The Perfect Storm

Stuart Ellman

Will Porteous (my partner and co-professor at Columbia Business School) and I return today from a week in Europe. We came here to teach a graduate seminar in venture capital for the CDTM (Center for Digital Technology and Management) in Munich. CDTM is a joint program of Ludwig-Maximilians University and Technical University, both of Munich. As a point of note, we are extremely impressed with both the quality of students and the effort put in by many of the leading German venture capitalists who participated in the program.

While we were in Europe, we decided to visit a number of our existing Limited Partners and some prospective new LPs. In addition, we just had our annual LP meeting for RRE last week. From this confluence of events, we have gained some timely views on how many leading LP’s are thinking about venture capital, both as an industry and an investing segment.

Obviously, the pitch to these prospective LPs is the RRE story over the past few funds, particularly our two latest funds, RRE III and RRE IV. Without getting into too much detail, we feel good about the choices we’ve made over the past eight years, both because we have chosen some very good companies and because we have made some strategic investing decisions that kept us away from some areas that have performed poorly. As we went out and told our story, we heard three entirely different responses.

First are the LPs who are committed to venture capital. These firms, by and large, are thrilled. Those firms that have a long term approach to venture capital realize the importance of getting into the best performing funds in each segment (the alpha) and staying with them throughout the venture capital cycle. They do not simply seek out venture “exposure” (the beta); they focus intently on how their managers create value over the long term. We hear from them that they are very happy with the choices we have made and look forward to a long term relationship.

The second category of LPs believe in venture capital but do not know if they will have the capital to continue to play in these markets. That will continue to be part of the fallout from the market crash.

The third category are those LPs who are constantly debating where they should allocate money within private equity, whether it should be in LBO’s, growth capital, distressed, or venture capital. These people, for the most part, are skeptical and believe that the venture model is broken. Here is why: they have been the victims of a “perfect storm”.

The bull market of the late 1990’s and the extraordinary returns generated by the venture capital industry led to a wave of fundraising that brought many new Limited Partners into the market. The crashing of the dot-com bubble in 2001 was devastating to the returns of funds raised from 1998 to 2000. It was a once (or maybe twice) in a lifetime complete crash of a market segment. The tech market finally started to show some signs of life for VCs in 2006 and 2007. This led to some optimism and some high valuations being paid during this time period. Then the entire market crash of 2008 happened, taking the IPO and the tech market right down with it. The worst market crash since 1929, again, “once in a lifetime”. But, for VCs and fund investors that may have been in the category since 1999, devastating. As one LP told me, he has been investing in great venture firms for a decade and has not yet made any money. Therefore the model must be broken.

The model has been broken for the past decade because we had two separate once in a lifetime crashes happen during one fund cycle. This is like Sebastian Junger’s “perfect storm”. Most VCs (and by extension, LPs), have been tiptoeing in a minefield for the past decade. What are the odds of this “perfect storm” happening again? Statistically, not very high. Twenty year venture returns are still over 20% annualized. In the long term, risk equals reward. This will happen again in venture.

Here is what I believe: Fewer venture firms will get funded and those funds will be smaller. Supply of venture money will be less and prices will continue to be attractive. As my respected venture friend, Fred Wilson, points out, there are many reasons to believe that tech IPO markets will return. So, lower prices and a rebound in exits. I think we are going to have a great period of venture returns over the next decade. Patience and discipline are the words I am going to try to live by.

Venture Beta

Stuart Ellman

Eric Wiesen

The Q1 numbers on Venture Capital investing were released last week. As is often the case with VC numbers, especially when they’re bad, there was no shortage of press and blog attention to the drop in both venture investing (in terms of capital deployed) and venture liquidity. And the general narrative that initially emerged was largely one of panic and, schadenfreude.

