7 ms·

When Is a “Mark” Not a Mark? When It’s a Venture Capital Mark

120 points by aston 10y ago

simbalion 10y ago
When you try to 'mark read' the hacker news rss feed and 20 minutes later the same stories are re-posted 3 or 4 times.. zing!
mathattack 10y ago
Cash is king. Interim metrics are a necessary evil. I find the OPM method interesting. Has anyone here used this? Is it always more conservative? Is it a better predictor of realized value?
- PhillyPhuture 10y ago
  OPM is terrible. Even the academics realize it (I think). This paper evaluates the analysis. There's a caveat on pg. 24. GIGO. In my opinion, it's not just a caveat. It's a killer. I'm not sure what the overarching societal value to applying OPM to private, illiquid company valuations could be. http://repository.upenn.edu/cgi/viewcontent.cgi?article=1035&context=wharton_research_scholars http://repository.upenn.edu/cgi/viewcontent.cgi?article=1035...
  - mathattack 10y ago
    It seems to require knowing the equity volatility and IPO price in advance. That is shaky. But isn't it that it just needs to better than other methods?
emilyfm 10y ago
From the title, I was expecting this story to be about the con-trick use of the work "mark" (sucker, target).
- wiredfool 10y ago
  And Marc.
CPLX 10y ago
Vaguely condescending blog posts by founders of financial firms about why top-tier financial reporters are underestimating their returns is a leading indicator that actual returns will be even worse than the reporting implies.
- michaelkeenan 10y ago
  Huh, that's an interesting correlation. What examples led you to notice it? Have you found a way to make money from this?
  - wbl 10y ago
    If you have hard numbers showing the reporter is wrong, you will trumpet them. If not, you won't. Sadly shorting VCs is hard.
    - rlucas 10y ago
      Not necessarily. VCs' lawyers are big big sticklers for preserving their Reg D exemption from SEC registration, which is contingent upon no general solicitation. If AH wants to be able to sell any LP interests in the next 12 months they are going to be very, very careful not to state any performance figures, particularly the trumpet-able kind. (Exception: there do appear to be firms who are cavalier about this kind of thing, mainly seemingly new or nontraditional firms. But if you have DLA or Gunderson or Proskauer or whoever it is these days advising you, they are not going to be cool with you possibly blowing your Reg D in order to have a twitter feud with a reporter.)
    - deleted 10y ago
      [deleted]
    - flylib 10y ago
      no you won't, the VC doesn't report to a random reporter and numbers change all the time (WhatsApp last public valuation was of 1.5 billion (Sequoia held them at this position) and it sold for 19 billion)
XiZhao 10y ago
Rare for a Finance Analyst at the WSJ to make such a simple mistake, but is it so surprising that a media outlet would overlook accounting details in the chase of a headline?
daveguy 10y ago
Holy hell what a terrible title.
evetheattacker 10y ago
From the original WSJ article: "Since its founding through last year, Andreessen Horowitz had returned a total of $1.2 billion in cash to investors, net of fees. Sequoia returned more money on WhatsApp alone." Unlike the blog states, it seems that WSJ is, in fact, using "actual, realized returns" as evidence. http://www.wsj.com/articles/andreessen-horowitzs-returns-trail-venture-capital-elite-1472722381 http://www.wsj.com/articles/andreessen-horowitzs-returns-tra...
- ScottBurson 10y ago
  WhatsApp was a hell of an outlier. I think you have to put the size of that gain down to luck.
  - kooshball 10y ago
    VC as a fund class is literally about finding outliers. How much of that is luck is arguable* but it doesn't make any sense to ignore outliers when comparing returns. * How did Sequoia end up as the only VC that made money from Whatsapp? It certainly wasn't an accident.
    - rokhayakebe 10y ago
      Could you elaborate on your last line?
      - tlb 10y ago
        Jim Goetz and Jan Koum talked about this at Startup School 2014: https://www.youtube.com/watch?v=8-pJa11YvCs&list=PLQ-uHSnFig5OyY5JWSQrl_gESiEUJxe1m&index=6 https://www.youtube.com/watch?v=8-pJa11YvCs&list=PLQ-uHSnFig... starting around 8:10. TL;DR: Sequoia didn't get that deal just by random chance.
        AndrewKemendo 10y ago
        Great link thanks. I had no idea they were that effusive about venture money. Really hammers home the idea that if you have a killer tool, money will find you.
noahmbarr 10y ago
"Mark" as in "mark-to-market"
jboydyhacker 10y ago
So I agree with the sentiment that marks are not useful however you can do an analysis of the "non-realized gains" and the age of each fund then compare that to benchmarks of other funds of the same year. That's basically a backend way of figuring out how much of their returns are pie in the sky. One other thing to keep in mind to give a16z the benefit of the doubt is their funds are MASSIVE. Putting that amount of capital to work is hard- and relatively harder than Bessemer and the other funds they are compared to. That said, the % of Fund III in particular that is non realized is fairly scary. I'd take a wager that it does not return capital. Note also A16z pretty quickly raised a new fund before a lot of these returns for 3 become clearer. That's just guessing on my part but I'd def bet III is not gonna be good. That said I still love a16z and the partners and their approach...I actually hope I'm dead wrong.
