Sean Park Portrait
Quote of The Day Title
The Web will own every bit.
- Kevin Kelly

Articles from January 2010

Probably the best start-up you’ve never heard of.

Today Markit Group announced that General Atlantic has invested $250 million, valuing the 7 year old company at a whopping $3.3 billion. Founded by Lance Uggla, Kevin Gould and Rony Grushka in 2003 to address the growing need for quality data in the burgeoning credit derivatives market, what followed was several years of unbelievably good execution and disciplined acquisitions which has positioned the company as a critical component at the heart of the trillion dollar OTC derivative markets. The products they provide aren’t considered sexy (something that is often given all too much importance in this status conscious industry) – but their data, valuations, indices, trade processing and other products and services are the plumbing that is key to the continuing operation of many financial markets. They are a great example of creating value by building a great platform and understanding how to monetize data. I had the good fortune to be a non-executive director from 2003 to 2006 and I can say without hesitation that this team is one of the best I’ve ever seen and fully deserve the success they have achieved. (Congratulation guys. Awesome, truly awesome.)

And I am certain there is more to come. Their primary constraint has and will likely continue to be the physical/logistical limitations of growing as fast as they have but each year they only improve and in terms of acquisitions the company they most remind me of (in terms of disciplined and deliberate execution) is Cisco. Besides, General Atlantic doesn’t invest in companies where they don’t think they can make 20-30% annual returns or more.

And yet many (most) people in the ‘start-up’/'tech’ scene whether in the UK or the US have never (or only vaguely) heard of Markit. (For example, I counted only about 50 or so tweets referencing the announcement today, less than for any TechCrunch launching start-up…) Why is that? Obviously I can’t say for sure but (in no particular order) would guess the explanation perhaps lies in the following:

  • not venture capital funded; funding initially came from it’s cornerstone customers, the investment banks, and then later from some very smart hedge funds
  • focused on the wholesale financial services industry (and not on consumer or media or other mass markets)
  • key products and services (and associated economics) unknown to those outside finance and even worse generally considered ‘boring’
  • management team laser focused on execution, not PR (although to be fair they had this luxury not needing to sell to the mass market)
  • and so folks like TechCrunch and VentureBeat don’t know or write about them (aka “if a startup isn’t listed in CrunchBase does it really exist?” syndrome)

Indeed for me, Markit is a poster child for the cognitive, cultural and expertise chasm that exists between ‘Wall Street’ and ‘the Valley’ (or the ‘City’ and the ‘Roundabout’ to use the less good UK-centric metaphor.) They might as well be on different planets. Indeed bridging this divide is at the core of what we set out to do at Nauiokas Park and was the driver that led Paul Kedrosky and Tim O’Reilly to launch the Money:Tech conference in 2008 (which sadly didn’t survive the financial crisis and quite frankly was met by a deafening indifference by the vast majority of the Wall Street side of the equation.)

And yet, the opportunities available to those who can successful bridge this gap are enormous. Well, anyway that’s what we think. And the crisis in venture capital ostensibly caused by too much capital? I’m going to disagree with Paul and Fred and suggest it’s not too much money overall; rather it’s too much money concentrated with too few investors, focused on too few sectors, who end up all chasing the same deals. So to the LPs out there my message would be: don’t shrink the pool, enlarge the opportunity space. Oh, and try to make sure you’ve got exposure to the next Markit Group.

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Through the Looking Glass, Midterm Report

Five years ago I wrote a thought piece called ‘Through the Looking Glass’ to provoke non-linear thinking and foster debate on the possible future direction of the financial services industry and market structures. (I later turned it into a short video called AmazonBay.) It was a retrospective told from the point of view of an observer in 2015. It was never meant to be taken literally – in particular with respect to (most of) the specific corporate mergers – rather I used these as a concise and dramatic way of highlighting the possible or even probable consequence of the deep secular currents that I felt would inevitably work to reshape the landscape.

(December 2015:) …The global securities and investment banking groups that dominated the market in the last century are now extinct. In their place we have an intelligent galaxy of new specialist advisory, investment management, algorithmic software and consulting firms networked with a universe of powerful transaction facilitation exchanges. Banks now exist only as giant regulated pools of capital.

Following the sweeping banking reforms proposed last week by President Obama, and the fact that we are now halfway to this hypothetical future, I thought it might be worth doing a quick mark-to-market of how my ideas have lined up with reality.