Shortly thereafter, however, people started to dig into the data a little bit further. We want to give big kudos to our NYC brethren, Fred Wilson, for his blog post on this topic. Two interesting analytical slices have emerged from this further examination. First, there was a meaningful disparity amongst geographies, with Silicon Valley seeing a much larger drop (even as a percentage of capital) than sectors in the Northeast like New York or Boston. The second was that certain sectors (like CleanTech) saw a far larger decline than other sectors (like health care).

And in looking at these second-order narratives that have emerged from this major change in venture behavior on both sides of the equation, it starts to become clear that there may be a sort of “beta” attached to different sectors within venture capital, much like there are differing levels of beta within sectors of the public market.

Beta, for those who aren’t familiar with the term, means that while most securities move in the same direction as the overall market, some tend to move more than the market while some tend to move less. A stock with a beta of 2.0 will generally increase by a percentage twice that of the overall market when the market is up, and correspondingly will decline twice as much as the market when the market is down. A stock with a beta of 0.5, by contrast, will only be up (or down) half the amount of the overall market. High-beta stocks are great in a go-go market and really bad in a down market. Low-beta stocks are generally less exciting when things are good, but hurt much less when things turn south.

The data emerging out of the down numbers for venture capital start to suggest that perhaps certain sectors (like health care, thought by some to be a safe source of “singles and doubles”) will generally act lower-beta than others (like CleanTech or the consumer web, which enjoyed massive momentum in the years prior to the downturn). Similarly, areas like New York and Boston start to look generally lower-beta than Silicon Valley. There have been fewer massive high-priced companies in New York, but the fall has been far less precipitous. We can only assume that the beta may be directly correlative with the supply of capital in those regions. In NYC, where there are fewer venture firms, there tends to be less upward (and obviously downward) pricing jumps because there are fewer firms to both jump in and jump out of the markets when sentiment changes. In the NY venture market, we have seen pretty rational pricing over the past few years, while other regions were seeing significantly higher pricing as the funding markets picked up steam. Since our region’s pricing never got too high, it has not fallen nearly as dramatically either. It is reassuring to see Fred’s analysis back this up.

Liquidity Perspective

Eric Wiesen

Courtesy of this morning’s VentureWire, the numbers for venture liquidity in Q1 are out. And I’m sure you will all be shocked to hear that they aren’t very good. In fact, overall liquidity across the venture industry was just $3.2B, the lowest for any quarter since 2003.

Full stop. Lowest quarter since 2003. So in the midst of the worst financial contraction of the modern era, venture capital liquidity was bad, but better than it was in 2001 or 2002. I think that, while not to be a Pollyanna about where the industry is today, it’s important to note that during a quarter where the public markets had their worst Q1 in 70 years, the venture liquidity numbers are bad, but better than they were the last time things went badly.

Further, and also of interest, median hold times were down dramatically in Q1, from an average of almost 8 years in Q4 to about 4.7 years in Q1. Part of this is just a shifting “market mix” where more companies are getting taken out early. It will be interesting and important to see if this trend continues into Q2 and beyond.

Ultimately, this data is not dispositive about where venture capital is headed. When I was at the most recent Kauffman Fellows module in Palo Alto last month, we had a number of high-profile industry experts offer a range of perspectives on where the venture business is going, and some of them were powerfully pessimistic about returns, shrinkage within the industry and the amount of capital that will be deployed over the next few years. Here at RRE we continue to believe that there is a core need for this type of capital, and that while this cycle is worse than any we’ve seen, the fundamental business purpose behind the venture business remains vital.

If You Build It…

Stuart Ellman

Eric Wiesen

“Should I build my company to be a profitable, standalone business or should I be aiming to fit into the long-term plans of my likely acquirers to facilitate an M&A exit?”

This is a question that entrepreneurs ask themselves every day. If you asked a hundred venture capitalists this question, I suspect the overwhelming majority of us would give you the canonical answer – build for long-term profitability and a standalone business, because the tides of M&A can come and go. In the previous era, many VCs liked to see every investment as an IPO candidate. And that made sense in an era when a pre-revenue web company burning cash could actually go public. But in today’s market, when even nine-figure companies with positive EBITDA can’t go public, it is worth asking this question again.