- mason55 10y ago
  > you can do an analysis of the "non-realized gains" and the age of each fund then compare that to benchmarks of other funds of the same year. Just so I'm clear, the idea here is to look at all funds that started in the same year, average the non-realized gains, then compare that to the non-realized gains of the fund you're evaluating? How do you know whether the difference is how they mark vs. actual alpha?
  - jboydyhacker 10y ago
    Look at the funds a specific "vintage" year, then look at: 1) Realized Returns/ Total Size of Fund 2) compare above to prior vintage years of same partnership/ similar funds 3) Look at unrealized returns as a percentage for this vintage across funds and for same partnership for prior funds for same years out. The bulk (like 80%) of unrealized gains can disappear in a quarter if you have a large market correction. Some of the variance is going to just be market conditions but in general the weaker those numbers that's a pretty bad sign.
pbreit 10y ago
"does nothing to tell an LP what a company’s ultimate value at exit will be" "nothing" is the wrong word here. My experience is that the "marks" are indeed quite helpful and for the most part, reasonably accurate. My experience is also that many portfolio company valuations are not particularly sophisticated. The hedge fund comparison is odd since many hedge funds investments are as illiquid or more.
jonstokes 10y ago
I read the title and I thought "mark" as in "the target of a scam". I was super excited to read a post about how VCs scam founders but get away with it because they're, well, VCs, and on a VC blog, no less! Imagine my disappointment on clicking the link...
everly 10y ago
The lady doth protest too much, methinks.
johnwheeler 10y ago
The big takeaway from the journal article is a16z charges 30% of profits. Top hedge funds are known for 2 & 20, and Berkshire Hathaway doesn't charge anything. 30% is murder. Scrutiny is justifiable.
randomname2 10y ago
With all the talk about a16z money, important to remember that partners give half their earnings to charity: http://fortune.com/2012/04/25/andreessen-horowitz-to-give-half-their-earnings-to-charity/ http://fortune.com/2012/04/25/andreessen-horowitz-to-give-ha...
PaulHoule 10y ago
I dunno. Whenever I mention "mark to market" to anybody involved with swaps, their blood runs cold, black people turn white, etc.
jgalt212 10y ago
I don't buy it. They assign value when then invest (which of course is a very rough estimate). What's so hard about assigning a value a few months or years down they road when they presumably have a lot more info about the biz than they did on day 0 (the initial investment/mark).
grandalf 10y ago
One thing that the article doesn't really elaborate on is why different valuation strategies exist (and are allowed to exist) within GAAP. Accounting should be done in a way that maximizes the usefulness of financial reporting for strategic and management decisions. In some cases, firms are required by regulators to adopt specific practices, but there is a fair bit of freedom given to the CFO. VC firms must make wise financial decisions and satisfy their LPs with some degree of transparency. The accounting strategy chosen must accomplish both goals. In many cases, it makes sense to be very pessimistic about valuations, and doing so often reduces tax liabilities. On a side note, the whole "mark to market" scandal from the 2008 financial crisis was a case where firms typically marked assets in a way that matched their management goals, but at times failed to reflect short-term price fluctuations. Regulators thought that forcing firms to mark assets to a known market price would result in better financial reporting. The problem was that the balance sheets containing those assets were also used as underwriting capital. So a market price increase (or bubble) in the assets was suddenly leveraged into a lot more risk capital by the firm (whereas before the rule, the CFO would not likely have wanted to mark the assets that high). This resulted in industry-wide increases in risk capital for "free" because of asset price spikes, and following that it led to increased investment. The problem was, when the price fell back down, the firms were over-leveraged. It's generally a bad idea to use highly volatile assets as underwriting capital. So while "mark to market" sounds good, it can enhance natural fluctuations (minor boom/bust cycles) in a destabilizing way. The art of being the CFO of a VC firm is likely a very interesting thing, and it would be fascinating to learn more about how this happens across the industry.