Oracle

  • stock exchange consolidation and emergence of new exchange venues (A-) pretty close both in outcomes and timing – the major stock exchanges have been merging a-go-go while at the same time new trading venues have proliferated, and exchange (or quasi-exchange) trading of new asset classes continues to develop strongly.
  • sports/outcome trading in US legitimized (B-) my narrative had this happening in February 2010, not there yet but Congressman Frank’s bill might open the doors later this year and the trend seems to be on the right track and will probably be signed into law by Obama (!); as an aside was way early on a Betfair IPO…
  • giant bank mergers followed by break-up of vertically integrated universal banks, with Goldman Sachs leading the way (A) we have seen the big get mostly even bigger (RBS/ABN, BoA/ML, Barclays/Lehman…and while JPMorgan didn’t buy MS, they did get Bear Stearns and WaMu); GS hasn’t yet broken itself into three as predicted but I’m still confident it will lead the way when/if industry structure changes, and more generally the trend of regulatory thinking across the globe is definitely a trailing wind for the kind of change I envisioned. The 2010-2012 timeframe for the re-organization of global banks is probably a bit early but plausibility has certainly gone up (from near zero) significantly since I wrote this.
  • more (and more) algorithmic / automated intermediation of markets (A-) this was obliquely referenced in my article but was really at the heart of the idea that this fictional ‘AmazonBay’ platform would end up dominating this aspect of markets; clearly the market is heading this way – in fact it may seem obvious now but most people did not fully understand this even as little as five years ago.
  • Amazon anything (B+) The jury is probably still out on this one, but in my view it is looking increasingly likely that Amazon.com will become a giant of the next economic paradigm; whether or not they use their vast intellectual and technological resources to participate more directly in the financial services arena is not yet clear, but I can tell you the only ‘big company’ job I would not hesitate for two minutes to accept if it were offered would be CEO or CSO of Amazon Financial Services (AFS) Jeff are you listening? ;)

(Note: Remember I used real company names mainly to add vividness to the ideas underlying the narrative. The key concept I wanted to convey with this GS break-up vignette was that the vertically integrated model would decompose under the light of new technology and regulations into a (technology-centric) Sales & Trading component, a more focused, relationship driven Advisory component (cf. the emerging proliferation of pure advisory ’boutiques’) and independent, conflict-free Asset Management businesses (cf. the secular growth of hedge funds and Barclays sale of BGI, etc.))

(February 2009:) …Reacting to new competition, Goldman Sachs becomes the first major investment bank to break itself up. Securities and distribution are sold to Ebay Financial Markets, while the remaining activities are split into two new companies: GS Advisory Services and GS Capital management…

Charlatan

  • eBay anything (D) Despite the fact that the actual companies cited are more symbolic than literal, the choice of eBay to represent the cutting edge of online, data-driven, algorithmic marketplaces was simply awful. To the extent that it risks distracting the viewer from the key, underlying messages. It is now entirely implausible and so instead of bridging the cognitive gap, the inclusion of eBay simply extends it. Thank goodness this is somewhat mitigated by my inclusion of Amazon.com (see above) as the other new markets avatar but they come late to the narrative…
  • sports trading developing as an asset class (C+) this clearly hasn’t happened, although there are one or two small funds and firms offering managed accounts; and a vibrant ecosystem of professional traders and the associated software has emerged around the Betfair and other exchange platforms. In my defense, I picked sports as just a provocative and emotionally attractive example of the idea that – enabled by technology – a vast array of new tradable markets in goods but also outcomes, would emerge. Work in progress.
  • credit crunch and asset bubbles (D) although the overall purpose of the piece was to provoke thinking on the sustainability of existing business models in financial services in the face of radically shifting underlying technological, economic and demographic trends, I failed to include a thread touching on the possibility of catastrophic systemic discontinuities arising as a result of the prevailing market structure and business models. It’s a significant ommission, especially as at the time of writing this I was in the process of exiting my former responsibilities as a senior executive in the credit business due in part to my increasing discomfort with the sustainability and prudence of the risk pricing in that market.

All in all, I would give myself a mid-term grade of B+/A- with room both to improve and to slip back. Mostly on the right track, especially with respect to big themes but perhaps a bit optimistic in terms of some of the timelines. What do you think? Better? Worse? To be fair, the correct measuring stick is not so much whether or not I was right or wrong, even in terms of ‘macro’ predictions but whether or not this article and video helped catalyze serious discussion, debate and thought about the potential for disruptive and non-linear change in the financial services industry. Alas I have no idea how one could even attempt to measure that, but any thoughts or anecdotes you might have with respect to this would of course be appreciated.

