Hi, everyone, good morning! We’re doing something a little unusual today; we’re running a guest post by Greg Gretsch of Sigma West, who was among numerous people to write to StrictlyVC on Monday in response to our piece about how many tech companies break out each year (and how hard it is to verify oft-cited research that suggests that number is 15ish).
Turns out a number of you question the numbers but are reluctant to say so publicly. Not so Gretsch, who wrote us such an impassioned email about the industry’s widespread acceptance of the meme that we asked him to author a post about it. Hope you enjoy it. Either way, we hope you’ll tell him what you think and why.
Have a terrific weekend! (Also, web visitors, this version of what you see below is easier to read.)
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The “15” Meme Fallacy
StrictlyVC recently observed that 10-year-old data of investor-entrepreneur Andy Rachleff has done much to inform how venture capitalists now behave. That data found that between the mid ‘80s and mid 2000s, about 15 tech companies are founded each year that account for 97 percent of all public returns. It was popularized around 2009, when Marc Andreessen and Ben Horowitz – who were launching their venture firm at the time — began discussing it widely with reporters.
Yet the idea that only 15 tech companies each year go on to produce $100 million in revenue and therefore “matter,” has never sounded right to me. It doesn’t square with my own experience, having led Sigma’s investment in three companies that reached more than $100 million in revenue per year: EqualLogic, which sold to Dell for $1.4 billion; Responsys, which went public, then sold to Oracle for $1.6 billion; and oDesk, which recently merged with Elance and remains private. I’m working with several more companies now that I’m confident will reach that very important milestone.
So what? Well, the problem isn’t the belief that a small number of companies generate the lion’s share of venture returns in any given year. That’s been the conventional wisdom for years. The problem arises when this belief is taken the next few steps. In other words: If there are only 15 companies founded each year that matter, then in order to be a good firm you have to be an investor in those 15 companies (or many of them), then therefore (and this is where many firms go off the rails), it doesn’t matter what you pay for them.
Overlooked in this march toward the “winner’s circle” is the time required to build a company to $100 million in revenue. It took EqualLogic roughly 6 years, Responsys roughly 12 years, and oDesk a decade. Rachleff’s research (which he no longer has) covered a span of time through the mid 2000s. All of my $100 million companies were founded in those cohort years but reached the magical $100 mark in more recent years, meaning they wouldn’t have been in his 15-per-companies-per-year estimate.
To believe that such a narrow number of companies is all that matters doesn’t make intuitive sense, either. According to Morgan Stanley, there were more than 20 venture-backed tech IPOs each year between 2001 and 2014. It’s safe to assume the vast majority of those companies mattered to their investors. The same is surely true of the countless great M&A transactions we’ve seen over the same period, like WhatsApp, Nicira, Instagram, and YouTube.
Worth noting: None of the aforementioned M&A deals got to $100 million in revenue on their own.
This brings me to another point. While it’s true that venture investing follows a power-law — meaning that a small percentage of companies each year represent the overwhelming percentage of gains from that year — you can still generate fantastic returns without being in those monster hits.
Even if you take out the “15”, there will still be many 10x exits that are just making up for the companies that lost everything for that vintage year. And any venture investor would be happy to invest in a 10x company whether or not it was among those that generated the bulk of the returns in venture for its vintage.
The biggest problem in investors’ religious adherence to the 15/$100 million meme is that it causes bad behavior. When every investor is chasing that mythical yearly batch of 15 companies, valuations for those anointed companies skyrocket. That’s bad for investors who often end up investing at valuations greater than the public market is willing to give these companies (see Groupon, Zynga, et al.). It’s also bad for companies. Those for which capital is cheap and easily accessed are at greater risk of making non-economical business decisions that create business models that rely on increasing amounts of cheap capital (see Fab, Box.net, et al).
Bill Gurley put it best when he told the WSJ: “Excessive amounts of capital lead to a lower average fitness because fitness, from a business standpoint, has to be cash-flow profitability or the ability to generate cash flow. That’s the essence of equity value . . . [and] we get further and further away from that in the headiest of times.”