The argument for the traditional answer is simple and compelling – when you go to start your company, you don’t know what Google or Cisco or Dell will be buying in 3-5 years when you achieve sufficient scale to be interesting to them. As a result, if you build toward M&A, you’re likely to build toward whatever they’re buying when you start, and that will likely change significantly over the build period of your company.

There is also a huge issue of stage and valuation. Acquisitions tend to happen in two lumps. First is the “cheaper and quicker” route. This means that Dell can buy something for $10 to $25mm because it is cheaper and quicker than building it themselves. The second is “they already have scale” route. Obviously, a company like Dell can pay a great deal more for a company that sufficient scale that cannot be reliably replicated simply by recreating the technology. A good example of that would be the acquisition of Pure Digital Technologies (creator of the Flip video camera) by Cisco. Could Cisco build its own version? Sure. But they paid almost $600mm because Flip already had brand and scale . (BTW, kudos to Jonathan Kaplan, CEO of Pure Digital and a former RRE CEO). If you are selling in the “cheaper and quicker” category, it better be at a single-digit valuation. Nothing past a Series A.

The emerging counterargument is that the IT landscape has so significantly consolidated that the it’s become easier to project the tectonic movements of the “continental” companies like Microsoft, Google, Cisco and Dell. But is this true? Can you forecast what these companies are going to do? We sold MessageOne to Dell because it wanted to make a big move in hosted services. Could we have forecasted this in 2001 when we funded the company? Again to the Pure Digital example, how could you have guessed that Cisco would be going after the consumer market in 2002 when Jonathan was raising his first round.

We think this question is being answered in real-time. The standard advice to build for the long term is still good advice, but if all the exits are going to be via M&A for the foreseeable future, we’ll be thinking pretty hard here at RRE about what the big guys are really looking for. We still want to fund great entrepreneurs solving big problems in growing markets. But we also want to know what acquirers are looking for. Time to get smart in this area.

Rolling 8 the Hard Way

Eric Wiesen

Stuart Ellman

Experience in the venture business teaches many lessons. One that is often painfully learned is very easy to see from a distance but hard to see when down in the trenches. There are easy ways to make money and there are hard ways.

At one level this is intuitively obvious, but at another level, it’s clear that a lot of folks (founders and investors alike) don’t necessarily see the world through this lens, and as a result, a lot of businesses get started that are just not really geared to creating excellent investment returns.. At this point, we must make it clear that making money (i.e. generating profits), is not the same as successful deal exits. Many companies come in the door to our firm with clear paths to go from $10mm in revenues to $50mm in revenues and they are much less interesting as investment than some companies that have no revenues and fuzzy plans for profit generation but can solve large problems and will be highly sought after. This may seem confusing, but lets dig a little deeper. It really comes down to markets and competitive positioning..

What’s the easy way to make money? The easy way is the traditional way: solve a problem that lots of people have (or a very big problem that a few people have) and offer them a really good reason to pay you lots of money for what you made or do (we might call this a “value proposition”). Hopefully you’re doing it in a way that isn’t being done by a dozen other companies, and in a way that isn’t easily replicable by others. The easiest business in the world is one where you have something everyone needs and you’re the only one that has it. So if you could manage to situate yourself over the world’s biggest undiscovered oil well, you’d be set – you have something people need and (milkshakes not withstanding) you are very hard to displace. To use an example closer to home, a startup came to us looking for money. They had four people and an idea. The idea was a technically elegant way to create additional money for e-tailers with little downside. They had nothing built and two pilots lined up. They wanted a high valuation and they got many competing term sheets. They also had $0 revenues and it was unclear when they would really start to make money. Why was this deal “the easy way?” Because it was a hard ROI, created money in a sector that needed profits, was reasonably hard to copy, and whatever e-tailers used it had a competitive advantage. Therefore it would either get big very fast or get bought very quickly no matter what the financials looked like.

