Multiples vs IRR

One of my most popular posts from VC Confidential…

“You Can’t Eat IRR.” — anonymous

I was at a business school today helping judge several business plans. As group after group presented, I saw each make the same mistake as the previous. When they tried to justify the investment from the perspective of the VC, they kept telling us that this was a 40% IRR deal or a 25% IRR as if we had magical IRR thresholds.

The reality is that the venture world is all about multiples and the IRR’s are the results. I don’t know what the original legacy behind this was, but from a practical perspective, it is driven mostly by the fact that we live in a boolean world. Some is also based upon the high net worth legacy of our business. Originally, because pension law did not permit the large institutional investors in, our business was funded by family offices, endowments and foundations. Multi-generational families, while they want high IRR’s, are really looking to double or triple their invested capital.

From a portfolio perspective, if we invest in 10 deals, 4 are tube shots, 2 we fight to get our money back on, 2-3 we get 2-5x on and the 10th deal drives the return (hopefully north of 10x). If we doubled our money in 1 year (100% IRR) but lost all our money on the next deal over 6 years, we aren’t happy (net gain is $0). We don’t care that we made 2x in 1 versus 3 years or lost all of our money over 6 years versus 4 years (this impacts IRR), because we earned 1x on the capital.

We often see complex financial models with discounted cash flows, hurdle rates and such. These are useless. I have never seen a set of financials in an early stage company that ever reflect what Darwin will allow to happen in reality. So, you start your modeling with unreliable numbers. Secondly, what is the beta for an early stage biotech deal, a semi-conductor start-up, etc? Can you assess the risk associated with a given management team? How about a new market space?

Perhaps we are too lazy to try and figure this out, but after decades of effort, the only method that seems to work in the venture world is to target 10x on each early stage deal (3-5x on later stage plays). They all look like the next Microsoft, but eventually, the portfolio of these settles down to the profile above. In the early stage world, if you target, say a 40% IRR, through assuming a number of 5x wins in a compressed period of time, you will likely be out of the business. Your 5x wins, while possibly generating high IRR’s, don’t return enough multiple to pay for the 4 tube shots and 2 break-even deals. Your winners need to deliver 10x.

So, next time you are trying to convince a VC about the merits of your firm, show them how they can make 10x capital on a realistic exit scenario (not how to get a 40% IRR).

The 15 Year Tech Cycle: Reloading for Another Tour

“If you can see it, it isn’t the revolution.” — Steve Jurvetson

I wrote the following post in Nov, 2008. It demonstrated two things. 1) Tech and the stock market have a little dance they do…tech has roughly a 15 year cycle and the stock market has roughly a 7-8 year one and 2) tech is non-linear…just as FB/social was about to take off, many thought cleantech was going to be the next bellweather sector. If you can see it, it isn’t the revolution. It is possible that we are going to skip through this current cycle into a second one that goes to 2021 or 2022 due to the continuing decline in interest rates.

The markets in 2008 were very different. The banks were overexposed with bad real estate debt. Their current balance sheets are relatively clean. It is only when the banks get into trouble that the economy truly contracts as they pull in credit.  I wrote in June 2008 that I thought the venture/market cycle was coming to an end and this one in Nov 2008. Today, lot of people are going to cash and getting nervous about the market this year. Fortune 500’s are cutting ad spending for Q1 (some significantly) and I recently spoke to two elder ladies in a hotel lobby who were “short the market”. Also, more VC money was invested in 2014 than any year since 2000. So, while I believe in the 15 year tech cycle (e.g. things go boom in the night in the coming year), with this many people looking for it, it seldom hits. That said, probably not a good time to aggressively put money out and a good time to get your house in order. I’ll revisit as the year progresses…the IPO market vs. last private round valuations is a key metric to monitor.

From Nov, 2008:

“As the bad news keeps pouring in, a lot of people are wondering what we can expect in the coming years. Additionally, everyone is trying to figure out what hope exists. Well, I’ll give two thoughts on this (briefly).

First, the world of technology is driven by two factors: the laws of exponentials and the Black Swan. Progress does not occur linearly but exponentially. We can expect to see changes the magnitude of the past 100 years in just the next 20 years. This means a lot of people are going to a) be really busy and b) be dramatically better off. These changes will come from places you can’t predict (Black Swans). Market crashes and negative developments are not the only unexpected six sigma events.

