Forecasting Out

In the business of financing technology businesses, one of the most tricky areas is how you treat the forecasts in the pitch decks.  Typically, you are taking a very limited, usually heavily biased, data set and using it to provide a baseline for forecasting a much longer trajectory.  If you are familiar with probability, you’ll know that while this is possible, the result will have a very low confidence level.  Therefore, you need to discount these forecast very, very heavily.

I was reminded of this when I read the Bloomberg New Energy Finance press release on Electric Vehicle sales forecasts.  The headline is that Electric Vehicles will Accelerate to 54% of New Car Sales by 2040.  I a sure there’s sound methodology behind this work, and the resulting graph looks great:

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Now, please consider that Tesla Roadster, the first street-legal, serially produced EV with a viable range was introduced in 2008. When you are taking a 1% market share figure and growing it to 54% over 25 years, a tiny variance in that slope can end up with a vastly different figure.

As a VC, you come across enough forecasts to intuitively discount the out years.  This is not really a science but more of a sense.  However, it can make a massive difference in the eventual exit size and how much capital the business may end up consuming.

Online Retail Turning a Corner

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We have a love-hate relationship with online retail companies.  My partner Evren is the founding investor at Trendyol, Turkey’s online fashion champion.  We have backed Vivense, the leading online seller of furniture that is growing rapidly with healthy metrics.  Trendyol is now one of the biggest Turkish tech success stories and Vivense has become the leader in its focus area of hard furniture.

Our experience, laced with blood, sweat, and tears, has shown us how difficult it is to build a sustainable and healthy online retail business, and we have also passed on a very large number of online retail startups.

Recently, I am sensing a change in how the world views online retail. In the recent months, we have seen some major moves in the sector:

  • Emerging Markets conglomerates are investing into retail e-commerce.
  • Amazon has made a rare market-entry driven acquisition in MENA.
  • The leading local e-tailer in India, Flipcart, has raised a massive new round is rumored to be contemplating buying its largest local competitor, Snapdeal.
  • Walmart paid $3b for Jet.com, which, at the time, was little more than a large repository of know-how and ambition.
  • Unilever acquired DSC for $1b, showing the potential in smart vertical integration in certain e-commerce niches.
  • It finally looks like Birchbox is profitable (read: perhaps sustainable), providing new hope for subscription models.
  • Trendyol is now nicely profitable, without compromising from its rapid growth.
  • Leaders like Amazon (generalist) and Zalando (fashion specialist) are trading at all-time highs.

I think these headlines are a sign that strong execution, operational excellence, and adequate funding are coming together in select pockets to show that retail e-commerce can work.

Startup Selection Bias

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It is not sexy to write about the $40m acquisition of an 8-year old company with $4m EBITDA. The headline about Snap’s 60+ P/S ratio gets more attention.

The entrepreneurial mythology is full of epic stories, such as those of Apple, Google, Facebook and Amazon.  Yet, the reality is much more boring, as represented in this chart. The selection bias around what you hear about is a trap in the entrepreneurial journey.

We frequently find ourselves in valuation discussions with founders where we think the asking price for the round is expensive.  What keeps us grounded is the data represented in the chart above.  Mind you that the exit sizes in Europe, and especially, Emerging Markets are lower than the global figures.

As an entrepreneur, you would be well-advised to keep in mind that your exit will likely be smaller than what you read about.

Time and “No”

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The word “no” is the most valuable tool for founders. It’s the currency with which you buy time, your most precious asset, as you are building your business.

Time is your asset, but it works against you.  The moment you launch your business and start spending money on your team, your overhead, marketing, etc., you notice that they are mostly denominated by time.  Almost all of your KPIs are also time-driven.  Revenues, gross profit, visitors, customers… are all meaningful when you attach time to them. The same with your monthly burn and your runway.  Time dictates your success.

When you say “no” to activities that do not contribute to the few success metrics on which you focus, you are buying yourself time, with which you can continue that focus.

Snap Thoughts

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Since the Facebook IPO in 2012, I had not been asked to opine on any new listing as much as Snap. The company had its highly-anticipated IPO last Thursday, and things went smoothly, with the stock popping to $24/share at the opening, a big jump over its issue price of $17.

What do I think of the company and the IPO?

It’s expensive given the numbers. The current $30b market cap is 75X 2016 revenues.  I also think that the quality of Snap’s ad revenue is lower than that of Facebook and Google, as it’s largely intermediated through media planning agencies. Almost all of it is brand advertising.

Still, i was not surprised with the strong IPO. With the small float (scarcity), hey could have priced higher and didn’t. I think the buyers were willing to take the risk of a 50-60% downside, with the hope that this becomes the next Facebook.

I, personally, did not bet on it. Facebook is, at its core, a tech company, whereas I think Snap is more of a media company. With the Facebook, Messenger, Whatsapp and Instagram apps, Facebook is the most dominant force on mobile.  Either Facebook’s 13X sales price is mispriced, or Snap’s 75X.  Both can not be right.

Facebook owned (and still owns) the identity layer of the internet and that makes it very resilient. Snap owns the attention of the (very valuable) US teenagers. Not as resilient.
I have not looked at the allocations that Fidelity, T. Rowe Price, etc. got at the IPO. These public market investors were already shareholders and had an insider’s perspective. If they bought more at IPO, it’s a bullish sign.
The great news is that this was a closely-watched IPO and it will usher in a wave of listings, creating liquidity for VC LPs.  Those dollars are likely to get recycled into VC fund providing the fuel for the global innovation economy.

Absorbing Daily Shocks

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It would not be controversial to classify 2016 as a tough year, both in Turkey as well as the rest of the world.  We have seen increased terror attacks globally, and surprises like the coup attempt in Turkey, the Brexit vote and Trump’s election.

Startups require relentless focus on execution.  Yet, founders are human and they, like everyone else, are vulnerable to the distractions caused by the barrage of shocking events.  Add to this the ups and downs of a startup – landmark client wins, finding your company in the headlines, your competitors releasing new features, your co-founder leaving… The list can go on for pages.  With this much hitting a founder’s psyche, they have to work hard at keeping their focus and not get swayed too much by external factors.

I’ve always felt that helping our founders absorb these shocks is one of the ways we as investors and board members can be valuable to our portfolio companies.  We are there to remind them that it’s usually not as bad (or as good) as it feels at the moment, and that they are in a marathon, not a sprint.  They need to keep their  dual focus : one eye on the horizon, at their destination, and the other one on their desk, at their immediate next step.

Focus on the Upside

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Point Nine’s Pawel has a good post on why complex liquidation preference structures are bad for your startup.  It’s worth reading.

I agree with Pawel that complex liquidation preference starts entering term sheets in tighter VC markets.  Being notoriously lemming-like in behavior, the mood pendulum swings very dramatically in the VC industry.  You can go from SAFE term sheets with $30m caps at seed stage to offers with 2X participating preferred clauses in a matter of weeks.

More than the economics involved, complex liquidation preference terms are alarming to us in what they tell us about the VCs mindset. In our experience, success in VC comes from helping build great companies.  True, strong liquidation preference terms can theoretically boost a fund’s returns by a few basis points.  However, we believe that they do more harm in the precedent they set for future investors, the needless extra pressure it extracts on the others on that cap table and impede the VCs alignment with the founders.

We try to keep our focus on the upside in every investment we do and concede that some of our investments will not work out as planned.  The best way to keep those cases to a minimum is to stay aligned with our founders as much as possible.  Sticking with simple liquidation preference structures helps us achieve that.