Umair, Dude, Uh, What? (On Fixing VC)
Posted by Bob Warfield on April 18, 2008
Umair Haque responds to the conversation surrounding his original posting on fixing venture capital. It’s a good post. Umair wants to stick to his guns, so it’s a refutation post rather than a deepending of the conversation. Let’s take a look at what he’s saying, because I think he’s weakened his case more than he’s helped it. Recall that his original thesis is that the reason VC is in trouble is that there aren’t enough Googles, and that the reason for that is people simply are selling out too soon. They lack commitment.
First, RE Paul Graham’s response that Google wanted to sell out but didn’t get a high enough offer, Haque says Graham has missed the “strategic richness” of the story. He admits Google shopped Page Rank for offers in the millions range, but then suggests they changed their minds and stuck to their guns as proven by their refusal to take offers in the $3B-5B range in 2002.
I’m don’t see how Haque really refutes Graham’s point with that. I guess he’s saying that anyone motivated by money would have taken such an offer, and so Google’s founders clearly were motivated by a desire to change the world.
I’ve no doubt they do want to change the world and are doing so, though I do wonder slightly how that reconciles with having shopped their deal early on. The shopping business sure sounds more like what Graham was saying about a value disconnect. Just out of curiousity, let’s play the numbers the way the iBankers would be presenting them to Google and their investors.
Haque says there were $3-5B offers in 2002. Google’s numbers for 2002 were $347M in revenue (4x what they were the year before), and the earnings were $186M (17x what they were the year before). Most investors suggest that a PEG ratio (PE/Growth) of 1:1 represents a good buy. So a “good buy” for Google’s 2002 earnings would be 1 x 17 x 186M = $3B. In other words, $3B would have been a bargain for that business. Clearly they also had to know pretty clearly that Google was hugely more successful than the vast majority of startups in terms of dollars, not just hype, and so deserved more than a bargain price. Whether you’re motivated by money and financial sensibilities or changing the world, I can’t see why they’d spend much time on a $3B offer.
By comparison, as I write this, Yahoo is trading at a 3x PEG which doesn’t even reflect Microsoft’s full offer value. That would imply that back in 2002, for Google to be valued as Yahoo is today, it should have been valued at 3 x 17 x 186M or over $9B. That’s almost 2x the $5B Haque says was at the high end. And recall Google would’ve looked a lot hotter then than Yahoo does today in term’s of its potential.
Dude, Umair, it looks to me like Google didn’t get an offer that a cold blooded iBanker would have told them was what they were worth. I gotta think the advice was to let it ride, we can triple the business again and go public at a better valuation. Graham called this one right: blame the acquirers for being arrogant enough not to value Google properly. Imagine if Microsoft had paid $10B then for Google instead of $42B for Yahoo today. Of course Google probably wouldn’t have survived the assimilation.
BTW, the wonderful thing is that everyone’s interests would’ve been aligned–the money men would’ve held out for more, and the world changers would get to keep building an even bigger agent of change. It’s a beautiful thing, and it has spawned one of the world’s greatest companies.
Next up, very little seed capital available, also credited to Paul Graham, and my major refrain here. See for example, Where Did All the Software Seed Money Go?. There’s a lot of transactions available, but very small dollar amounts. Haque takes the VC’s to task on this, and that’s what I’ve been saying as well.
On to his response to Ashkan, who said basically Google had an unbelievable string of lucky market breaks. Umair says basically, sure, but 2001, when Google was climbing rapidly, was an even tougher economy than today. I think Haque’s perspective that firms influence and shape their environments is worthwhile. To that, I would add the piling on effect of success. People want to be associated with success. Ashkan talks about those “exogenous factors” like they were all just luck. Some were, but others were a function of folks wanting to align with the new new thing, which Google clearly was in 2001 giving their financial traction. We see this time and again where one minute we can’t get people to return calls, and then they hear about success and suddenly its us not returning our calls. We’re in agreement.
SmoothSpan is next up, which I’m flattered by, as Umair responds to my remarks on the subject. Thanks for the link love, bro! And if others are wondering what all the “Dude” talk is, I picked that up from Umair’s remarks when he characterizes my post as, “Dude, the IPO window’s been closed, by SmoothSpan.” There’s something else there about NINJA loans and how the whole world could do IPO’s so why not VC’s? BTW, those NINJA home loan guys have liquidity issues too, not sure they’re the best refutational role model. But, dude, Umair, maybe its just me who thought the window closed, or maybe the business world also thought the IPO window was pretty tenuous during those years. People like, um, BusinessWeek?
