Ben Horowitz: Capital market climate change

http://finance.fortune.cnn.com/2013/07/15/capital-market-climate-change/

by quant • 13 years ago

114 50 13 years ago

finance.fortune.cnn.com

ryanobjc3• 13 years ago

I find that CEOs are often the last to realize or admit the reality of suckitude a company is under.

I mean if you did your job right as CEO, you are the dumbest person there. You spend all your time being upbeat and optimistic in public (maybe horribly depressed in private?). Your engineers and managers, who are experts in divining information out of the smallest bits of data (single line bugs anyone?) are much smarter than you realize.

I have rarely seen a CEO that I completely respect. They just don't have the ability to aggregately integrate every detail in the company and tend to lead things to a crash and burn as a result.

omilu• 13 years ago

What about Gates, Jobs, and Buffet?

ryanobjc3• 13 years ago

Perfect counter examples, and I respect them all.

kaib• 13 years ago

Extrapolating from your use of "they" and the implied "us" I'm guessing that you haven't worked in the role of a CEO yourself. Taking that responsibility for a few years might not increase your respect for individuals but it will increase your respect for the difficulty of the job.

ryanobjc3• 13 years ago

I think my problem doesn't have to do with how hard the job is or not, but with the quality and honesty of the communications.

A lot of the startup CEOs I have seen tend to have a "this is my company" sort of feeling. But by expressing that feeling to their employees, they crowd their employee's feelings in this regard. Everyone who works for a startup wants to feel like they OWN the company. That's why you join one. For that feeling of ownership.

But when a CEO talks with these "sole ownership" feelings, people GET it. Also if a CEO uses evasive or trivializing language or behavior about the state of the company, people's internal sense of dissonance causes a rift of trust AT THE WORST POSSIBLE TIME.

I have seen this pattern play out a few times as the "non CEO" position. Yeah it's a hard job, but if you didn't want the challenge of a lifetime, why take the job?

gfodor3• 13 years ago

Two things to nitpick on a macro perspective, both things I would have not expected the article to go into anyway.

First, corporate earnings are at all time highs. Looking at P/E ratios as a measure of if we are in a "normal" sentiment environment is kind of a bad idea, since the P/E ratio captures two cycles at once: the sentiment cycle (higher P for less E), and the earnings cycle (higher E overall). At P/E of 15 when the earnings cycle is at it's peak (as it is now) may still be reflecting extremely high (read: irrational) relative sentiment towards equities, even though the ratio itself sits only slightly above average. And, in fact, there are many indicators that point to the fact that the public is more bullish on stocks now than they have been since before the 2008 crisis, even though the P/E ratio is only 15-16.

Second, the consensus right now is forming that we may have finally turned the corner in the 30-year bond bull market, and interest rates are on the rise again. If this is true, it represents an important change for asset managers, and will trickle all the way down to private equity and startup funding. As rates rise, particularly if they rise not just due to inflation but due to tightening monetary policy, investors will need to deploy less capital to reach for yield to places such as private equity, so you can expect deal terms to get more "investor friendly." (I am not sure if we are actually at the beginning of a bond bear market, but many people believe so.)

edanm• 13 years ago

"when the earnings cycle is at it's peak (as it is now)"

Why do you think earnings are at a high?

kalininalex• 13 years ago

You can use profits-to-GDP metric, for example: http://money.cnn.com/2012/12/03/news/economy/record-corporat....

It's no guarantee profits won't go even higher, of course, but they are quite high now.

RockyMcNuts• 13 years ago

isn't sentiment a lagging indicator of earnings?

so sentiment shouldn't really have peaked unless earnings already did too?

wonder if anyone else has seen this, and when he wrote that, if it was during the Fed scare correction that seems to have been succeeded by the Fed relief rally.

http://stockcharts.com/h-sc/ui?s=%24spx&id=p33407302522&def=...

gfodor3• 13 years ago

Arguably the downwards pressure on bond yields due to fed policy has inflated asset values enough to dislodge sentiment from valuations. Many people are rotating money into stocks since they can't think of any better place to get a return, and the bull market is enticing them to overweight.

minimax• 13 years ago

In fact, if you are like most companies, your managers probably implied to your employees that your stock price would only rise as long as you were private. They might have said something ridiculous like: "Based on the current price of the preferred stock, your offer is already worth $5 million." As if the price could never go down. As if the common stock were actually the same as preferred stock. Silly them.

Is this something that actually happens or is he being hyperbolic? I thought there might be some legal issues around making claims like that.

acchow• 13 years ago

Yes, he is presenting common practice.

Many software engineers have read a few finance books and will understand that preference provides a large premium in preferred stock.

georgemcbay• 13 years ago

I've never personally heard someone make an absolute number statement like "$5 million", but back during the first dot-com boom and bust I certainly saw managers at startups imply untold millions, even to people who held relatively small amounts of common stock. Suffice it to say, those millions were generally fictional, even among companies lucky enough to have big exits before the bubble popped (generally, due to massive dilution of the common stock pool).

pmarca4• 13 years ago

That happens exactly as Ben described it, including at some very well known startups.

It's a ticking time bomb not just in terms of employee morale but also 409A (tax law).

chiph• 13 years ago

You just need one to say yes and she will erase all 20 no's.

That works as long as the potential investors aren't comparing notes: "I heard Moneybag Ventures only offered you $180 million valuation..."

jusben1369• 13 years ago

I think the points simpler. 20 people have told you a flat out no. One person says "yes" That's all you need.

mathattack2• 13 years ago

The conclusion is sound - "Today is different in funding than yesterday" Similar to other posters, I nitpick how he got there.