A friend recently asked, when told about this way of looking at companies, whether Google was an easy model or a hard one. And the truth is – Google was a hard model that turned into an incredibly easy one. If a startup came in the door and said, “we’re going to become the primary destination for search on the web, then sell ads against that search activity”, my guess is they’d have a hard time convincing us (or anyone else) how they would accomplish the first part of that, since changing consumer behavior around search is extremely challenging and expensive. However, if Google came in the door in 2001 and said, “We are already the primary destination for search on the web – now we’re going to sell ads against that search activity”, it would be moderately obvious how easy it would be for them to make money at it. Because the hard part of the model – building a huge stream of consumer activity – had already been accomplished.

So with that backdrop in mind, we’ve been looking at new deals that come in the door explicitly with this question in mind – does the company have an easy model or a hard model? This has particular resonance around B2C companies. While a lot of people in 2009 view the web as synonymous with “software”, B2C web companies that give their service away and monetize with ads (or other behind-the-scenes streams like lead generation) are media businesses, not software businesses. Those that charge for web services are software businesses. So – salesforce.com is a software business while Yahoo Finance is a media business. And startup media businesses are challenging, especially today. The really tough part is how many of them there are. As previously mentioned, there was an explosion of B2C web companies a couple of years ago, along with an explosion of ad networks launching to try to monetize them. This crowding, along with the current collapse in display ad rates, makes a web-based media startup (especially one starting from a dead stop) a very hard way to make money.

Let’s look at another example to compare the startup that sold to e-tailers above. A different startup came in selling a useful but inexpensive enterprise solution. It had $5mm in revenues, a clear pipeline for more sales up to $10mm, a very solid and earnest CEO and management team, solid reference accounts and well known VC backers. This is the “hard way.” Because this is a specific industry with large players that dominate the competitive landscape, the exit possibilities are few. The existing players are large and trade at about 1X revenues. Even if the startup struggles and really succeeds for the next five years, it will not be large enough to remain a standalone company and there will only be two to three potential acquirers who will not have the stock multiples to pay much more than the money being put into the company. And this is if everything goes right.

Without turning this into a portfolio survey for RRE, one thing we’ll note is that many of the companies in our portfolio that are continuing to do well even throughout this difficult economic period are those that have easy models – they make something someone (either businesses or consumers) need (or at least really want) and sell it in a relatively lightweight way. They are also answering unique problems and are changing the competitive paradigm of the industries in which they compete. And this learning will likely inform how we look at new opportunities that come in the door.

Is Capital Efficiency the Enemy of Innovation?

Eric Wiesen

I’ve been thinking about two themes that have generated a lot of discussion lately. The first is a growing sense that we are in a period of weak innovation; that Silicon Valley (and the rest of the US tech ecosystem) is broken, and that most of what’s being invented today is incremental, with no real innovation taking place. The second is strong focus on capital efficiency within the technology startup world.

At this point, given both the trends in web development and the macro economy, it’s practically a race between the entrepreneur pitching and the investor being pitched as to who will bring up how capital efficient the business is. The large majority of companies we see these days make a point of how capital efficient their models are, and the majority of investors (VCs and angels alike) are quick to dismiss companies that are viewed as capital inefficient.

Let’s step back for a moment and talk about what capital efficient means, and then we can get to the heart of the question. Capital efficient, in its simplest form, means you can accomplish a lot with a small amount of capital. And of course if you stop there, it sounds like an unadulterated good thing. More for less, right? And as a first-order question, I think the answer is yes. Doing more with less is a good thing.

But the second theme contextualizes the first for purposes of our question. We are in a period where much of the technology innovation taking place is in “soft technology”, be it software, web services, technology-enabled services or data businesses. And while it’s certainly an enabling environment that so many of the tools required to create these businesses have become commodity and free, there is an increasing concern that people are simply using free, easy tools to create slightly better versions of things that already exist.

