in a perverse sort of way. But they never answer, or avoid, any questions about sucessful businesses they have invested in - strange that….
June 25th, 2007 at 1:49 pm
Good plug for weather risk.
The big risk a crush facility faces is the input/output spread risk. The spread is not as easily hedged with weather the way volumetric risk might be. Actually one weather play that I would like to investigate is if one could hedge basis (or some piece of basis) using weather. In major ag crops one component of basis is often the difference between local weather and the weather that drives the contract prices (e.g. Iowa and IL weather drive corn prices on the CBOT). Seems like it might be able to be hedged.
June 25th, 2007 at 11:23 pm
I like the idea of structuring a basis product. Not sure if this is something WeatherBill should be providing directly or if WeatherBill should just provide prices and risk capacity on the underlying component risks and let some 3rd party create the custom structured derivative.
Unless I’m mistaken, this is essentially a correlation trade no? I wonder if - at least at this stage of the market’s development - this isn’t a step too far along the complexity curve? If you were to structure a basis/correlation contract how would you imagine it should be parameterized?
July 2nd, 2007 at 2:44 pm
My weather and basis concept was half baked and hair brained. You are exactly right that its a correlation trade. And also right that it is something that should be handled by a third party (grain elevator, cooperative, etc). That’s the very essence of the risk quark idea!
As I reflected about the issue of basis in ag commodities, the basis is mainly driven by local storage availability and transportation costs. So maybe the better correlation trade would be a calendar spread since demand for storage is highly driven by the slope of the forward curve for the commodity in question.
-JD