Archives For Rambling

Comparisons Are Odious

codebloo —  February 27, 2015 — 2 Comments

Growing up, I wasn’t popular in the conventional sense (and by the conventional sense I mean having friends and such). As a result, I spent a lot of time reading. Mostly it was epically nerdy science fiction (Heinlein, Piers Anthony, etc) but there were a few conventional writers I liked as well, embarrassingly including Judy Blume. Somewhere in between her kid stuff and her adult stuff (if you never discovered WIFEY I feel sorry for your loss) was the adolescent classic TIGER EYES. While it now seems hard to imagine YA fiction without a dystopian future plot, trust me, this book was good. Two salient points: a)my now wife was the model for the cover art on the book (!); b)there is a reoccurring quote that I’m using as the title of this blog, “Comparisons are odious”.

I’ve been running “comps” for 20 years now, since I started at Bain Capital in 1995. For the uninitiated, comps are a list of similar (specifically: comparable) companies that are theoretically useful in determining the proper valuation ranges for an investment you are thinking of making. Eg, “Yeah, I know paying 10 times revenue seems high, but Workday trades at 14X.” Or, “How can you pay 10 times revenue for Tesla when Ford trades at 10X earnings?!” I’ve never really understood the logic of this type of analysis, and I’ve actually become convinced it’s the diametrically wrong guide to use as an investors. Given that we hold our investments on average for 5-7 years, shouldn’t we do the opposite of what Mr. Market is doing at any given moment? Comps are a popularity contest and rarely durable.

If at any given moment, horizontal saas companies trade at a premium to vertical saas companies, what are we to make of that? Presumably investors believe that the TAM (total addressable market) benefits of broadly applicable software trump the sales and marketing inefficiencies. Suppose it becomes clear that, at scale, vertical saas companies have 500 basis points of additional margin due to structurally lower go-to-market costs … don’t we think revenue multiples will expand, on average? Surely we can anticipate changes in the conventional wisdom of this sort over a multi-year hold period. (If you have any doubt about the likelihood of this, let me remind you that cardiologists have recently reversed their position on cholesterol and are recommending people eat eggs every day. To my long list of regrets I now add every single egg white omelette I’ve ever had.)

If anything, low multiple comps can be a draw to a segment, in that they usefully point out that the incumbents are doing something fundamentally wrong, to wit:

  • Lead gen companies typically trade at low multiples because their customers (or users) are transitory and bounties fluctuate cyclically. Credit Karma flipped this on its head, in that they have loyal users who trust them to recommend, in context, a broad variety of pre-approved financial products. How are the lead gen comps relevant to Credit Karma?
  • Issuer processing companies trade at 15-16X EBITDA (a high multiple, by the way, on a relative basis). Google bought TxVia, a prepaid issuer processor, for [A BIG NUMBER] X Revenue… TxVia and Google both saw how mobile wallets were creating a new use case of account based consumer financial services that had nothing to do with traditional prepaid.
  • Debt collection service providers trade at poor multiples historically, as befits a cyclical commodity service with regulatory overhang. To an entrepreneur like Ohad at TrueAccord, that’s the opportunity … he can do it better, and flip the model on its head. Should we value TrueAccord in the context of the traditional comps?

The relevant thing about comps, ultimately, is not the revenue or EBITDA multiple levels themselves, but the implicit logic behind them. If an entrepreneur can build a company that challenges the traditional economic logic of a segment, they are likely on to something big.

Salesmanship of Fools

Matt Harris —  December 26, 2012 — 7 Comments

I was talking to a fellow VC the other day, who I know but not well, and he was clearly searching for something to compliment me on, and what he come up with was “hey, I really appreciate how you’re not always nice on Twitter.” As I replied “thank you… I think?”, I was actually thinking that my portfolio companies sure I wish I were nicer, and followed the standard tradition of hyping them at every turn. Hopefully most of them went in knowing that salesmanship, in the traditional sense at least, is not my forte.

They should also know that it used to be worse. When we were starting Village Ventures 12 years ago, and particularly in the aftermath of the bubble, I used to have a downright dystopian sales strategy. I would go in to see potential investors and spend the first 20 minutes talking about how horrible the environment was: “You know, I agree, that’s bad news, but what’s worse is this…”. After setting the appropriate nuclear winter tone, I would go into my spiel: “As we’ve discussed, it’s not obvious that anyone will ever make money again, but if anyone were to, it’s not impossible it would be us…”. Then I would get to my big finish: “I’m sure this isn’t a fit for you now, but if we’re both still in business in a year or two, we should circle up and chat again…”.