Because how many of the really innovative technology companies throughout history were actually capital efficient? Whether we’re thinking about Edison Electric or Google, Amgen or Intel, Nvidia or Nucor, we often find that companies that really transformed industries with new technology or approaches took a large amount of capital and significant time to achieve it. And while these are clearly cherry-picked data points, I think that even on the web most of the really significant, innovative companies have taken in quite a bit of resources along the way.

I was recently on a panel with a friend of mine who’s an angel investor. And what shocked me was when he said that his group was looking primarily to invest in businesses that could, from a dead start, achieve profitability on significantly less than a million dollars of capital. And while, on its face, this sounds amazing – who wouldn’t want to invest in businesses like that? – another part of me really had to wonder, can you build anything interesting or important if that’s the hurdle you establish at the outset? Would any of the companies who have significantly raised the innovation bar have fit that screen, back then or now?

So I don’t think there’s a clear answer – we at RRE Ventures are clearly going to continue to seek businesses that can accomplish their goals with as little capital as possible, because it’s essentially obvious to do so. But I also agree with the criticism that “Web 2.0” has been at least in part an exercise in excessive capital efficiency, and that people were building incremental products and services with no real innovation in the hope of a quick flip or tuck-in acquisition. In the back of my head, I’m still going to be thinking about opportunities to create something really transformative, even if the road is a little longer and tougher.

Pitching 101: Be Prepared

Eric Wiesen

Today’s installment of Pitching 101 was motivated by a great recent presentation I saw. The message this time is – be prepared for each pitch. Two young entrepreneurs had been referred to RRE by one of our portfolio companies and we set up a time for them to come and tell me about the business and what they think it can be. These are guys a couple years out of college who have bootstrapped the business for the first year and who have achieved significant proof points while working on the company part-time and holding down “day jobs”.

Separate from the business itself (which I liked), it was immediately clear that these entrepreneurs were well-prepared for this meeting. They were prepared not only to present the business in a systematic, thoughtful way, but they had clearly looked at RRE’s current and previous investments and were prepared to talk about investment themes that we had already explored and where they might be an intersection with their business and its model. They had gone through the bios of the different investors at our firm to see ways in which we might be a good fit for their company, and had even read this blog and worked some of the ways we’ve indicated we like to be pitched into their presentation.

Is it work to do what these guys did, especially if you are pitching a lot of firms? Absolutely. But think about it the other way – you’d prep for a major sales meeting, partnership meeting or other significant line-of-business presentation. When a company pitches a potential investor, you are typically asking to be one of the two to five (depending on fund size) investments that firm is going to make that quarter, and are asking the VC to get involved with you and your company for a period of several years (and potentially as many as eight or nine years, although few want to admit that hold times can be that long). If you come in with a presentation that shows you were thoughtful and prepared, it’s a huge positive indicator of other things we can expect from you.

If you’re wondering what happened, the company doing the pitching isn’t going to be an RRE investment, for a few reasons. On the one hand, it’s not in a sector that’s of particular interest to us. On the other hand, the company doesn’t need very much money, and have quite a bit of their round already spoken for by angels. It would be a very small investment for RRE even if we took the whole thing.

And in most cases that’s where the story would end, but in this case I’ll be actively referring this company to either firms who specialize in seed rounds or to angel investors I think might be interested, because I want to see these guys succeed and because the level of professionalism and preparation for our meeting lends me confidence that I can recommend them to others.

In sum, take an hour to know the person or people you’re pitching. It will improve your odds of getting to next steps with them, and will generally help you form a relationship with that investor that may be helpful down the road.

