The Biggest Venture Capital News in October 2019

The Empty Promise of Data Moats (a16z)

Data has long been lauded as a competitive moat for companies, and that narrative’s been further hyped with the recent wave of AI startups. Network effects have been similarly promoted as a defensible force in building software businesses. So of course, we constantly hear about the combination of the two: “data network effects” (heck, we’ve talked about them at length ourselves).

But for enterprise startups — which is where we focus — we now wonder if there’s practical evidence of data network effects at all.

As networks effects have continued to grow in popularity as the competitive advantage of choice for startups, there is a similar growing notion that simply collecting data, which is an input to developing and scaling network effects, guarantees the existence of a competitive advantage. Simply stated – just because a company is collecting, monitoring, and using data does not mean it has an advantage over one that does not.

Why It Matters

Entire VC funds have dedicated their focus to companies that generate network effects (such as Nfx Capital) – because it’s commonly the deepest moat a tech or platform based company can build. However, it’s critical to allow the effect part of the verbiage to be true: the effect only exists when the value to participants in the network grows as the number of interactions and users grows. It is not the existence of a network that creates the advantage. Seems obvious, no?

This very much sounds like the adage that an idea is worth nothing, it’s all about execution – but with data you have to consider the fact there’s good data (helpful insights) and bad data (false positives, poorly classified), and importantly, how the insights drawn from that data can scale. As a VC, many are well versed in discovering how effectively the chicken-or-the-egg paradox is solved for platform businesses, but many are less adept at being able to determine if the data and collections methods of these companies will give rise to a sustainable moat.

This Venture Capitalist Has Made a Science Out of Backing Women-Led Companies. Now She’s Helping Another Female Founder Perfect Her Pitch (Inc.)

Kindur founder Rhian Horgan wants Baby Boomers to leave their retirement planning to her platform. Anu Duggal, founder and CEO of the $33 million Female Founders Fund, offers expert advice on a crucial issue: earning customers’ trust.

An unfortunate irony of retirement planning is that it’s often done too late. Anu Duggal and Rhian Horgan want to change that with Kindur. The company’s focus is on helping those who have successfully planned for retirement continue to make good choices after the champagne has dried up.

Duggal and Horgan share their background, experience building Kindur, and finding and funding women-led startups.

Why It Matters

If there is a sense that diversity initiatives in VC are trending, you’re right (and for good reason). Another lost irony in many instances is the fact that for an industry filled with players who thrive when able to seek out ways to differentiate themselves and carve out a niche, finding opportunities to hire from a diverse pool of resources is often not among these strategies.

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A women-led, financial-advisory based, VC-funded startup is a rare commodity. But often great ideas can only come from those who have different backgrounds and the VC community is well served to continue to find ideas in what appear to be nascent areas – areas with rare intersections such as these.

Have we reached the tipping point? (techcrunch)

Limited partners or  LPs — the pension funds, the university endowments, the family offices that largely provide venture firms with their spending money — are receiving a lot of attention from venture capitalists, some of it unwanted. VCs have begun knocking down their doors with requests for fresh capital commitments so they’ll have money to invest if the market cools down.

The problem is, many of these LPs are already over-allocated.

Given the historical skewness in the risk/return profile of Venture Capital as an asset class, it is (outside of The Endowment Model) commonly a smaller allocation within institutional portfolios, relative to more traditional asset classes such as public equities and fixed income. Has this, coupled with the growth in valuations and broader allocations for investors seeking more upside over the past decade, pushed LPs and investors to a point where allocation to VC is maxing out?

Why It Matters

On the surface, a shrinking pie is no good for anyone at the dinner table. More importantly, however, than simply stating the obvious problem (fewer dollars flowing into VC is bad) is thinking about a solution that goes beyond, “Well this is a cyclical problem, it will revert”.

How do mega-funds affect the overall makeup of the VC industry? What effect does that have on smaller funds’ ability to raise capital (despite the macroeconomic environment)? How does the adoption of technology lead to greater efficiencies so that VC funds can do more with less capital? How can the industry generate new and more creative investment vehicles that potentially offer different risk/reward payoffs? How can the industry align itself better in a portfolio?

The Great Public Market Reckoning (Fred Wilson)

For the last five or six years, I have been writing here that I very much want to see the wave of highly valued and highly heralded companies that were started in the last decade come public. I have wanted to see how these companies trade because it will help us in the private markets better understand how to finance and value businesses.

Have private valuations become too frothy? Are we back to ignoring fundamental financial data when considering the future growth rates (and therefore valuation) of companies? Fred Wilson thinks so.

Why It Matters

Finance 101: The Time Value of Money. It’s the first thing every undergraduate Finance student must learn. Building off the concept that a dollar today is always worth more than a dollar tomorrow (because today’s buck can be invested and earn a return), the second law of Finance-dynamics is that the value of anything is nothing more than the present value (i.e. today’s value) of its future cash flows.

An important distinction here is the term cash flows. This does not mean profits (which can be either real cash or generated by accounting magic) – but actual cash flows. This is why valuations for pre-revenue (and obviously pre-cash flow positive) companies is such a guessing game. Back-of-the-envelope this, comparable that. An underlying assumption is the growth rate at which companies will be able to sustain to justify a valuation (cash flows or not). These growth rates are generally absurdly high for in-favor unicorns – and so when these companies IPO and these growth rates do not materialize over the expected time horizon, the market punishes these companies, badly. Just ask Blue Apron.

How can VCs and private investors gauge the validity of pre-IPO valuations? Look at fundamental financial data, such as margins (making the assumption there are no real cash flows) and operating income. This is where management efficiency, company quality, and future potential cash flow generating power is all derived. Investors took a blind eye to internet tech companies who were all growth and no cash. Are we caught up in this again?

WeWork’s $47 billion valuation was always a fiction created by SoftBank (cnbc)

When business school professors are writing their WeWork case studies years from now, one of the biggest practical lessons may be this: WeWork should have taken far less money from SoftBank’s Masayoshi Son.

SoftBank almost single-handedly pushed WeWork’s valuation from $17B to $47B, before again driving the valuation down to $12B after the failed IPO attempt. With 20-20 hindsight, it would have been better for WeWork co-founder Adam Neumann to have taken less and tampered valuations.

Why It Matters

In HBO’s Silicon Valley there is a poignant scene where a fellow startup founder is chatting with the show lead and realizes he could have been more successful if he had taken less investment to avoid a down-round and eventual collapse. As we’ve seen recently, greed isn’t good, and sound fundamental valuations always play a critical role within the Venture industry.

WeWork’s problem was in chasing happily available capital from willing investors and misaligned incentives (more money in both founder and investors’ pockets at the expense of other, later-stage investors and long term company health overall). Perhaps worse yet is the fact that Neumann, after steering the ship nearly ashore, walks away with a $1B compensation package – a golden parachute. The sky-rocketing valuation in the face of mounting losses is an easy thing for critics to point to, but it’s not fair to single out one instance of poorly managed capital raises and valuation practices. Can the industry do better? Can it align incentives more appropriately?