Heck, I may not know too much, I only just went through the core of that period at one of the few tech companies that did have an IPO back then (2nd guy on the left, yay!). I might have heard a thing or two about how iBankers and VC’s think of the IPO market, but I probably just misinterpreted it. NOT!
But it’s okay, Haque essentially goes on to say just what I said in my post, with, “the IPO window remained closed because venture guys weren’t investing seriously in meaningful new business models and markets – just in features and add-ons.” We’re on the same page in the sense that this is what my post was all about.
But, I think we view the way we got there differently. I get the impression Umair thinks they just aren’t smart enough to invest in something besides features and add-ons. In my experience, most VC’s are very smart people. Many have extensive experience outside VC, have built companies on their own, and know many many entrepreneurs who they’ll be the first to admit they’ve learned from. The trouble is, they’re sold on a model that says they can’t accurately predict what will succeed early on. Who can blame them? Seeing enough good ideas fail and going through economic hard times can do that. So, they came up with the plan to invest later, after the world at large had validated the idea, and just pay for a higher valuation. Again, this is not a dumb move. It’s the Wisdom of Crowds at its best.
The trouble is, it is a good idea for an individual firm and a bad idea for an ecosystem. If every firm goes that route, the seed money dries up. How you gonna build much but features and add-ins for $250K in angel money? Google had friggin’ $25M before they made a dime! That’s why I say the problem is in the beginning, not in the middle with conviction (ala Umair), and not in the end with liquidity (ala Fred Wilson). I’m all about the IPO window closure being somewhat temporary and said so in my post. Sounds like we’re close to what an old friend used to call “violent agreement.” We just came at it from different angles.
Umair muddies the waters a bit by bringing up Mixi and Megastudy, which apparently went public overseas. He says my criteria (stable earnings, >$100M revenues, yada, yada) are bogus and there is an existence proof in these two companies of that. Now mind you, Google way exceeded my criteria before they went public, and I thought that’s what we were talking about, but let’s look at Mixi and Megastudy and see if we can learn.
Mixi is out on the Tokyo Exchange listed at $50M in revenues with $10.7M in profit and trading at a $1B market cap. How is this a counter-example, Umair? These guys track Google pretty well. If anything, I’d wonder why they needed to “sell out” in your terms so soon instead of following Google’s track? After all, they’re profitable on $50M in revenue. These guys fit my profile exactly for being able to IPO in the US in a year.
How about Megastudy? They’re on the Korean exchange. They are doing $163M in revenue, $46M in profit, and a market cap of $2.3B. Again, they have scale, they’re growing, they’re profitable, how is this different than what I’m suggesting for US markets? Why are these guys so revolutionary and why are these other markets so much shrewder?
I don’t see these two as, “an existence proof that’s not the case.” You don’t have to look too closely at the numbers to see that it’s quite the opposite. Both are on a very Google-like track, could have followed my criteria, and IPO’d on the US markets, but they “sold out” to use Umair’s words and went public overseas, perhaps a bit sooner.
Haque concludes by saying:
Dude, it was obvious that Google was, well, special – a general refrain. I think it was far from obvious: in 2002, Yahoo’s revenues were more than double those of Google. Google’s hypergrowth was dependent on the continuing success of AdWords, etc – and though it seems certain to us today, the very real story is that Google took massive risks to make AdWords truly revolutionary – while Yahoo evaded risk, and continued to buy and sell media exactly as it been bought and sold for the last century.
No Umair, I think it really was obvious that Google was special. They were breaking all the records for startups of their size. It’s one thing when this happens with your first $10M in revenue, and quite another when you are a $300M plus company. Yahoo did evade risk, and to their downfall. OTOH, perhaps it wasn’t even so much evading risk as it was in not having any deeper insight in what to do next. A lack of vision in other words. They are certainly not demonstrating any risk evasion in their Microsoft dealings today (they’re taking a high risk road to keep going on alone), and it’s the same decision makers.
I love the passion Umair communicates: it’s good to get all fiery and romantic. Startups need that to sustain them through thin times. There are startups that sell too soon. There are startups and VC’s that sell too late. But a lack of passion and commitment is not the problem with the industry. I meet tons of great passionate entrepreneurs with fascinating ideas. Let’s get started building some new stuff besides features and add-ons. No more feed aggregators, ways to Twit, Twitch, or Tweet on 27 different lifestreaming services, or other Inane 2.0 innovations.
Let’s change the world. On that I bet we can agree.