I have been watching with fascination about the follow-on rounds at companies like Groupon, Twitter, and Facebook. A lot of money is changing hands, a billion dollars here and a billion dollars there, and these companies are so closely held that their financial performance is still a mystery. Every time I hear a number about Facebook’s future value it is twice as high as the number I heard a day before. The new rumor is that Facebook will IPO at over $100bn. That is more than the value of Cisco, which makes all the stuff the Internet runs on, and Cisco has about $40bn in cash on its balance sheet. But what can I say? The rumor mill also says that Twitter will sell for $10bn.
I am not sure why this select group of companies includes only consumer-facing businesses, and I don’t have financial information, so I won’t comment on valuations. But I do know that the syndication on these mega rounds includes some surprising names, including traditional early-stage firms like Kleiner Perkins and Battery Ventures. And there are sometimes as many as ten VCs in a single deal.
I look at this and I think the world is changing. This type of investing doesn’t feel like venture capital to me. It feels more like momentum trading. Get in on the uptick and get out at the top. With so many VCs involved I don’t know how the companies schedule board meetings – I have a hard time setting up a call for three investors, let alone a dozen. My assumption is that these boards operate a lot like public companies, and there isn’t as much outside involvement at this stage.
But here is the rub: doing the math from my spectator seat, a fund manager with a standard 2% management fee will make roughly $15mm in fees on a single, $100mm investment in Groupon (assuming a tail on fees over a 10 year period). That doesn’t even take into consideration performance fees on the upside. It is a good deal if you can get it.
This opportunity is available today because the IPO market is failing early stage companies. If these companies were public, investors could own shares for $9.99 on eTrade. Instead they have to jump through hoops, sacrificing fees and a percent of the upside. Maybe that will change over the next few years with new regulation, but at the moment there is a window out there for private momentum investing. This is a relatively new phenomenon and I am paying close attention to see how it all pans out.