Second, markets run in roughly 7 years cycles and technology in 15 year waves. Vacuum tubes to main frames to mini-computers (DEC) to PC’s (Apple/Microsoft) to the Internet. The next wave, then, should start in 2010-11 and hit full force in 2015-16. Many in the business (us, Kleiner, etc) feel this will be in Cleantech. The energy market is 10-20x the IT market. We are not talking about billion dollar markets but trillion dollar ones. There will be a lot of casualties but some enormous wins.

So, there us no doubt that life is really brutal today. But, prepare and get ready for enormous, explosive market opportunities. It’s going to be mindblowing.

So, I stick my neck out again typing on my small iPhone. I declared the old venture cycle dead last June. I am declaring the the next cycle, even bigger than the former, will kick in during 2010 with foundations forming by the end of next year. I also believe we will see 30-40% of remaining venture firms will not survive to see this through (food for another post)…

The Key Israeli Story: StartUp Nation

Larger Post coming…without appreciating the context (yesterday’s post), it is hard to fully grasp the origin nor significance of the tech renaissance that is taking place in Israel.  One has to see it to fully appreciate it. Much like Boston and Silicon Valley had its origins in military R&D and culture, Israel’s tech ecosystem also comes out of this. It has had innovation after innovation emerge from its advanced defense work. For example, ICQ (not AOL messenger) launched instant messaging onto the world and originally came from te Israeli Defense Force’s internal uses. Same with voicemail and many other innovations. Israel has some of the world’s best minds in Big Data, IT security software, messenging, telecom infrastructure, etc.  A lot of this is described in the book, Start-Up Nation by Dan Senor and Saul Singer. Some of the numbers are eye-popping…one start-up per 2,000 people in the country for example. Necessity is the mother of invention.

Equally important is the Israeli resilience & tolerance for risk.  This is at the heart of the entrepreneurship.  When living in the charged environment discussed yesterday, you can’t help but to grow up with a DNA that accepts risk/change’s role in life and embraces the necessity of innovation.

I have to run to Tel Aviv’s accelerator, SOSA (their equivalent to Chicago’s 1871). More to come.

Up Close & Personal with Middle East Conflict

Today was one of the most memorable days of my life. Things in the Middle East got very real today. We spent the entire day on copters flying South to Gaza with the Israeli Defense Force and then North to Golan/Syria and Lebanon with Israel's "Wolf Blitzer".  We were 10 seconds away from Gaza's Hamas mortar batteries as well as 200 yards from Hezbollah's missile arsenals in Lebanon. We also looked out over Syria's massive civil war from the Golan Heights.
 
Region on Fire: My summary takeaway is that there is seismic change going on in the Middle East across nearly every country. Most of the countries in the Middle East (Lebanon, Syria, Iraq, etc) were created arbitrarily by the British and French who took nomad (and warring) tribes and drew nation-state boundries around them (a concept foreign to them).  Each is now in the process of splintering apart into its Shiite, Sunni, Christian, etc sub-factions. The only thing that held these entities together were brutal dictators who used force/terror to bottle the 1700 year old genie (when Sunni & Shiites first split). Syria is splintering, Lebanon is getting bold, Gaza re-arms, Iraq is fracturing, the Palastinians are slow rolling and Iran races to go nuclear (while funding many of Shiite terrorist activities around). Israel sits in the middle, growing more resolute to take action while Europe prepares to impose its will on Israel and the US sits bewildered. It feels like something is going to go bang in the night coming up.
 
Breakfast w/the General: We started the day with bfast with Major General Amos Yadlin, the former head of the Israeli intelligence operations. He commented that much of the conflict is being driven by Sunnis vs Shiites vs secularists, especially their extreme branches. As a result, unnatural alliances are forming. Arabs vs Arabs, Arabs vs Israelis, Arabs with the west and against the west. Billionaires in Saudi Arabia funded initial ISIS activities but now, as ISIS has grown more radical, they have pulled back as ISIS condemns the Saudi secular rule. Hamas is in Gaza and Egypt is at war with fellow Arabs and allied with Israel. Hezbollah fights ISIS in Syria (terror organization vs terror organization). 
 