After months of this, my then partner Bo took me aside and explained how things worked. To paraphrase, he made it clear that while I wasn’t ever going to star in Glengarry Glen Ross, I could get better. First, I needed to understand that being negative is a crutch. It’s easier to look smart when you’re being critical and dour, and so it can be a refuge for the insecure. Second, people not only expect salesmanship, but they actually want to be sold. Investors know that salesmanship is important to success, for VCs and particularly for entrepreneurs, so in a sense investor meetings are not only a test of your strategy, but also a test of how well you can persuade. This coaching was at least incrementally effective and I’m proud to say I’ve gone from horrible to bad over the last decade or so.
This all got me thinking about the different levels of salesmanship, which I think could stand to be better understood. The top rung is probably pretty obvious: to paraphrase Lewis Gersh, the prototypical salesman is one who could not only sell ice to Eskimos, but could sell them Sarah Palin for Governor as well. There is something deeply cynical, though obviously effective and maybe necessary, about this type of sales … it requires no link between reality and what is being claimed.

The other end of the spectrum is where I think I’ve ended up, which is that I can be persuasive if and only if I believe in what I’m selling, and my belief system is pretty well defined and constrained by a normal probability distribution. In other words, I can definitely be wrong, but not on purpose. The middle ground is the area I find most interesting, which are those people who technically only sell things they believe in, but are capable of such wild optimism (when it’s in their self-interest) that they can believe a whole hell of a lot. As such, the distinction between them and the unethical (my view) salesperson is a pretty fine line, when it comes down to it.

I’d like to think that at the core of entrepreneurship lies innovation, but you could make a good case that the actual core is salesmanship and persuasion. As such, I think it’s important for all of us in the field to remember that it’s a multi-round (and increasingly public) game that we play, which has enormous implications for sales philosophy and strategy.  One of my general gripes about entrepreneurs and VCs is the hype machine aspects of it, and i think too many people take comfort that they aren’t actually “lying”, they’re just being optimistic.  Ultimately the choice comes down to either a)sell stuff you don’t truly believe in; b)be ineffective because you don’t feel comfortable selling what you’re working on; or c)only work on projects you truly believe in, so as to be in a position to sell like crazy. I think the answer is obvious.

In a World With No Sevens…

Matt Harris —  January 14, 2011 — 1 Comment

The Judgment of Paris

As the anecdote goes, a group of women is sitting around discussing recent conquests. One turns to another and asks her to characterize her latest flame on a scale of 1 to 10, but adds “now remember, we’re in a world with no 7s.”

Think how elegantly that puts the answerer on the spot. In my experience, anything reasonably good is always a rated a 7. Forcing yourself to go with either a 6 or an 8 is hard to do … on one side is wheat, and the other, most assuredly chaff. A 6 is only 20% better than average, while an 8 is only 20% away from perfection.

[As an aside, the other ridiculous human tendency in these matters is to add a .5 to whatever scale is offered. 1-5? You will definitely get a 3.5 in the mix of answers (of course, that is the equivalent of a 7). Even 1-10 will produce some 4.5s and 8.5s. People, if we wanted .5s, we would double the scale. We get it … 8.5 out of 10 is 17 out of 20. That wasn’t the question.]

I was thinking about this recently as we analyzed our portfolio companies. We haven’t ever really put it in these terms, but we have a good “no sevens” culture at our firm, thankfully. The temptation is to conclude that most all of your companies are doing well, are “largely on plan” and “our initial investment thesis holds, despite some bumps in the road”. The fact is, some companies are continually raising your eyebrows in a good way, and others in a not so good way, and deep down you usually know it. Having said that, things change quickly in our business, and you really do not want to go negative too early. But there are important issues on the table and decisions to be made, about where you invest your follow-on capital and your time, and “sevens across the board” doesn’t help you to do that. Some firms force rank their portfolios, or have each partner force rank his or her companies; we don’t do either, we just push each other to avoid the banal 7.