At some point someone will do the definitive piece of academic research on the topic. Unfortunately, given the long time required to scale most companies to $100 million in revenue, the mature cohorts will be so far out of date that they won’t be relevant to the then-current investing climate.
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Edison DC Systems, a 1.5-year-old, Grafton, Wi.-based company that develops power supplies for data centers, has raised $1.3 million in Series A funding led by Chicago’s Energy Foundry, with participation from individual investors.
TheGrid, a three-year-old, San Francisco-based company that uses artificial intelligence to help people create and design their sites, has raised $4.6 million in Series A financing led by AME Cloud Ventures.
Lulutrip, a seven-year-old, Santa Clara, Ca.-based online travel service for Chinese-speaking customers, has raised an undisclosed amount of Series A1 funding from Lightspeed China Partners.
Novelda, a 10-year-old, Oslo, Norway startup that develops sensors for home automation and other uses, has raised $12 million in Series A funding led by Norwegian government fund Investinor AS. Other participants included Alliance Venture, Sparebank 1, SMN Invest, some company employees, and angel investors.
Prong, a 3.5-year-old, New York-based company whose accessories keep smartphones charged, including a case that incorporates a detachable back-up battery, has raised $1.6 million in Series A funding led by the Atlanta-based private equity firm Georgia Oak Partners. The company has now raised $3.1 million altogether, shows Crunchbase.
Ring, a two-year-old, Santa Monica, Ca.-based “smart doorbell” that uses video, motion detectors and mobile connectivity to let users know when someone is at their front door, has raised $4.5 million in Series A funding led by True Ventures, with participation from earlier backers First Round Capital, Queensbridge Venture Partners, Upfront Ventures, and angel investors. Ring has also secured $2.5 million in debt financing. Venture Capital Dispatch has more here.
Sirakoss, a five-year-old, Edinburgh, Scotland-based company that makes synthetic bone grafts for spine, dental, and other applications, has raised $4.8 million in Series A funding led by Epidarex Capital, with participation from Scottish Investment Bank, Armourers & Brasiers’ Co., and other undisclosed investors.
ThreatStream, a three-year-old, Redwood City, Ca.-based threat intelligence platform that identifies cyber threats, has raised $22 million in Series B funding led by General Catalyst Partners, with “significant” participation from Institutional Venture Partners and earlier investors Google Ventures and Paladin Capital Group.
Tute Genomics, a two-year-old, Provo, Ut.-based cloud-based software for genome analysis, has raised $2.3 million in Series A1 financing led by Eurovestech, with participation from Peak Ventures and numerous angel investors. The company has now raised $3.8 million altogether, shows Crunchbase.
Uber, the 5.5-year-old, San Francisco-based car service company, has raised $1.2 billion in new funding from investors that include the Qatar Investment Authority; two hedge funds, Valiant Capital Partners andLone Pine Capital; and the venture firm New Enterprise Associates, according to the WSJ. The bidding process lasted “several weeks” and drove the valuation of Uber to more than $41 million, says the report. Uber has now raised $2.7 billion altogether.
Histogenics, a 14-year-old, Waltham, Ma.-based regenerative medicine company, raised $65 million in its IPO, selling 5.9 million shares of its common stock at $11 per share in the IPO.
OnDeck Capital, the seven-year-old, New York-based online lender, has increased the amount it intends to raise in its IPO to $207 million. The company expects to offer 10 million shares at $16 to $18 a share and will give underwriters the right to purchase up to an additional 1.5 million shares.
Comparison-shopping website Become Inc. has been acquired by Connexity Inc. TechCrunch has much more here.
The ride-share service Lyft has a new chief marketing officer and chief financial officer, reports Bloomberg. Kira Wampler, who most recently worked at real-estate website Trulia, will lead Lyft’s marketing efforts in a newly created position; Brian Roberts was promoted to CFO after briefly working on business development at Lyft. (He joined the company three months ago from Walmart, where he was an SVP.)
Rovio Entertainment, the Finnish mobile game developer behind the “Angry Birds” franchise, is slashing roughly 14 percent of its workforce, completing a round of layoffs announced in October. Ars Technica hasmore here.
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