Musings on Venture Capital Portfolios

Two posts (here and here) over at Jeff Nolan’s site (regarding a speculated hedge investment holding by TCV) prompted me to write a more general post on venture capital portfolios.

To set some groundwork, I think about investments in two ways: 1) individual investment and 2) portfolios of investments.

From a typical entrepreneur’s vantage point, the entrepreneur seems to be mostly sensitized to the former aspect of investment theory. How so? Early-stage entrepreneurs tend to be more schooled in answering VC questions about prospective investments in their company in isolation of the rest of the world. The "investment-in-isolation" perspective tends to address three base areas that concern VCs:

  1. what the makeup of the company management team is
  2. whether the company can clearly articulate who the customer is and why they will buy
  3. how the growth rates and potential will justify venture capital.

On the other hand, one core aspect of portfolio theory basically goes along the lines of this: one cannot look at an investment in isolation. Any investment in a particular security needs to be looked at in the context of other investments. An example commonly used in business school is the concept of house insurance. This type of insurance is basically a near-perfect hedge investment. That is, the value of one investment (e.g., the insurance) only goes up if the other one goes down (e.g., the house burns down). Some business schools also introduce the concepts of vector analysis and hedging where underlying factors are not necessarily so orthogonal in their outcomes (as is the case of the simple house insurance case).

Other aspects of portfolio theory include minimizing idiosyncratic risk through diversification (much like index funds do by investing in a large number of investments which VC funds cannot do to the same extent).

Blogs by venture capitalists have done a good job to date of shedding light on things like the mechanics of terms sheets, how individual investments are evaluated, how board relationships work, where innovative sales models are going, etc., but I have seen very little to date on how portfolio theory ties in from various angles. This is not to say that portfolio theory does not apply – perhaps it has just not been addressed widely, it is less transparent, or it is not as sexy. Business schools tend to characterize venture capital firms as never investing in competitive firms (overlapping investments for both legal and portfolio reasons) and never facilitating operational measures that intensify idiosyncratic risk. Synergies between venture portfolio companies tends to be a subject that is not addressed in business schools.

Two areas where this affects the entrepreneur are:

  • in practice, entrepreneurs have unclear guidance (only anecdotal information) on whether to approach venture capital firms that hold competitive offerings (whether to create buzz, to seek financing, or to seek M&A)
  • some entrepreneurs use portfolio company connections to make connections with the VCs that have provided funding (to exploit synergistic opportunities or to take advantages of brokered introductions) – where traction is actually obtained is more or less anecdotal.

In any case, it is my impression that many entrepreneurs are less sensitive to venture capitalists’ needs as investors and as portfolio fund managers. Some entrepreneurs tend to look at VCs as either vulture capitalists or white knights only.

As a final digression, I find it interesting that in TCV’s note in Jeff’s second post, that TCV made mention of board participation in one company and absence of board participation in the other. I suppose this was intended to highlight that TCV has no conflict of interest at the Board-level as far as synergies go (whether existing or not) between the portfolio companies.

Update (3/15/05): I missed this post from Silicon Beat on the Technology Crossover Ventures (TCV) subject.

Update (3/18/05): More updates on the TCV thing. Is the story getting worse?

Steve Shu

Exponential Growth in Blogs But More Linear Growth in Page Views?

Dave Sifry has got a great post on the state of the blogosphere. Very noteworthy is an interesting discussion on the emergence of spam blogs.

What is not shocking to me is the exponential-type growth of the number of blogs, where the number of blogs appears to double every five months. Some in the blogosphere have noted potential artifacts in the measurement process. Perhaps so. Probably so. But hey, I’m not sure where one can get better data at this stage of the game.

What is more perplexing to me is the closer to linear daily page view growth that I see via Alexa for TypePad (one of the blog platform market leaders). Would be interesting to normalize # of page views by # of active blogs.

I am looking forward to Dave’s upcoming post on posting volume for blogs. Although this is separate from page view growth, maybe this will help me to reconcile in my mind where the overall blogging market is going and who is going to get squeezed.

Update (3/15/05): Dave has new post on posting volume. Posting volume looks closer to linear to me. Whew!

