What’s happening to all that money?

There have been many accounts recently about the implosion and explosion of the private equity, venture capital and hedge fund markets.

image Given that there are few high-profile hedge funds and private equity funds that have imploded in a big way -including a few of those which were playing in mortgage backed securities.  Many are viewing this as a necessary correction, and just desserts for funds that are not playing by the rules (wasn’t the whole idea behind hedge funds to be "hedged" in down markets?). But there are a large number of hedge funds that have not only survived the downturn of the market in the last quarter, but have generated positive returns.

By and large the amount of capital in the market is growing, but the distribution of the money is the big open question.

Venture capitalists raised 34.7 billion in funds in 2007, the highest amount raised since 2001 which was 38.8 billion according to Thomson financial and the National Venture Capital Association (NVCA).

So is all of that money going?  As of last year, not a whole lot found its way into the pockets of entrepreneurs!

According to the Los Angeles Times, the VC investment into local companies fell to $689 million in the fourth quarter of 2007 compared to the $921 million during the same period in 2006. However the number of deals actually went up indicating that investors might be making smaller bets and waiting for the market to shakeout.

The New York Post (Private Equity Is Exploding) reports that the private equity boom in 2006 - 2007 is continuing through the early part of 2008.  Despite a few spectacular flameouts, PE firms are continuing to raise tens of billions of dollars.  Even with pension funds scaling back their investments, money has continued to flow in from foreign wealth funds.

image For now much of the money in alternative investment funds seems to be sitting in the sidelines waiting out the crazy market dance.

As the gurus of Wall Street would say — "staying in cash is a perfectly acceptable market strategy".  So the current wait-and-see-attitude where funds are not deploying all of their capital, might simply be a legitimate defensive position, and not the doom and gloom scenario that it is  sometimes made out to be.

SimplyShe raises $600k in financing

image Agility Capital recently closed a $600,000 financing to SimplyShe, Inc.  The debt facility is in the form of a growth capital loan.

Located in San Francisco, California, SimplyShe, Inc.  is a branded consumer products company providing fashion-based merchandise to the mass market. SimplyShe™ has multiple business units including: women’s apparel and accessories, children’s apparel image and accessories, pet apparel and accessories, publishing and entertainment. The Company’s brands include: SimplyShe™, SimplyWee™, SimplyDog™, Lulu Pink™, Max-A-Million™, Big Paws™ and SimplySingle™. The Company is on a rapid growth path reporting over $20 million in sales in 2007.

Agility Capital provides innovative debt solutions to Venture Capital backed private companies and Small Cap public companies in the technology/ communications/ medical device and branded consumer products markets in the Western United States.

Success factors of early stage venture investing

image What are the factors that determine the success of Angel investing?  In the most comprehensive study of Angel investors, Robert Wiltbank and Warren Boerker have looked at the portfolios and exits of 539  Angel led investments, in a three year study conducted through the Angel Capital Education Foundation and the Kaufman foundation (study is here Returns to Angel Investors in Groups).  They gathered data from several prominent angel networks including the Tech Coast Angels in Southern California.  Their analysis provides interesting insights into the factors that determine success in early-stage venture investing.

First, the numbers: the average ROI on investments of individual investors who are part of angel networks is 27% on average, with 2.6x return in 3.5 years.  The returns are concentrated in a small number of investments with only 7% yielding more than 10x.


1.  Due diligence: the amount of due diligence conducted on an investment is a direct predictor of success.  It is clear from the study that a higher number of hours of due diligence relate to greater returns on the investment.  This confirms that the large number of hours that angel networks spend in due diligence, per deal, is indeed time well spent.

2. Expertise: The experience of the angel investor in the industry that they invest in is also correlated with the success of the deal.  The strength of large angel networks lies in the depth and breadth of the expertise of its members.  This finding regarding the correlation of investor experience with returns indicates that in angel networks, investments are best led by (or actively supported by) members who have specific domain expertise in the area.