Through the Looking Glass (2005)

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One day…

…we might see GigaOm write this:

Amazon JP Morgan, displaying a sense of urgency that is perhaps driven by the pending launch of Apple’s tablet-style computeranti-trust legislation which will end the US banking oligopoly, is turning its Kindle device banking and payments infrastructure into a platform. The Seattle New York-based company has announced that it will allow software developers to “build and upload active content applications” and distribute it through the Kindle Chase Store “later this year.” Amazon JP Morgan will be giving out a Kindle Chase Development Kit that will give “developers access to programming interfaces, tools and documentation to build active content innovative financial services and products for Kindle. Chase” The company will launch a limited beta effort next month. From the press release:

“We’ve heard from lots of developers over the past two years who are excited to build on top of Kindle Chase,” said Ian Freed, Vice President, Amazon Kindle Bo Nusmore, EVP, JP Morgan Chase. “The Kindle Chase Development Kit opens many possibilities–we look forward to being surprised by what developers invent.”

Vertically integrated black box? Or open platform? Which type of bank makes for a more robust system? Which type of a bank is more evolutionarily fit to compete on a level playing field? I know that their is an enormous moat protecting large financial institutions from competition but I would hope they would be using the super-profits that this affords them to prepare for the day the moat is breached. And perhaps behind the parapets they are. Because I pretty sure there are an increasing number of very clever, ambitious (and even angry) folks starting to congregate on the edge of that moat and while it might take some time and a dash of luck, it would seem certain that eventually they will be inside the castle. And then, it just might be too late.

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Nokia: Banking People

If I ran Nokia, I would probably do two things:

  1. I would set upon transforming the company into a retail financial services powerhouse, focusing in particular on developing markets like India and Brazil; and
  2. I would buy Skype.


I don’t have time to articulate the whole thesis here (and besides, if they want the whole thesis they can hire me!) There are some hints in my Platforms, markets and bytes presentation.

The Economist has a good summary of the fix they find themselves in. I think they are at risk of becoming the new Microsoft, in that they buy all sorts of neat, smart start-ups (including a minority investment in Obopay), only to then kill them. According to the Economist, they are trying to adapt and having some success especially in markets like India:

All this will no doubt help Nokia come up with better, if not magic, products. The firm may even reach its goal of 300m users by the end of 2011 because its efforts are not aimed just at rich countries, but at fast-growing emerging economies where Nokia is still king of the hill, such as India. There, services such as Nokia Money, a mobile-payment system, and Life Tools, which supplies farmers with prices and other information, fulfil real needs, says John Delaney of IDC, another market-research firm.

Which only strengthens my view that their path to salvation lies in (yet another) complete re-invention, this time to a 21st century, sixth paradigm, retail financial services platform (built on a mobile substrate.) They might even want to keep (at least some of) their handset engineering know-how: it might come in handy for building handsets that are particularly well adapted to mobile financial services.

In any event, if Nokia want their share price to go up, they better hurry up and change their frame of reference. I mean really, who would you rather compete with? Apple? Google?

Or Citigroup?

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Weather forecasting.

I’ve been avoiding putting together a list of predictions for 2010 (more on that later) but just couldn’t resist suggesting that 2010 could well be a breakout year for weather risk management. All of the conditions necessary have finally started to come together and with the worst of the 2008/2009 hysteria behind us (without passing judgement on the future direction of markets), companies (and hopefully individuals) will start to wake up and respond to the risks and opportunities inherent in weather variability. I wouldn’t be surprised if weather risk was one of the top three risks faced by the vast majority of (non-financial) corporations, perhaps even the most important risk in some cases, and of the same order of magnitude as liquidity, foreign exchange, commodity and interest rate risk – all risk categories for which massive global markets in risk pricing and transfer exist. Weather in this regard remains significantly underdeveloped:

(via Ben Smith, First Enercast Financial) For example the Department of Commerce estimates that more than $1 trillion of U.S. economic activity is exposed to weather. Even if a small fraction of new risk is hedged through derivative contracts, 2010 will be a very good year for these markets.