This is important for entrepreneurs as well. The most obvious application is in evaluating or hiring your team. GE famously force ranked and fired their bottom 10%. If I thought the evaluation techniques were good enough, I could endorse that; inevitably, they are not. But some flavor of that kind of rigor is vital, to avoid the gentleman’s 7, as it were. I think this can be applied to a company’s pipeline of customers, its funding options, partnership opportunities, etc. Anywhere there are prioritization questions, force yourself to truly separate … it is too easy, and all too human, not to.

Power vs. Influence

Matt Harris —  November 19, 2010 — 2 Comments

Earlier in my career I worked at a large private equity firm (in my view, one of the great ones: Bain Capital), and for the last 13+ years I’ve worked in early stage venture capital. Those two ways of investing, ie buyouts vs. early stage venture, have lodged in my mind the subtle distinction between power and influence.

As a general matter, private equity or buyout firms purchase 100% of their portfolio companies, while venture firms purchase minority positions (though over time and across syndicates, venture capital ownership in aggregate often exceeds 50%). In one sense, the difference between 25% ownership and 100% ownership is just a math difference, particularly when you consider the various “control provisions” many VCs put into their terms, in practice the difference in governance style is (or at least should be) radically different.

I was reminded of this distinction twice yesterday. The first was in a conversation with a search and HR consulting firm, whom I greatly respect. This particular firm works nearly exclusively with private equity funds, but in this case was interested in working with one of our portfolio companies. It slowly became obvious to me that the firm thought they were in my office to make the sale, ie, that I was positioned to decide to use them for a search at one of our portfolio companies. I hastened to make it clear to them that they were in the wrong office, and that the team at the company would make the decision, and at most I would have input, or influence. The second conversation was with an outside director candidate, where similarly I had to make it clear that while my opinion mattered, ultimately we were looking to the management team to lay out a strategy for building an effective board, with our guidance.

I would contrast this with the typical process at a private equity firm, where quite literally the management teams at the portfolio companies work for the private equity folks. That’s a fine arrangement, and probably appropriate for more mature companies, but that would be a terrible outcome for an entrepreneurial, venture-backed company. Any entrepreneur who wants a “boss”, in that sense, is probably not the right person to execute the kind of high risk, high growth innovation that is the underpinning of a successful venture.

The fact is, there is really no sense in which any of my CEOs work for me. From a user experience perspective, most of the time it presents as though I work for them … most of my job consists of helping them meet their objectives, rather than the other way around. (Though, of course, by helping them meet their objectives I sneakily achieve mine, which is to own good-sized chunks of valuable companies.)

While proudly acknowledging that I don’t have any real power, I do think in most cases I have a reasonably amount of influence. I guess, to paraphrase WHEN HARRY MET SALLY, I am the dog in the scenario above. Management teams clearly have the prerogative to go against any opinions I may have, and all of my good ones commonly do that. But it is the case that the stakes of doing so and consistently being wrong about it grow higher over time. Hopefully, in addition, I’ve gained some level of influence just by having a degree of credibility with regard to certain aspects of building companies in my lane (financial services industries).

Lest anyone read this as a venture capitalists currying favor with entrepreneurs (not that I’m above that…), I should admit that my strategy here isn’t just about being a good guy and empowering management teams as a value in and of itself. I do it because I think it’s more likely to make money. Ultimately, my view is that power and accountability go hand in hand. To the extent to which I, as a director and venture capital investor, am making decisions at or for one of my portfolio companies, I am taking on accountability for the outcomes. To the extent to which I take on accountability, I am removing it from the management team. My view is that accountability shared is accountability lost, and a lack of accountability is the first step on the road to ruin.


Matt Harris —  October 20, 2010 — 8 Comments

I think that, sometime soon, people are going to stop making predictions.

Actually, tragically, that isn’t likely to happen. Human beings are seemingly irrepressible predicting machines, in that it is a way to sound intelligent without anyone being able to immediately call bullshit. By the time the future arrives, most people don’t care enough to back-test you. I was jolted into reconsidering this issue by the recent news from England, that they are going to go into austerity mode in order to reduce their national debt. Personally, this feels smart to me, in a “I’m no expert but isn’t balancing your books a good idea?” kind of way, but you can definitely find any number of economists violently committed to either side of the debate.