3. Follow-up: Hands-on investors had a higher success rate than those who were less involved with their portfolio companies.  This finding certainly makes sense, as companies that are closely mentored and receive the benefits of the investor’s experience, are more likely to succeed.


image The study covers investors in major angel networks.  Individual Angels are not included in the study.  It is not clear how the performance of individual Angels would compare with the results of this study.  One can only guess that single investors would not invest the tens to hundreds of hours of due diligence typically conducted on investments in angel networks.  On the other hand, angel investors with very strong know-how in a particular domain might perform very well if they invest within their own area of expertise.  Individual Angels tend to invest in companies and people that they are familiar with, so they might have more insight into the strengths and expertise of the entrepreneur. 

The issue of an investor keeping in close touch with the companies that they invest in, is a big one.  The standard recommendation is that an angel investor build up a portfolio 20 to 25 investments, so that they are properly diversified. For an individual investor (or even one within a network) the job of tracking that many companies can be very time consuming indeed.

And then there is the issue of what is "suitable diversification" in a venture portfolio. If we use the results of this study - that only 7% of investments are in the category of "make-the-fund" transactions that return more than 10x, it implies that in a portfolio containing the recommended 25 investments, 1.75 on average, will generate high returns.  With an error of 0.75 on the average number of investments needed, there is a 67% (1 sigma) probability that the investor get between one to two big hits under their belt. 

The last piece of analysis assumes a normal curve for venture investments. But but of course we know that there is nothing "normal" about venture investing, and that the highly interesting phenomena really lie in tails of the distribution!


Slide valued at $500M+, half a billion dollars


From Today’s NYTimes:

Slide, the maker of applications for social networks, has raised another round of funding - $50 million from the private equity funds at Fidelity and T-Rowe Price, two major Wall Street investment houses. The firms have taken a 9 percent stake in the three-year-old, 64-employee Slide, valuing it at $550 million.

Most interestingly, the investors are Fidelity and T. Rowe Price.

I guess one could argue that Slide is not a widget company but an ad network.

Here is what Max Levchin said in his interview a few months ago:

Think of Slide as a giant media network for people to transmit information. The content that’s in there now has been provided by users — it’s whatever they want it to be.

But my issue with that argument is that the slide is not hosted voluntarily by MySpace and FaceBook - users put it there. It is unlikely that MySpace will let Slide monetize their presence on their pages and Facebook looks kind of dicey too. The point is that Slide is not in control of their visitor count - they rely on other networks to get the audience.

How much is a Facebook application worth? Face book is valued at $15B which equates to $250 per user. There are some, who argue that an application on Facebook is worth $250 times the number of users. That is just wrong!

Facebook applications are like little antenna balls for the car. Don’t tell me that the goofy antenna ball is worth as much as the car. Some have argued that each install of an application is worth $3 to $0.30 for each install, which is high but at least in the ball park. Again, the number is per install, not per application view.

Slide is not saying that they have 150M registered users or 150M installs - just 150M visitors. They might have 25M to 35M install base. With $550M valuation, they are valuing it at $20 per install. Also, the widgets have a short lifespan; they come and go, so active install base might be smaller.

And then there is the Facebook "tax" (rev-share that Facebook will demand), which further reduces the value.

Some may argue that the basic fallacy in this valuation calculation is that you are looking at current numbers - extrapolate to 2011 and then calculate the valuation. Its the growth potential that demands a much higher premium. I don’t fully agree with it but the argument has a certain conceptual merit. One should calculate these numbers by examining the forward flow and not the current numbers. Not sure if I can stretch my imagination to 2011, but if Fidelity with deep pockets can see farther than I can, more power to them.

This sort of reminds me of the BlueMountain network, it was valued at $780M when @Home acquired Excite for $6.7B (at $400 per user) during the period of last exuberance.

But I am glad that deals are happening, and the developers are creating more applications. And if widgets are being valued highly in the marketplace, I am giddy, incredulous but giddy nonetheless.

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