The massive costs incurred in much of the northern hemisphere over the last few weeks due to heavy snowfalls and cold temperatures are just one more example of how important a factor in economic outcomes weather risk can be. For example, just take the exceptional – and uninsured – costs incurred by local authorities and airport operators across the UK for snow removal, sanding, salting, loss of revenues, etc. Previously, a manager of a company (or government entity) who suffered an exceptional weather-related loss could shrug their shoulders and plausibly say “it was out of my hands.” In a way that would be impossible if for example their organization suffered a massive loss because their buildings or equipment perished in a fire and they were not insured. In that scenario, shareholders or taxpayers would be incandescent with rage at the incompetent risk management of the managers. Not managing weather risks is no different in substance (now that appropriate weather insurance and derivatives are increasingly widely available), only remaining so in perception as awareness lags.

Of course I am biased, having invested in Weatherbill, which is at the vanguard of transforming weather risk markets:

(via J. Scott Mathews, WeatherEX LLC) The weather market was built upside down, which is quite a feat, even for financial engineers. What we mean is that it started on the wholesale level without any retail underpinnings. It started out like a castle in the air…The changes coming in 2010 for the weather derivative market will be keyed “from the bottom up.” Solutions companies such as Guaranteed Weather and Weatherbill who bring management choices to “ground level” risk holders are helping to complete a strong base to keep that castle from crashing on us.


The difference between weather derivatives (Weatherbill.com) (or any other new risk management tool) and say books (Amazon.com) is that risk management tools need to be ‘sold’ – there is a learning curve, however shallow; and while most people instinctively understand and can conceptualize their weather risks, their survival instincts – honed by decades of doing business with rapacious financial services firms – and fear of ‘getting their eyes ripped out’ means that they are understandably cautious when considering using weather risk management instruments for the first time.

This is where Weatherbill’s business model I think is particularly well adapted to the opportunity: on the one hand, they have a very modern (open) approach to pricing: anyone can go to their website and play around in their pricing ‘sandbox’. Try doing that ten years ago when you wanted to price up a complex FX or interest rate option. Basically it was build your own model or keep sending pricing request to your favorite sales person (who would then have to go beg the trader for a price, and in addition to the regular parameters, the client’s identity, the salesperson and the trader’s mood would also be imputed into the price. That is of course if he felt like making one.) On the other hand, (and this is something that has evolved over the past couple years) Weatherbill has aggressively sought out distribution partners – insurance brokers, industry platforms (eg travel sites), etc. – as trusted providers to their respective customer bases, they are ideally positioned to help their customers manage their weather risks by leveraging Weatherbill’s platform. I first wrote about this a few months ago, and since then they have signed up a number of new and significant partners.


I love skiing and my family take a season pass at Les Trois Vallees. Obviously weather risk is central to running or enjoying a ski resort. While there are many different types of risk you could look at in the context of a ski resort, in the interests of simplicity (ease of understanding/customer acceptance) and maximum pain relief, there are two risks that I would have loved to have had an embedded hedge for in our season ticket (and I suspect the same would go for someone buying a week-long pass for their holiday, in fact they would probably be even more sensitive/appreciative.)

  1. Not enough snow to ski risk: ie not that the snow is great or this or that…the basic risk that the pistes are closed. For most modern ski resorts this is actually a function of temperature and not precipitation, as they use snow-making machine to lay down a base. Temperature risk is much easier to measure and price (than snowfall) and has much lower geographic variability ie you don’t need a weather station on every piste on the mountain.
  2. Rain risk: ie the only time it is absolutely unpleasant to ski is when it is raining. Also, rain typically doesn’t help the existing snowpack, making skiing after rain often unpleasant as well.

Using Weatherbill to hedge their risk, Les Trois Vallees could offer a ski-pass that reimbursed me for every rainy day and for every day say less than 80% of their runs were open due to lack of snow. In an age of increasing climate uncertainty (or perception thereof) I am 100% certain this would help them market (and sell more) season tickets. And for week-long tickets, it would be a great marketing tool for advance sales (with significantly positive cashflow benefits), and great for improving the user experience. Imagine a vacationer whose week in the Alps is ruined by 5 days of torrential rain…getting their money back on the lift tickets (irrespective of whether or not they braved the elements) would go a very long way to having them consider giving it another try next year.

Of course this is but one example, I’m sure all of you can think of hundreds more. In fact it might be harder to think of services or businesses that are completely immune to the weather. So really, what are you waiting for? Start hedging!

