Sean Park Portrait
Quote of The Day Title
Everyone has a thirst for information."
- Eric Schmidt, Google

(Venture) Capitalocracy?

AMEE announced today that they had closed a new round of financing. I think this is a fascinating company and compelling opportunity. Given the chance, would I have for certain chosen to invest? Based on what I know of the company and its management, I would like to say yes. Probably. I’m forced to hedge my opinion because I just don’t know enough, especially with respect to the financials and the attractiveness of the valuation given the opportunity. But given what I do know, I would have loved to have them in our portfolio. And I’m certainly more than a little disappointed that we weren’t in a position to throw our hat in the ring, do our homework and at least make an offer…

Which brings me to an idea I’ve been toying with for the past several months. I’ve been contemplating publishing a virtual portfolio of venture and private equity investments – ie the investments we would likely have made (and would make) had we the capital available. A sort of an analogous take on Covestor or Marketocracy but for private investments.* There are however a number of reasons I have not taken the plunge. Perhaps most obviously is the issue of proprietary knowledge. After all, the heart of the value proposition we make to prospective investors is that we have a unique and robust investment thesis and that based on this foundation, we have identified (and will continue to identify) exciting young companies who are naturally adapted to grow and prosper in the coming years. If we tell everyone who these companies are, why would anyone need to pay us a fee? Why wouldn’t they just invest directly. Or more likely, why wouldn’t competing investors just ‘free-ride’ on our research and analysis, using our list as a filter or more? And what if the companies we listed failed (see below)? What benefit would there be to publishing such a list?

Further, there are a number of structural factors at work that mean that the ‘Covestor’ metaphor is imperfect at best and fundamentally inappropriate at worst. Investing in private companies involves a number of challenges that are different/additional to those faced by a public company investor. A number of these factors are interrelated but for the sake of clarity I’ll try to enumerate a few:

  • deep information deficit: for most of the companies that would appear on such a list, our information is significantly limited, especially with respect to financial aspects (budgets, sales, valuation, etc.) As a practical matter it is usually not possible to obtain this level of detailed information unless one is actively engaged with the company in view of a potential investment. Obviously it would be completely disingenuous for us to misrepresent our capacity and intentions simply in order to be able to put our slide-rule over the financial model. Further, without the potential pay-off of being able to follow through and invest in companies that pass due diligence and valuation muster, quite frankly we don’t have the luxury of doing such a deep analysis even if the company was happy to provide us the data.
  • price (valuation): while perhaps less important (within reason of course) the earlier you are in the life-cycle of a company, it is obviously a key input that is quite often unavailable. To be fair, one could possibly – at least for the purposes of such a list – assume that if respected investors participated in a given financing round that we would have been ok with the pricing too.
  • value enhancement: call it hubris if you like, but one of the key inputs in our investment process is understanding to what extent our participation as an investor can help reduce risk and accelerate success. Elements of this analysis can be done from ‘outside’ but without a deeper understanding of the business and in particular a personal relationship with the management team, it is hard to properly assess what value, if any, we can bring to the table. Some companies that look great to us from afar might just not be a good fit.
  • managing destiny: (a variation/specific case of the point above) particularly for seed and very early stage companies, one of the biggest risks they face is securing follow-on finance. In this context, a theoretical investment and a real investment are fundamentally different: there are many ways a company can fail. Failure is failure of course but I suspect there is a risk that some of the companies on our wish list might indeed fail to raise follow-on capital, whereas had we invested for real, we would be prepared to follow-on in most cases, mitigating if not eliminating this risk. Of course it’s probably impossible – even ex-post – to definitely identify companies whose failure was ultimately unavoidable (market driven) from those whose failure was only due to a financing gap.

The case for publishing such a list – assuming you can overcome some of the structural limitations outlined above – really boils down to building reputation and trust, both with potential investors and existing and aspiring entrepreneurs in particular and within the wider venture capital / private equity ecosystem in general. Part of me also likes to think that there is less risk, in terms of ‘giving away’ intellectual property, than would be the case for say a hedge fund manager focused on public equities: anyone can buy a public security, the same is not true of private companies. Wanting to invest is not sufficient to allow one to invest. Further, let’s be realistic: for better or worse, I’m not Warren Buffett or John Doerr or anyone really…will the fact that I say AMEE is a must own company really make a difference to anyone? More importantly (to me!), will it make it more or less likely that I will be able to use my skills to make a living identifying and investing in great young companies?

Basically the only potential downside to publishing a virtual or ‘wish-list’ portfolio I can see is the fact that one would have to assume that any nuance and qualifying information attached to such a list would ultimately get lost and that for better or worse, the companies would be inextricably linked to me without qualification. I was thinking that a list constructed as ‘Probables’ and ‘Possibles’ might just allow some useful qualification without diluting the impact. And yet, I hesitate. And I’m not sure why. So I thought I’d ask you.

  1. Why should I not publish such a list?
  2. What (if any) qualifications should I include, were I to publish such a list?
  3. Why don’t other investors publish lists of deals they would like to or would have liked to have done? (before outcome is known of course!) (Or if any do, please tell me who/where.)

* Is there a business idea in here somewhere? Sort of a Covestor meets seedcamp for aspiring new private equity managers? A set of tools and a community to help LPs identify new talent and spread their investments in this asset class more widely (and intelligently) without the limitations of the existing fund of funds business model…

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  • ChrisGrew

    Sean:

    Two data points:

    -- Several years ago, The Wall Street Journal (Europe Edition) published a regular (quarterly?) column on European venture capital investments and the journalist would poll various VCs as to what investments they would have like to have made in the past quarter. I believe that the resulting list of such investments was called the "Envy List". It made for an interesting read, given that it was most likely that the VCs would have had sight of such opportunities but did not invest, for one reason or another. (As an aside, I liked this concept so much that I suggested it to an award ceremony organiser as a potential award -- the "Deal Envy Award" for the investment that most VCs would have liked to have made. I think that the award is now in its third year.)

    -- Bessemer Venture Partners has its famous "Anti-Portfolio": the deals that they passed on (and probably regret doing so). See http://www.bvp.com/Portfolio/A... -- it's a fun read.

  • Sean,

    I'm not sure that playing this version of fantasy football in public will help you raise funds (so that you can play the game for real). As you rightly point out there are information asymmetries that make such a virtual portfolio a poor proxy for a real one (and there are reasons why investors sometimes keep portfolio companies in stealth). Ultimately the problem is that when you're making $0 bets on something there will always be a temptation to go wide rather than deep, and lose the quality you'd strive for with real money. Of course you would be betting reputation, and at this point you don't have much to lose (reputation being one of the major obstacles to innovative funds raising money) - I think this goes some way to explain why the established players don't do this, and why you'd be inclined to stop once you're better established.

    I think like the 'dead pool' this is certainly something that you should track, but making it public doesn't make sense to me.

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