This is an old story, but it bear repeating: At the start of the year, a stockbroker sends a letter to 1,000 prospective clients, each containing his recommended “best pick” for the coming month. He sends a different ticker symbol to each of 10 groups of 100 prospects. In February, after 5 of the 10 stocks perform above average, he targets those 500 remaining prospective clients, further dividing them into 5 groups and repeating the trick. By June, assuming the same level of performance (ie, 5 of 10 picks perform above average), he has 30-odd prospective clients who think he’s a genius. Rinse and repeat, and you’re in business.

How different is that from Roubini and the rest of the economists out there? The bulls were right for the better part of a decade, until they were horrifically wrong, and the bears have famously predicted 7 of the last 2 recessions. Maybe it was always thus, or maybe it’s newly true, but I think at this point we can conclusively say this: the world is too complicated to predict. There are too many variables to fit in any one model. Just focus on what you know, do a good job, try to add value, say/do something novel, don’t listen to the experts, and you’ll be fine.

I was talking with one of my favorite entrepreneurs the other day, who was trying to choose a lead for his next financing round.  This is a guy who had plenty of options.  Facetiously, sort of, he said he was planning on picking the VC who had the most unique visitors to his blog.  That, of course, sent a chill down my under-publicized spine.  Again, i think he was kidding, but also kind of not.  He went on to explain that his biggest single job, and therefore problem, is recruiting, and a VC who can help him tout his company, and add credibility simply through association, is a major asset.

My response:  kill me now.

The fact is, relatively few venture capitalists I know went into this business because they were self-promotional.  Most of us are geeks who like technology and like hanging out with people who create new things.  The overlap between that personality type and the kind of folks who go on reality TV shows is roughly zero.  Despite that, a wave has hit our industry; a wave that previously hit the media industry and will go onto spill more broadly into corporate America.  The old methods of being successful, which were predicated on hand-crafted, person-to-person networking and leveraging the brand name of your firm, have been supplanted by the need to build your own profile online.

This has been playing out in the media for a few years.  As the traditional media brands totter and cast about for a business model, the onus has fallen more on more on the “talent” to forge relationships directly with their audience.  It is less the case that George Stephanopoulos works for ABC than that he leverages his position at ABC to build a profile for himself (and garners nearly 2MM followers on Twitter in the process.) The days when a cub reporter could get a job at the New York Times and simply do good work are, sadly, behind us.  That cub reporter had better be on Twitter, Facebook, Tumblr, etc, building an audience and creating quasi-personal relationship with her followers.  When her contract is up, she had better be able to point to the thousands of people who will follow her to her next gig.

This is becoming more and more true in the venture business, starting with those VCs that invest in social media, and moving beyond that sector.  This trend has challenged some of the incumbent leaders, many of whom are still on the sidelines as it relates to social media, and created room for new players.  Mark Suster is relatively new to the venture business, but has build a profile for himself that is second to few.  Having said that, I’ll bet if you quizzed 100 of his Twitter followers, fewer than half could name the firm he works for (GRP, by the way, who have been killing it lately.) This is a disruptive moment for our industry, and the new leaders will be individual VCs, rather than firms.

What’s next?  I think corporate America.  As with media and venture capital, right now having a well-known social profile is just an opportunity, not a threat.  Tony Hsieh at Zappos created equity value for his shareholders by being early and compelling on Twitter, but other CEOs are not yet feeling the pressure to follow.  That will change.  In 10 years, I believe that consumers will bias towards buying products (and retail investors will bias towards buying stock) from companies whose CEO they “know”, and have an online relationship with.  Personal publishing will move from being an opportunity, to a competitive advantage, to an absolute necessity.

As for me, I feel late but I’m running quickly.  Twitter is a better fit for me than blogging, as my musings tend toward the short and insubstantial.  [I feel certain my partner Bo would interject here that “short and insubstantial” could actually BE my personal brand].  I had a meeting today with an angel investor who I’d known previously only through Twitter, and I felt like we skipped forward at least two meetings worth, based on seeing each other’s faces every day.  I love the opportunity to praise and comment on my companies.  I continue to believe that there is no substitute for the “old” ways of doing things:  doing great deals, being a good guy and getting out and meeting people.  But there are new ways, too, and we ignore them at our peril.