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RabbitFX: simple, transparent and secure.

One of the downsides of having a reasonably ‘international’ life is having to manage foreign exchange risks and effect international currency transfers and payments reasonable regularly. If you only do this once every few years for a few thousand pounds/dollars/euros/etc., you may not notice or care that your bank generally makes this quite hard to do and charges you an arm and a leg for the pleasure (no commission is just dishonest marketing-speak.) If however, you need to make a few foreign currency payments or transfers each year; and/or you have more significant sums at stake, your bank is probably not the best place to do your FX business.

 
                        
 

You could (and perhaps do, as I did) use one of the literally hundreds of FX brokers, and if you have the time, knowledge of spot rates and inclination to haggle and shop around, you will get a good price. For a transfer of £10,000 for example you could easily save on the order of £100 or more compared to your bank. However (aside from needing the time, skill and energy to haggle and shop around), in my experience that is the easy part. It is only once you have traded that the fun really starts. Faxes, printing pdfs, clunky websites… getting your money to the broker and then back out in the new currency to the destination account is all too often a long and painful experience. Not completely surprising given the traditional business culture found in financial services: the trade is done (and revenue is booked), the rest is just ‘back office’, paperwork…boring. But from a customer point of view, this is upside-down: the trade is the easy part, undifferentiated, relatively painless (notwithstanding the see-what-you-can-get-away-with pricing algorithms of most of the industry.) Your time (and mental health!) is valuable, being able to trade painlessly in just seconds is often times as valuable or more than a tight price. In any event, you shouldn’t have to choose between them, and now you no longer need to.

 
                        
 

So when an ex-colleague of mine Nigel Verdon came to me with a new concept in FX payments and broking, one that was predicated on transparency, simplicity and automation, I listened. I liked what I heard and I became one of the first guinea pigs customers. I liked it so much, I bought (a stake in) the company. The company of course is FX Capital Group which I’ve written about previously, here and here. Nigel and his team have built an extremely robust and technologically modern FX payments platform that essentially acts as middleware between any end user and their bank accounts and the enormous and highly efficient wholesale, interbank currency markets. On top of this platform, they have built two applications: FX Capital – adapted for corporate customers, and RabbitFX for private clients. In the coming weeks, they will also release their API, with the clear objective of allowing anyone to embed FX and international payments into their website, workflow or application. Indeed, one of the first target markets for their platform technology is the hundreds of FX brokers who currently struggle with poor or non-existent technology. By allowing them to focus on what they do best (generally distribution – client acquisition and relationship management) and improve the level of service to their customers by outsourcing the technology to FXCG, everyone – client, broker, FXCG – is a winner. Think of it as FXaaS (FX as a Service.)

…[FX Capital Group provides] FX-as-a-Service.

The reason for today’s post however is to announce the new RabbitFX website, which I hope you will agree looks fantastic and even more importantly is easy to use and understand. It’s not perfect (still lots of improvements and features in the pipeline) but we think it is ‘good enough’: we are confident that the user experience is better than any other specialist FX broker in the market. And this starts right from the beginning: sign up for an account today and you’ll see what I mean. For UK customers, you should be able to get everything done online; customers based outside the UK (and some UK customers) can do 90% online and will need to send some identity documentation (in order for RabbitFX to fulfill its ‘know-your-customer’ regulatory requirements.) And once your account is open, I’m sure you’ll find like I did that making a FX payment has never been easier.
RabbitFX

It really is “Currency Exchange made simple, transparent and secure.”

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NovaBanca.

I think there has never been a better time (well in at least 100 years or so) to build a new bank. A new sort of bank. I’ve been meaning to post (some of) my ideas on this since last spring but have never had the time. Plus given that this is something I would love to actively drive and participate in, I probably sub-consciously was a bit loathe to spell it all out. Until I get a day or so free to translate my vision and copious notes into something coherent, here are a couple articles that might give you a taste of how I am thinking:

  1. Take full advantage of a blank canvas (cf “Silo but deadly”); and
  2. Embrace the possibilities offered by 21st century ICT (cf “Doing IT wrong”)

It also seems I’m not alone in this thinking, at least not in the UK, with first Tesco and now Virgin Money aggressively entering the (retail) banking space.

(via The Guardian) Virgin Money has made its much-anticipated move into the retail banking sector by taking over a small private bank.