Steve Shu

Continue reading “Exponential Growth in Blogs But More Linear Growth in Page Views?”

Trash Talking the MBA Degree Again

Seth Godin (Stanford MBA, bestselling author, entrepreneur and also evangelist in my book [see my side links]) is trash talking the MBA degree, and it’s quite entertaining. What I find hilarious is his comment (emphasis added by me):

An MBA has become a two-part time machine. First, the students are
taught everything they need to know to manage a company from 1990, and
second, they are taken out of the real world for two years while the
rest of us race as fast as we possibly can.

Now as a Chicago MBA, I’ve hinted (with some tongue in cheek too), that there are ways my clients can bypass the MBA.

That said, I feel that I really should come to the defense of the MBA degree because it has become the butt of many jokes of bloggers and professionals I respect like Om Malik and Jeff Nolan (not to mention Seth).

For those that are considering the degree seriously, off the top of my head there are some areas of the MBA that are harder to bypass via book reading:

  • finance and accounting (introductory through entrepreneurial finance, analysis, etc.)
  • operations
  • negotiations.

Taking courses in these areas is generally much more complementary to both real-world experience and book reading than other subjects in the MBA program (IMHO). My mention of negotiations may be a bit of a surprising one, but negotiations may be one of the most underrated subjects in business schools. I can think of no other setting where you will have the opportunity to participate in controlled negotiations settings where you can find out your score and ability to negotiate in different situations. Many of the negotiation cases are built on game theory foundations, and there are measurably right answers, less right answers, and wrong answers. Anyway, if you want to bypass the MBA degree, consider taking courses in these areas (for example, I know a number of experienced execs that would feel more comfortable if they had more formal training in finance).

I think that it also noteworthy to mention that most people don’t realize that many of the people who want to get an MBA want to switch careers. While it is debatable whether you need this type of degree for management consulting or investment banking from an actual skillset point of view (beyond just having the stamp of approval), many will have an easier time switching jobs with an MBA stamp as opposed to marketing oneself as having read 30-40 books.

Other things I’m only going to mention briefly are the importance of alumni networks and having additional confidence, endurance, and resolve on the job. Places like Harvard are known to be boot camps and the West Point of business schools. There’s a lot said for practicing in the gym so to speak and defending business positions unto death in the classroom.

Now the MBA isn’t for everyone. I’ve also hinted that there are some areas where you can bypass the degree. I’ve also been known to say that the MBA is no substitute for real work experience. But I’m a tad softer on this issue than Seth.

Update (3/15/05): Based on comment from Jeff, I want to clarify the commentary I made about Om, Jeff, and Seth above with respect to ragging on the MBA. In my haste to post, I should not have pointed at them specifically. To go further, I may have characterized their stance on the MBA inaccurately, and I am glad that Jeff clarifies below. The MBA is under a bit of heat as of late as I indicated in a prior post (here another Economist article I missed as well). Seems like little defense for the MBA degree has been put up to date (which is the real reason for my post).

Steve Shu

Related posts: here and here.

Affirmative Action for Bloggers?

Link to a friend in need. But do we know what we are talking about here in terms of demographics?

And I thought tea leaf reading was hard. Anyway, since metablogging is not cool anymore … that’s all.

(*) Some people cited in this MSNBC article talk about highlighting minorities in
need of having their voices better heard. Given that blogging is turning out to be a new communications medium, I suppose the concerns are valid, but it does feel a little weird on first blush.

Care Matters In Customer Service

I’m a true believer that there are many ways to skin a cat when it comes to solving business problems. Measurements and metrics for operations, however, are something that I’m borderline on being religious about. I was recently hired by a COO to diagnose the breakdown of a customer service operation for a Series C carve-out/venture deal. For this company, I discovered that a big problem throughout the organization was a lack of metrics, an executive dashboard, and time-series view of data. Had headquarters and regional management been looking at the same picture of the business, it would have been much easier to see the decline in service, turnaround time, etc. as it related to other controllable factors in the business (such as introduction of a new, less efficient IT platform). In addition to making recommendations on implementing a new measurements system, I had made the recommendation for the company to look for a new rock star, good lieutenant, and proactive person for running the customer service show, especially coming off a year of service decline. I suggested that numerous managers be involved in placing such a key position, and I also volunteered to interview people for the slot.