Nothing in efficient market theory suggests constant PE ratios over time. Nothing in efficient market theory suggests that your stock will be higher if you double your bookings. (If the initial price assumed 3x bookings, you'll tank even if the market is the same) PE ratios revert over long time horizons (many years) but even what is considered earnings changes over time.

That said, his conclusion is true. If you raise money in great times, you may need to take a hit in bad times. Better not to overpromise.

jacques_chester2• 13 years ago

The Efficient Market Hypothesis is actually a family of hypotheses. Folk usually pick the strong EMH because it's easiest to transform into a strawman and beat about the head and neck.

One of the bloggers I host gave a very good explanation of what the EMH is and what it actually implies: http://skepticlawyer.com.au/2013/05/29/bubble-trouble-all-in...

Having particular bearing on the Horowitz post is this remark:

    Commentary often seems to presume that EMH,
    or notions of market rationality generally, 
    provide some implicit or explicit guarantee 
    that current prices will be sustained, which
    is false. No guarantee against asset price
    volatility follows from either.

mathattack2• 13 years ago

Exactly! Even the strongest form assumes many shocks.

cmbaus• 13 years ago

It is in Andreessen Horowitz's best interest to get valuations for Series A funding down.

davemc500hats3• 13 years ago

... and similarly, it's in YC's best interest for valuations (of YC co's) at Series A to go up ;)

gbadman• 13 years ago

I think that making claims on the changing capital market climate based on historical P/E ratios may be measuring the wrong thing. A declining trend in P/E ratios may suggest a decline in valuations but it also may suggest a change in capital structure. Or it may suggest a combination of the two.

It would be interesting to look at the trend for EBITDA multiples over time instead: https://cloudup.com/cHNL3Wcy5yH [1]. In this view, you can see that TEV/EBITDA ratios are very similar today to what they were in 1995 even though they took a very circuitous route to get there.

1: S&P Capital IQ (exported just now)

pg5• 13 years ago

We haven't seen a decrease in the valuations/valuation caps at which YC companies have raised money after Demo Day.

Valuations are high by historical standards, which means at some point they'll probably fall, but we're not seeing evidence of a fall yet.

It does seem to be getting harder to raise later rounds. But I think that is a secular change, not a market fluctuation. VCs seem to be shifting toward a strategy of spraying money at early stage startups, and then ruthlessly culling them at the next stage. This may well be the optimal strategy, but it's tough on the late bloomers.

fraserharris• 13 years ago

There is another aspect to this that is not getting much mention: many more startups are reaching profitability without VC, but still don't have metrics to justify going for a home run. Ergo, the "ruthless culling" is not resulting in the bloodbath that some predicted. In general, great for startup founders & great for (the remaining) active VCs.

pg - do you have any stats around how many more recent YC co's are profitable & have not secured/pursued Series A?

pmarca4• 13 years ago

My guess is very few but I'd love to know as well.

pg5• 13 years ago

That's a complicated question, because the nature of series A rounds has changed in the last couple years. A lot of so-called series A rounds now are de facto series B rounds, huge "seed" rounds having taken the place of series As (at least financially).

A bunch of the companies we've funded are profitable and haven't raised a series A round yet, but it looks like there is only one that is way past the (now much later) series A stage and yet didn't raise a series A: Weebly.

jacques_chester2• 13 years ago

VCs seem to be shifting toward a strategy of spraying money at early stage startups, and then ruthlessly culling them at the next stage.

Looking at this from way outside: I think this is because they're much more aggressive on product-market fit. Pivot once or twice, then give up when you're not the next instagram.

Ideas have consequences; here it's the concept of startups as early-terminating simulated annealing search algorithms that has been consequential.

ChuckMcM2• 13 years ago

I wonder if there isn't another force in play here, given the aggressiveness of acqui-hires a VC firm can make book by spraying a lot of 100 - 200K investments around, maybe a 1M and then harvesting the acquihire dollars when the team works out. They are essentially glorified head hunters with a bigger contract bounty but they put together teams instead of just individuals. So putting in a million $ to get a couple of young stars to recruit 5 or 6 of the best programmers they know, and organize them into a team that can build a project. Then scare them with the "Series A crunch" and sell them off to BigCo for a million dollars a head.

I know, I know, too cynical. But looking at the exits that way skews the numbers.

pg5• 13 years ago

Definitely not. For some reason there is a persistent myth that investors make money from HR acquisitions, but they don't. Even we don't, and we invest at much lower valuations than VC funds.

davemc500hats3• 13 years ago

i will defer to PG & YC in terms of their data on valuation/caps post-demo day, however our experience is that they probably reached a local max sometime last year, and they are certainly softer this year.

in general, most companies with similar progress are being valued less highly than last year.

which isn't to say they are either cheap, or a bargain -- just not as high as last year.

bayesianhorse• 13 years ago

On the other side of the table, are Investors suddenly finding better/safer/more profitable opportunities now?

loceng• 13 years ago

This just further reenforces to make sure you get enough money to get where you need to prove what you need to..

ivankirigin• 13 years ago

One explanation is that the startups you fund are on average better than ones you funded before. You did become increasingly selective. Having higher standards and valuations remaining flat implies valuations are falling on average.

pg5• 13 years ago

Hmm, yes, that could be.

joshuaellinger• 13 years ago

I don't think the data says what he think it says.

Sure, it is not 1999 or even 2002. I don't think anyone thinks it is.

Focus on the last 4 years. It looks pretty flat with a blip in 2010.

3/31/2009: 14.5 3/31/2010: 18.8 3/31/2011: 15.4 3/30/2012: 15.5

Of course, Ben could be (and probably is) right but the P/E ratio does not look like evidence to me.

inthewoods• 13 years ago

A simple rule I've found - if an investment manager is doing an interview, he's generally talking his book in one way or another.

Ben Horowitz: Capital market climate change

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