The £50m deal to buy Church House Trust was announced to the City this morning. It is a key part of Sir Richard Branson’s attempt to challenge the UK’s major high street banks, and comes two years after Virgin failed to win control of Northern Rock.

“Virgin Money aims to bring simplicity to the UK banking market, which has traditionally been a complex sector,” said Branson, who believes the move gives Virgin “a strong platform for growth”.

I’d love to meet the leaders of these two firms as I think a lot of what we are working on would resonate with them. That is, unless we decide to start a competitor!

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Another two-sided market.

This week NEA announced the close of their latest fund at $2.5 billion. That seems like a lot of money for one venture fund, although perhaps if the intention is to focus on (highly capital intensive) clean tech and/or biotech they will be able to deploy this amount effectively. Of course NEA, founded in 1978, has a long and successful track record, with I imagine many long-standing relationships with LPs and excellent ‘brand recognition’ within the universe of potential LPs, and so it is hardly surprising that they are able to raise such large funds. After all – especially with respect to institutional investors – the analog to the ‘nobody-ever-got-fired-for-buying-IBM” paradigm operates in their favor.


A couple years ago, when I first started thinking about what would become Nauiokas Park, a good friend told me that private equity was all about raising capital, not investing it. Of course I understood what he

…private equity is about raising money, not investing it.

was saying, but thought he was using hyperbole to make the point that raising capital was more important than just a means to an end (investing.)

Now I understand that however cynical it may sound, he wasn’t trying to be clever: the way the institutional marketplace for private equity (including venture capital) is structured is all about raising capital and only incidently about investing that capital.



For better or worse, the year-end is typically a time to step back and take stock, to reflect on the year that was and the year to come. And indeed I have been thinking about what we could have done better or differently last year and what we need to focus on in this new year. And the short answer is we need to spend less time thinking about the economic and industrial landscape, developing our investment framework, sourcing potential investments and nurturing our existing investments, and more time soliciting potential investors: pitching our skills, our approach and the opportunity we believe exists to people and institutions that will determine whether or not we can turn our vision into reality. And like any start-up, we are going to have to be hard-headed about how we approach this as the proverbial runway is running out. As they say, there is a fine line between tenacity and obstinacy. I want to try to stay on the right side of that line.



Of course, once the lightbulb goes on it becomes obvious that raising money would be the most important talent of any prospective private investment firm: your LP’s, shareholders, investors are your customers (and not your portfolio companies.) They are they ones that ‘pay the rent’. They consume your service which is to invest their capital. Ah but the better the service, the more customers you have and the more successful you will be, right?

Well not exactly. In investment management generally it is very hard to determine a priori the quality of service one is likely to receive, which is why so often prospective investors – be they retail or institutional – fall back on historical performance to make their judgements. This reliance on historical data is clearly imperfect. However, when considering (many types of) hedge fund or mutual fund, given the typical investment horizon and liquidity profile, a consumer of these services can at least adjust relatively dynamically if they make a mistake. The effect of this is to reduce the psychological barrier to ‘taking a risk’ on any particular investment manager in these asset classes. But given the long time horizons and relative illiquidity in private equity, investors cannot exit a decision easily and so are (even more) inclined to stick with well-established firms and are less open to considering newcomers.

Basically “track record” is the box that needs to be ticked. And is much more important than having a coherent, well-researched and plausible investment thesis. After all, if you have the money, the deals come to you. But a track record in private equity is hard to come by quickly. (And it needs to be the ‘right’ kind: the first time I was told (by a prospective investor) that having been a founding investor in two multi-billion dollar companies didn’t ‘count’ because I wasn’t “a professional investor” when I made the investments was frustrating and somewhat irritating I have to admit.)


Given our domain specialization and investment framework, we are very interested in understanding the dynamics of two-sided markets. Companies that successfully position themselves at the nexus of these markets are typically very, very valuable. There are many examples – credit cards, advertising, computer operating systems – and I suspect the number of such markets will continue to grow as the economy becomes increasingly digitized.


A company active in a two-sided market provides it’s services to two distinct constituencies. Often times, they provide those services for free to one side of the market, in order to increase the value of the services they provide to the other side of the market. For example, Visa provides consumers a free payments service (and actually often pays consumers to use their service via loyalty programs, cash back, etc.); in so doing they can charge merchants to use their services which have value to the merchants because of the number of consumers who use their platform. In effect, Visa sells ‘access to consumers’ to merchants. In a different context but the same vein, Google sells access to consumers to advertisers.