In any case, measurements are close to sacred to me. I’ve blogged about it in the past, and I expect I will continue to do so in the future.

Then Seth Godin shows me that there’s another way to look at things and that one can scrap measurements. I hate that, but he’s right.

Note that Seth has also posted links to his top ten posts in 2005. Worth checking out.

Steve Shu
Managing Director, S4 Management Group

Outsourcing Innovation – The Final Frontier or The Last Stand?

I imagine this could be a bit of a controversial article (Business Week). The article covers the outsourcing of innovation. We said we’d never do it, but here we are. Key snips from the article for me (bullet format is mine):

  • … Underlying this trend is a growing consensus that more innovation is
    vital — but that current R&D spending isn’t yielding enough bang
    for the buck …
  • … "It is a slippery
    slope," says Boston Consulting Group Senior Vice-President Jim Andrew.
    "If the innovation starts residing in the suppliers, you could
    incrementalize yourself to the point where there isn’t much left." …
  • … Still, most companies insist they will continue to do most of the
    critical design work — and have no plans to take a meat ax to R&D …
  • … Who will ultimately
    profit most from the outsourcing of innovation isn’t clear. The early
    evidence suggests that today’s Western titans can remain leaders by
    orchestrating global innovation networks. Yet if they lose their
    technology edge and their touch with customers, they could be
    tomorrow’s great shrinking conglomerates …

I suppose that at the heart of the question is what part of the R&D chain can be outsourced without threatening a company’s ability to appropriate profits (and under what conditions). The Business Week article hints at looking at R&D more comprehensively and that the last line of defense may be having a competence in orchestrating innovation supply chains.

Steve Shu
Managing Director, S4 Management Group

Blogads Survey Results

Steve Rubel points me to results of the recent Blogads survey, which surveyed more than 30,000 readers of blogs. Steve points out some good items that caught his interest. Some different items that jump out at me include:

  • question #14 regarding why people read blogs … 75.3% responded that it was for "News I can’t find elsewhere",
  • question #11 indicated that the median number of blogs read daily is five, and
  • question #12 indicated that in an average week the median hours spent reading a blog was 10 hours per week.

I’m sure there’s some measurement error here, but putting on my propeller head nevertheless, that’s 2 hours per week per blog. On the surface, a lot of eyeball time and a lot of unmet needs being met by some blogs.

Steve Shu
Managing Director, S4 Management Group

The Oracle-SAP Bids For Retek and History Review

The following has been cross-posted at The CIO Weblog but is also listed here as it references some core M&A valuation studies done in the management consulting industry. What is only lightly touched upon here is the importance of program management and operations during deal follow-through (operations and execution have been my past bread and butter work [shameless plug]).

Oracle’s latest bid for Retek, a category leader in business management software for large retail chains, could be a windfall for Retek shareholders. Oracle’s bid at $504 million US ($9.00/share) outpaces SAP’s bid Tuesday for $496 million US ($8.50/share).

Where this will ultimately wind up is anybody’s guess, but here are some facts pertaining to what has happened with this deal, and what has happened historically with other companies with respect to both shareholders and customers:

  • SAP’s bid of $8.50/share represented a 42% premium over Retek’s price of $6.00/share on the close of February 25. Shares of Retek have recently soared 21% to $10.40 (source).
  • Past McKinsey studies have shown that shareholders of acquired companies have received on average a 20 percent premium on friendly M&A (source).
  • Many mergers have failed largely because bidders paid too much ("the winners curse") with average takeover premiums in the 40% range (source McKinsey).
  • Although other studies by consulting firms such as Boston Consulting Group have shown that  companies  that systematically pursue acquisitive growth outperform competitors that pursue few or no merger deals, the large majority seem to agree that if deals go through post-acquisition integration is *key*.
  • BusinessWeek investigation in 2002 and 2004 have shown that big M&A deals have left customers dissatisfied half of the time (source).

So deal makers ought to take extra pause and pay attention to operations and the customer, especially since Retek is a prized category leader. On the good news side of things, boards seem to have been getting smarter about  M&A all the time.

Steve Shu
Managing Director, S4 Management Group