Go to War with the Army You Have

Stuart Ellman

Eric Wiesen

We recently had the opportunity to talk about the current funding environment with a bunch of smart people at a brown bag lunch hosted by our friends at Betaworks. A lot if important angles were discussed, including best practices for entrepreneurs, the mindset at different VC funds and tactical suggestions for getting a funding done in the current climate.

One point that’s worth stressing was raised by several people (including us): When you raise money, make sure you have investors who are prepared to continue to support you the next time around.

Backing up somewhat, let’s acknowledge that when times are good, fundraising usually follows a fairly standard pattern. An investor or group of investors funds a company at the Series A level for a given amount. When the company has reached sufficient proof points in the business and when new capital is needed, the company will raise an additional round of financing. A new investor usually leads this round, with participation (on a pro-rata basis) from the existing investors. The new investor is brought in for a number of reasons:

• This investor may be more oriented toward a later stage of the business and can add additional value;
• New investor may bring needed capital for future rounds of funding; but most importantly
• A new investor can set the price for the company. Prior investors may have conflicts relating to the prices of prior rounds.

When a new investor can’t be found, then the current investors face the choice of whether or not to do an “inside round”, meaning fund the company themselves. The point today is that many if not most follow-on financings are being done as inside rounds right now. The new investor who comes in and prices the company and puts in fresh capital is, in many instances, very hard to find. They are either trying to figure out how they are going to fund their own portfolio companies (and doing inside rounds for them) or they are struggling to raise their new fund and aren’t making investments in new companies.

All of this rolls up to the original point: when you build your syndicate for your Series A round, make sure you have a group of investors who will continue to support you when you need to raise more money. It’s fine to have an investor involved whose charter is solely to make Series A investments and then participate pro-rata down the road, but you should ALSO have an investor who is comfortable making Series B investments. Because as a lot of startups raising Series B and Series C rounds are learning, new investors are very hard to come by right now.

At RRE we are currently looking at funding two very promising early-stage deals. In both cases we could easily (given the amount of capital being raised) take the entire round ourselves, but we aren’t just thinking about today. Both of these companies are likely to raise more money later on, so in both cases we are bringing in partners who can both add value to the company, and who we believe will help us ensure that the company continues to be funded should the current climate last longer.

They say you go to war with the army you have, and the same is true for your venture syndicate. If at all possible, bring in investors you think can go the distance with you. It can make a big difference.

How Deep is too Deep?

Stuart Ellman

Now that the markets have tanked and pensions and endowments are selling off their private equity holdings to rebalance their portfolios, many people have gotten religion. VCs realize that the environment for raising new private equity funds is not great. If they are near the beginning of their new funds, as RRE happens to be, it is a very fortunate position because they have plenty of fresh cash to put into companies at attractive prices. If they are near the end of their most recent fund, it is not a pretty time. With little fresh capital to put in their existing companies, the first word out of their mouths is to cut costs at their existing portfolio companies. This makes sense, but only up to a point.

For some of our portfolio companies, especially web 2.0 companies that exist “in the cloud”, it’s realistic to burn very little money and grow virally. But, this model simply doesn’t work for companies in other sectors and with other cost structures. I sit on the board of a terrific company in an extremely attractive space. Given the current environment, some of their large contracts have been pushed out. With valuations down and the company on a path to burn through its cash, it seems obvious to cut the expenses and make the cash last as long as it can. This company will only remain the leader in its space if it continues to have engineers crank out the hardware and software that constitute its solution. It will only be a winner if it participates in most of the beta tests, trials and RFP‘s that most of its large customers are demanding. It needs to partner with many of the Fortune 500 companies and support these relationships. These things are not cheap. But we can only create value for the company if these things are done. The key is spending enough to remain on the “leading edge” without going overboard and hurting ourselves on the “bleeding edge”.