Successful private equity and venture capital firms “sell” access to dealflow to their investors and limited partners. It is a two-sided market. And so it is natural that network effects apply and rational for investors to be pre-disposed to the biggest, most established players. It is reasonable to think that NEA (and KPCB, Index, etc.) or Blackstone (and KKR, Carlyle, etc.) will see a high proportion of the best deals. So far, so true. But unlike electronic payments or algorithmic online advertising, investing (in private companies) does not scale and so unlike these markets, the law of diminishing returns kicks in much, much earlier. The industry (well, much of it) admits as much: I suspect if you offered the GPs of NEA a $10 billion fund, they would probably demur. Indeed I suspect if you offered USV a $500mn fund, they would probably turn it down. The key point is that for any given private investment strategy (sector, stage, etc.) there is clearly a maximum optimal fund size. For a company like Visa or Google, this is not the case – more customers, more merchants, more searches, more advertisers – it’s all good.


Jeff Bussgang recently estimated that the (US?) population of active VC partners was approximately 1000. I don’t know how many mutual and hedge fund managers there are but I suspect it is at least an order of magnitude higher than this. This seems intuitively wrong: investing in a private company is more work and there are more of them. You have a thousand investors looking at a universe of tens of thousands (or more) of investable private companies and tens of thousands of investors looking at investing in a universe of thousands of public companies…


Paul Kedrosky (and others) have written extensively and intelligently on how the venture capital industry needs to shrink. How too much money, chasing too few opportunities has destroyed returns. The logic is compelling. However I would posit that the problem is not too much money per se, but too much money with too few and homogeneous investors.

Let’s look at these two constraints sequentially (although they are co-dependent to a large extent.) If you double the number of GPs but provide ten times more investment capital, on average the valuations of the investments they make will go up five times (thus significantly compromising their future returns.) Ah but this logic assumes a closed system – ie that both the number and types of investments are held constant, and so increasing the ‘money supply’ drives inflation (and lower real returns.)

Well in a world where the number of GPs is constrained, and most of them come from similar geographic, educational and professional backgrounds, this assumption is likely to be more right than wrong. Indeed it is embedded in the initial conditions above – ten times more capital allocated to the asset class does not result in ten times the number of GPs. And yet the number of investments any GP can effectively manage is by definition bounded (at a reasonably small number.) (Which is of course why firms like Apax eventually exited venture capital and ‘graduated’ to private equity.) Perhaps an even more important gating factor however is the number of potential investments a GP can seriously analyze and consider each year (dozens? a hundred or two?)

And we uncover the Achilles Heel of the (otherwise extremely successful) ‘Silicon Valley’ model: the relative homogeneity of the environment leads inevitably to a collective narrowing of the universe of potential investments that is considered and amongst these, an additional narrowing in the way they are evaluated and considered. ie Everyone sees the same deals and runs the same slide rule over them. And so more capital simply means valuation inflation and ultimately, lower returns.

But what if we were able to disrupt this state of affairs? Having spent the past two years intensively researching the markets we are interested in, I simply don’t accept that the ‘problem with venture capital’ is a bounded set of investment opportunities. I’m sure there is some limit to the number of good entrepreneurs, viable business models and attractive market opportunities but we are nowhere close to reaching it. In fact, it is so far away we can’t even see it yet.


No, the problem is a failure of market design. (The irony being of course if this market design failure were in any other industry, venture capitalists would be aggressively investing in companies and business models designed to correct and take advantage of this failure.) The problem simply stated is too small a number of too many similar venture capital and private equity investors. The solution is more, and more diversity. The question is how?

I’m sure you won’t be surprised to hear that I have a few ideas on the subject, and for my first (and only) New Year’s resolution, I will endeavor to articulate these in a multi-part series I will call ‘Saving Private Equity’. Some earlier thoughts on the subject can be found here.


The more cynical amongst you might accuse me of simply ‘talking my book.’ Perhaps. Probably. A more flattering way to look at it is that I am living my convictions. And the lesson I’ve learned is that we need to focus almost exclusively on fund raising for now even if that means disappointing some of our portfolio companies or missing out on a great investment opportunity in the short term. It’s not fun or particularly interesting but like almost any other startup, without capital the rest is just theory. Time to stop thinking and start pitching!

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