He commented that the region is struggling to find a form of government that both is consistent with its history/culture and yet brings it economic strength & political stability. It has tried monarchies, dictatorships, socialism, capitalism and now, the extreme factions are pulling it towards religious Islamic rule (unfortunately back into the dark ages).
 
Iron Dome Command Visit: We drove down to Palmachim military air base & the Iron Dome battery to see what few get to: inside the Cube which controls and launches the anti-missile systems (Iron Dome, David, Arrow, etc) protecting Israel from the South. We sat 20 ft from the control room in the bunker.
 
Israel has three levels of defense:
Iron Dome for short range…2-10 sec to respond to rockets usually from Gaza
   – this summer: 7,000 rockets fired, 7 casualties, 1-3 shelter trips per day in Tel Aviv
Arrow 2: 10-60 sec to respond, midrange missiles from Iran, Syria, etc
Arrow 3/Patriot: long range ballistic missiles with 2-10 min warning
 
Gaza/Hamas Mortars in the South: Egypt and Israel are allied in fighting Hamas both in Gaza and the Egyptian border. Our copters landed outside Ashood which is 10 secs from Gaza mortar and rocket launches. This is where the underground tunnels under the security border from Gaza emerged into Israel that were destroyed over the summer. Hamas spent $50-100m building these 32 cement encased tunnels. Weapons came through these which were up to 90 feet down. They took two years to build, some 2 miles long and up to $3m each. In the Eqyptian side, Egypt claims it destroyed over 600 smuggling tunnels into Gaza. Some are so large that vehicles can drive through.
 
Gaza is a tragedy.  It has the potential to become a key economic center for the Palastinians…it has a port, sits on both the Egyptian and Israeli borders and had plans to build a regional airport. However, it lacks a middle class, with almost 2m fifth generation Palastinian refugees there. As a result, it suffers economically and Hamas has stepped in (funded by Iran & others) to provide key resources like schools, shelters, food, etc.  In exchange, Hamas uses these same homes & schools as origination for tunnels into Israel.  Additionally, it fires its rockets & mortars from these urban centers.  As you can see from this photo, Israel sits with its Security wall (upper right) and much of the border & parts of the interior Gaza lay in rubble from counter strikes (left).
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Jerusalem the current flash point given the Palestinian driver attack and his subsequent killing by the police. When the security wall left 300,000 Palestinians on the Israeli side and milliins economically shut off from Israel on the other side. I found out today that the Palestinian's funeral was the night we were in Jerusalem and many were watching to see if anything erupted. Today, there are clashes as Palestinians on the Temple Mount throw rocks down at the Wailing wall attendees.
 
New Canvas: We then flew North by copter to the Golan Heights/Syria and Lebenon border). I had the good fortune to sit next to Alon Ben-David, Israel's "Wolf Blitzer". He had a surprising optimism for the potential of the region. He pointed out that every 100 years, you have a chance at a new canvas. With Iraq, Syria, Lebanon, Kurds/Turkey and such all in flux, there was opportunity to bring parties to the table. The Palastinian issue seems to be a distant second to the Shiite/Sunni conflict across all countries.  The hope would be that with Saudi Arabia, Jordan, Eqypt, PLA all united by the Shiite/ISIS threat, they combined with the US/Europe could be a force of positive redesign of Middle East. That said, with the Egyptian peace talks likely stalled, Hamas rebuilds its tunnels, Israel digs in and Arab/Israeli relations in Jerusalem grow more tense.
Me with Alon (Wolf) on the copter:
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Syria Is Splintering up North: Looking down from the Golan Heights, we could see the battle lines of the massive civil war in Syria (could drag out for 10 more years). The Asad regime has surpressed the Sunni/Shiite tensions underneath a brutal dictatorship. There are a dizzing array of factors battling each other in Syria..Shiite Hezbollah (Iran supported), Syrian Shiites and minority groups like Christians support Asad. Meanwhile, Sunni forces take various forms, ranging from Free Syria Army (supposedly a moderate consortia),  Jabhat al-Nustra (Syria's Al-Queda…middle) and ISIS (extreme Sunni) and 10 various rebel Sunni groups.  These extreme groups feel empowered with the overthrow of Mubarak & Huseein. Here is the Syrian panorama from Golan:
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Let Syria Burn…for many in the Middle East, Syria at war works well for them. Hezbollah is dragged into this, Syria is not a unified threat to Israel and ISIS shows itself to be barbaric. 
 
