ELIAN D. ALVAREZ

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Startups Worthy of Investment … or not

May
11

It seems like those days are long gone when venture capitalists used SPRAY and PRAY strategy in the hope that one of the startups in the entire portfolio would make it big.

In other words, it is about time that startup companies show their ability that they are worthy of the venture capital (VC) funds.

 

Decline in the Number of VC Funded Companies

The PitchBook released the first quarter of the 2017 issue in collaboration with the National Venture Capital Association (NVCA). The statistics presented in that report were based on the thorough analysis of VC activity in the United States. According to that report, $16.5 billion was raised by 1800 companies alone. PitchBook and NVCA also observed that even though the amount of investment in the Q1 of 2017 was a bit higher than the capital invested in the fourth quarter of 2016, the number of startups has dramatically decreased to its lowest level since the fourth quarter of 2011.

 

VC Investors and Entrepreneurs Exercising Caution

It looks like the VC sector is facing a gradual decline after experiencing effervescent days of glory back in 2015.

John Gabbert, the CEO of PitchBook, said that during the past few years, the VC activity managed to attain intensified growth in the United States and now it seems to be coming back to earth. He further added that it feels like startup founders and investors have started following a more disciplined approach to investing the funds and taking reasonable caution by adopting measures, such as due diligence. These activities are carried out to secure fair deals on both sides so that each party gets something good out of it.

Ernst & Young, a London based auditing firm, reported that companies in the United States raised about 41.3 billion dollars in 2,802 VC deals in the third quarter of 2016. The San Franciso Bay area represented a total of 916 deals having a value of 16.9 billion dollars.

Jeffrey Grabow, the leader of VC in the U.S. based Ernst & Young, said that VC funding has slowed down and there are various reasons for the declining trend. The prominent reason, however, is the fact that investors want the market to absorb the already distributed capital in the market. Momentum capital has reached a later stage of VC funding and injected capital in almost every that was available in the market. Therefore, it is about time to see how it all turns out.

 

Comparison of the Number of Exits

In spite of the huge funding to a limited number of IT companies, a lot of companies fueled by $9.05 billion worth of venture capital took an exit in the first quarter of 2017. This exceeds the combined value of the IT companies’ exits in 2006, 2008 and 2009. The situation is relatively close to how it was back in 2007. If the same trend and immensity of initial public offerings and acquisitions follow, 2017 will either reach the same figure of 2014, i.e., 39.74 billion dollars, or might exceed it. Only time can tell what is to come next, but it continues to happen at the same pace, it would probably exceed the value of 2014.

IT firms around the world continue to leave behind all other kinds of businesses that are funded by venture capital. According to the NVCA and PitchBook report, Initial Public Offering of Snap and acquisition of AppDynamics by Cisco has been ranked among the top 10 biggest exits of their types during the past 10 years.

 

Investments in VC Activity

California has left behind all other states in the United States in terms of the number and value of VC investments. A total of 560 investments was made in 556 companies, which were worth 8.3 billion dollars. As far as the number of investments was concerned, New York was ranked second with a total of 218 investments. Whereas, Massachusetts was in the second position in terms of investment value as it was slightly higher than 2 billion dollars. Although, there may be a rising trend in the remote work among startup companies, yet, the concentration of venture capital is still high in the Silicon Valley.

Value Investment Strategy in Venture Capital

Sep
08

Why succeed in every investment (or the majority of them) is more important than depending on the statistical model of “Spray and Pray”.

Starting a business is not easy. One has to invest a lot of effort, time, and brain in order to introduce an idea that can stand out and is of value to others. Every individual is naturally inclined toward investing in a startup with better prospects than a start-up that would not generate any value and likely to fail in the future. Every investor would want to see his investment a complete success, whether it be an investment in a single stock or a bucket full of stocks. Same is the case with Venture Capitalists; they wish every investment to be successful, and for the same reason, prefer to use value investment strategy over the statistical model of spray and pray.

Although, spray and pray has got a lot of media attention in the past few years, and the face behind it is none other than Dave McClure, the founder of 500 startups, yet, you cannot deny the fact that it is important to reasonably manage your risk.

Nurturing the Idea is as Important as Making Money Out of it

Nurturing the idea is as important as making money out of it and this is exactly what value investors believe in, because you won’t be able to make money out of it if it doesn’t grow well. Manu Kumar, the founder of K9 Ventures, said that most companies do not turn out to be a failure because of their investors, but despite their investors. This is why he doesn’t want the startups, he has invested in, to fail, and wants a reasonable success rate in his investments. He keeps an average of four or five companies in his portfolio and he wants each one of them to be a success. This is why he is very selective and prefer to go for the one with good prospects. He keeps his investment between $100k and $200k and screen companies down while expecting a much higher rate of success. He looks for appropriately priced deals and doesn’t touch anything that is five or higher.

Value Investing Strategy – Bridging the Gap between Investors’ Mindset and Founders’ Perception

Another famous name among the Venture Capitalists, Thomas Korte, said that they do everything in a scaled way, because the majority of the founders tend to take the funds they are offered in the seed stage. There are very few in the market who believe that their investors would take them through Series B and Series C, and their apprehensions are true to a certain extent. At one point, McClure said, “it is not that their portfolio has a high death rate, it’s just that there is a higher death rate out there.” Instead of aligning himself with the founder and an acquirer, he prefers to align with an investor and acquirer. So, if a company has a scalable impact, he makes a deal as soon as possible. It is not easy to bridge the gap between investors’ mindset and this commonly held belief of startups. However, Value investing strategy can contribute towards changing this mindset and bringing harmonization to achieve common goals.

Benefits of Value Investing

Potential to Make High Profits – As opposed to spray and pray strategy, value investing has a potential to make high profits, because value investors tend to invest in companies that are being offered at a discount price and sell them well above their intrinsic value by bringing their true value to light through solid research on a value stock, its peers, and the sector.

Avoid Exposure to High Risk – Investing in a few companies with good future prospects will not only enable the investor to focus on materializing the potential value, but also keep the overall cost to a minimum. The investor will not be dependent to succeed on that only company that make the revenue beside all the others have already failed.

 

Yes, there might be a lot of effort and hard work involved the value investment strategy to be implemented while choosing the startups for investments, but it is important to note that short term price fluctuations are not always a true depiction of the true value of an asset.

As Benjamin Graham, the founder of value investing and mentor of Warren Buffet, once said, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”