The takeaway here is that the board of directors (and each individual director) has to set aside the desires of their specific class of shares and do what is best for all shareholders. If, for example, my fund is out of fresh capital to put in a company but the company needs to spend money to retain or create value, I must vote to dilute myself in order to be doing my duty as a director. This is not obvious to all board members, but reflects that Director’s duty to the company. Directors must work to maximize value to all shareholders, unless the company is in distress and worth less than the amount of debt. Then, the duty of a board changes and the directors must work for the benefit of the debt holders. This is tough medicine, but we have all lived through this before in 2001-2003. Things will turn around but we must all do the right things now to let these companies survive and flourish in the future.

Fundamental vs. Technical VC Investing

Eric Wiesen

Public market equity investors typically fall into one of two camps: Fundamental or Technical Analysis. Sure, many combine both, but most are essentially one or the other.

At a high level, fundamental investors look at the underlying business to determine how well it will perform. They look at margin expansion or contraction, performance of suppliers and customers and new market opportunities. They meet with management and assess their ability to execute the company’s strategy.

Technical investors, by contrast, are much more focused on the movement of securities within the market, and have developed a whole science around price movement, volatility, volume, etc… They look at “support levels” and patterns in time series charts. They are essentially trying to quantify the psychology of the liquid market to predict what the mass of other investors are likely to do.

Put in a simple way, fundamental investors buy the business. Technical investors buy (or sell short) the stock.

So what does this have to do with VC investing? There are no liquid markets, so everyone is a fundamental investor, right? I would argue no – that there is a type of thinking among VCs that is analogous to technical analysis, and that some measure of a VC’s decision-making process is usually contingent on this process.

The basic evaluation model here at RRE (and I suspect at most VC firms) is often described on this blog: Market/People/Technology. It’s relatively straightforward – is a given company led by great entrepreneurs, targeting a big opportunity in a defensible way? This is the fundamental analysis we perform, and it generally drives our yay or nay decision on companies we see. Is this (or is it likely to be) a good business? But once we’ve gotten comfort on these first-order questions, we then ask another set of questions:

• Who are the company’s comparables, be they startups or public companies?
• How do the markets value those companies?
• What success stories can we find of companies taking a similar approach to the one we’re looking at?
• Who are the likely buyers for this company? What multiple of revenues or EBITDA do those companies enjoy in the market? How acquisitive have they historically been?

These aren’t questions about the business itself. They don’t speak to whether the company has good leadership, whether its customers will want its product or whether its business model makes sense. These are market attitude and structure questions. They poll, to the extent that we can, the psychology and appetite in the market for this type of company.

Ultimately, this is the technical analysis piece of VC investing, and often is a part of the pitch process that entrepreneurs don’t expect. While there aren’t head-and-shoulders or cup-and-handle charts, it’s the part of the evaluation that gets done more on the position of the company as a tradable asset rather than as an underlying business. How will it be valued, and when, and by whom?

The approach to this piece of the analysis varies from investor to investor. Some will ask the entrepreneur straight out, “Who buys this business?” to see how the she thinks about the exit opportunities. Others don’t consider this a part of the process, but will think about it internally. Personally, I like to have this dialog with founders, to see if they are thinking early on about the exit trajectory the business could take, even though we usually agree we’ll have very limited visibility at an early stage. It’s more process and attitude than anything else.

Ultimately, you can see evidence of firms who prioritize the technical piece more than others. When you see VC “momentum investing” in a sector – consistent funding of a dozen or more ad networks, for example, it is at least partially the result of investors looking at the market, seeing the big exits and robust valuations and wanting to make a bet in a market that’s clearly in favor. This is the VC flavor of technical analysis.

Generally speaking, this element is something we do at RRE, but it’s second-order for us. To put it another way, we will not make a bet purely on momentum and analogous big outcomes, but it will help inform a decision about a business we like. If the fundamental analysis comes back strong, but the technical piece looks very bad (public comps are valued very low, previous exits in the space have been at 1X revenues) it will admittedly give us pause. Because ultimately we need to see an opportunity to return a multiple of capital to our limited partners, and if the market isn’t interested in a deal we do, that is going to matter.