Lebanon Waking Dragon: In the last two weeks, Lebanon has begun to stir after 7 years of quiet. After the 2006/7 war where Israel drove all the way to Beruit and destroyed Hezbollah's buildings, it has kept its head relatively low. However, recently, it blew up an Israeli jeep using an IAD.  This renewed confidence is troubling. Hezbollah is backed by Iran through Syria. In the picture below (only 200 yards away), there are large houses built by Hezbollah for civilians.  There are over 100,000+ missiles, all larger, more accurate than those from Hamas, stored or even have built in firing silos. Iran has armed Lebanon as a deterent to Israel bombing its nuclear bomb efforts. Syria is critical to Lebanon as it is the direct route to Iran for weapons. If these missiles launch, they will do significant damage to Israel. 
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We returned back to Tel Aviv for dinner with the IDF 8200 Elite Intelligence unit…the best of the best. Quite a day.

Stunning Day in Jerusalem…Day 1

Quite the first day…cultural day in Jerusalem (minus our guide saying “all schools have cancelled trips to Jerusalem given events this week…”).   Landed at 8:30am and off to the races. We visited the Old City where we walked through the four quarters, touched the marble Jesus was supposedly laid on (post Cross) and the cave he was supposedly laid, all encompassed in the Church of the Holy Sepulchre. While being in the heart of all the unrest you see on CNN, you feel amazingly safe…more so than parts of many major US cities.  Crossing streets being the most risky times 🙂
 
Intriguing dinner with two of Israel’s top journalists who gave us their take on the region & country while we stared out the patio at the old City. The context was almost surreal as we spoke and I was literally looking out at the infamous Security Wall and the intersection of four cultures in the Old City. You could feel the energy of all this history and intersection. Pretty wild.
 
After dinner blew me away. We went to see the City of David's tunnels…wasn’t certain what to expect. I assumed this would be the minor part of the trip and looked forward to the Wailing Wall.  I was wrong.  We toured the excavations of the City of David that were just discovered in the past 5 years (used to be under a parking garage of all places).  Sitting underneath parked cars had sat 3,800 years worth of layered remains from 18 different civilizations stacked on top of each other (Persian, Roman, Jewish, etc).  They also found letters with seals from actual messengers mentioned in the Old Testament (Jeremiah). This is significant because it foots with the Bible, indicating that the Israeli’s did live in Palestine first (however, doubt will solve the Mideast crisis 🙂   They then took us down to tunnels from 560 bc that ran up from the City to the “Temple Mount” at the top of the Hill.  It still had pottery and ash marks from when the Romans drove the last Israelis out in 70 AD and people literally took their belongings and fled. Romans smoked the tunnels as they tried to escape.
 
We ended the night at the Wailing Wall. I have one of these in my office when dealing with portfolio companies!
 
The Former "Parking Garage"…3,800 years/18 different civilizations stacked on top of each other…!
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How Many People Have You Impacted This Year?

As another year draws to a close, I increasingly ask myself the core question: How many people's lives have I helped to make better? Not enough. As I begin to draft my New Year's Resolutions and Goals, I'm going to push myself to get outside of my comfort zone and stretch in helping others in a larger way. Take a look at this great Upworthy video of the late Paul Walker's group, Reach Out World Wide. Be The Change You Want to See in 2014. Thanks Paul…

 (for those having issues with the playback, here is the original YouTube link,..because of the soundtrack in the video, I think YouTube/Zefer may be blocking some viewings)

 

17 Fundraising Ideas

Our portfolio company, GiveForward, is one of the standout "double bottom line" companies around. They help people with medical needs (and other) raise money to pay the bills. To date, they have raised $62 million for people. Given that 60% of personal bankruptcies are driven by mounting medical expenses, they have helped a large number of families in need.

They wrote a great piece called 17 Fundraising Ideas to Raise More Money. Whether running a charity event or a medical fundraiser, it is worth a read. Happy raising!

The Quest to Get Better

My friend, Brian Johnson, just posted on an awesome topic…Getting Better vs Being Good. Entrepreneurship is not only tough — it is non-linear and success often opaque. Also, short video link below of Carol Dweck's Mindset work…definitely worth everyone learning more about this. The key to managing this reality is:

1) to know your Northern Star (what you want to achieve, the change you want in the world)

2) but to focus each day at becoming better and better at how you deliver "unexpected joy" (thanks Desiree & Ethan at GiveForward for the phrase). This includes every customer touch point, delivering increasing value, innovating more quickly, improving stability, etc. Success comes from the daily little victories and improvements (even when you are dispairing) versus heroic swings of the bat.

If you simply focus on the "waiting" for the end game, you will become miserable and demoralized as the Entrepreneur's Journey is an unjulating one. As Brian says, "Be the Highest version of yourself at any given point in time…What would your highest version do?":

“My favorite piece of advice by far for dealing with difficulty is to make sure you think about your goal in terms of getting better, rather than being good. As you’ll recall from Chapter 3, when we are focused on personal growth and development, on making progress rather than on proving ourselves, we deal with difficulty far more gracefully. We tend to see setbacks as informative, rather than as signs of personal failure. We don’t worry as much about the likelihood of success because we know that even if we never do it perfectly, we will certainly improve. (And getting better is, after all, the goal.)” ~ Heidi Grant Halvorson from Succeed

Getting better vs. being good.

Those are two different orientations we can have in life and in goal setting. They roughly map over Carol Dweck’s “growth vs. fixed” mindsets. 

The basic idea: When we approach life with a “being good” mindset, we’re constantly trying to prove ourselves. We’re paranoid that any blunder we make might be the evidence that shows the world how messed up we are. So, we avoid taking action and freak out when we inevitably DO mess up. Eek.

On the other hand, when we approach life with a “getting better” mindset, we KNOW we’re not perfect, we’re not trying to prove ourselves, and we embrace challenges as they provide the path to growth—which, rather than looking good, is our primary goal. Setbacks are simply data points for us, not signals we’re unalterably flawed.

How do YOU tend to show up? Check in on that.

And know this: “If you focus on growth instead of validation, on making progress instead of proving yourself, you are less likely to get depressed because you won’t see setbacks and failures as reflecting your own self-worth. And you are less likely to stay depressed, because feeling bad makes you want to work harder and keep striving. You get up off the couch, dust off the potato chip crumbs, and get busy getting better.”

Amen.

Here’s to focusing on getting better rather than being good!

Success on Your Terms

I increasingly have conversations with both rising and established entrepreneurs around “what is success and why does it not feel fulfilling?”

Peter Drucker, the uber-management sage, said that as more people acquired wealth, they would shift to focusing more intently on making a purposeful impact on the world. The Millennials are focused on parallel tracking these.

I read a great post by coach, Erin Cox, on this. She focuses on not going after pure trophy achievements but on achievements that give you a sense of fulfillment and align with goals and the sense of your greater self…avoid the hollow victory.

“Not long ago, I believed being successful meant having a powerful title, a six-figure salary, and a beautiful home. These are all important, but I now understand the true meaning of success for me. During this past year, I achieved one of my greatest professional goals, which was to publish a book. By all logical means, I was experiencing great success!

Did I feel successful? I suppose I did on some level, but what I really felt was overwhelmed, afraid of failing, and stressed.

This experience was a powerful lesson to carefully create my goals and aspirations around the way I want to feel and live my life. After lots of meditation (and a little suffering), I became completely clear about what true success means to me.

For me, success is measured in moments of pure joy and time spent loving my children. Success means helping another person achieve their greatness and using my God-given gifts to make the world a better place. Success is having complete freedom, both financially and with time. I now work two or three days a week and spend more time with my family and creating a Zen home life.

Success to me means feeling peaceful, grateful, abundant, joyful, light-hearted, influential, and generous. (MBM Note: replace these with terms that resonate with you. Could be: authentic, empowered, energized, optimistic, change agent, connected, aware, etc)

Have you taken the time to get clear about what success means to you? How would you feel if you achieved all of your biggest goals?

I encourage you to gain clarity, not only about the goals you want to attain, but how you want to experience them. What would every part of your ideal life look like, from your bank account to your working space and your home life?

Once you are clear and in alignment, Life will support you in achieving success on your terms.”