120 points by aston 10y ago

When you try to 'mark read' the hacker news rss feed and 20 minutes later the same stories are re-posted 3 or 4 times.. zing!

mathattack 10y ago

Cash is king. Interim metrics are a necessary evil. I find the OPM method interesting. Has anyone here used this? Is it always more conservative? Is it a better predictor of realized value?

PhillyPhuture 10y ago
OPM is terrible. Even the academics realize it (I think). This paper evaluates the analysis. There's a caveat on pg. 24. GIGO. In my opinion, it's not just a caveat. It's a killer. I'm not sure what the overarching societal value to applying OPM to private, illiquid company valuations could be. http://repository.upenn.edu/cgi/viewcontent.cgi?article=1035&context=wharton_research_scholars http://repository.upenn.edu/cgi/viewcontent.cgi?article=1035...
- mathattack 10y ago
  It seems to require knowing the equity volatility and IPO price in advance. That is shaky. But isn't it that it just needs to better than other methods?

emilyfm 10y ago

From the title, I was expecting this story to be about the con-trick use of the work "mark" (sucker, target).

wiredfool 10y ago
And Marc.

CPLX 10y ago

Vaguely condescending blog posts by founders of financial firms about why top-tier financial reporters are underestimating their returns is a leading indicator that actual returns will be even worse than the reporting implies.

michaelkeenan 10y ago
Huh, that's an interesting correlation. What examples led you to notice it? Have you found a way to make money from this?
- wbl 10y ago
  If you have hard numbers showing the reporter is wrong, you will trumpet them. If not, you won't. Sadly shorting VCs is hard.
  - rlucas 10y ago
    Not necessarily. VCs' lawyers are big big sticklers for preserving their Reg D exemption from SEC registration, which is contingent upon no general solicitation. If AH wants to be able to sell any LP interests in the next 12 months they are going to be very, very careful not to state any performance figures, particularly the trumpet-able kind. (Exception: there do appear to be firms who are cavalier about this kind of thing, mainly seemingly new or nontraditional firms. But if you have DLA or Gunderson or Proskauer or whoever it is these days advising you, they are not going to be cool with you possibly blowing your Reg D in order to have a twitter feud with a reporter.)
  - deleted 10y ago
    [deleted]
  - flylib 10y ago
    no you won't, the VC doesn't report to a random reporter and numbers change all the time (WhatsApp last public valuation was of 1.5 billion (Sequoia held them at this position) and it sold for 19 billion)

XiZhao 10y ago

Rare for a Finance Analyst at the WSJ to make such a simple mistake, but is it so surprising that a media outlet would overlook accounting details in the chase of a headline?

daveguy 10y ago

Holy hell what a terrible title.

evetheattacker 10y ago

From the original WSJ article: "Since its founding through last year, Andreessen Horowitz had returned a total of $1.2 billion in cash to investors, net of fees. Sequoia returned more money on WhatsApp alone." Unlike the blog states, it seems that WSJ is, in fact, using "actual, realized returns" as evidence. http://www.wsj.com/articles/andreessen-horowitzs-returns-trail-venture-capital-elite-1472722381 http://www.wsj.com/articles/andreessen-horowitzs-returns-tra...

ScottBurson 10y ago
WhatsApp was a hell of an outlier. I think you have to put the size of that gain down to luck.
- kooshball 10y ago
  VC as a fund class is literally about finding outliers. How much of that is luck is arguable* but it doesn't make any sense to ignore outliers when comparing returns. * How did Sequoia end up as the only VC that made money from Whatsapp? It certainly wasn't an accident.
  - rokhayakebe 10y ago
    Could you elaborate on your last line?
    - tlb 10y ago
      Jim Goetz and Jan Koum talked about this at Startup School 2014: https://www.youtube.com/watch?v=8-pJa11YvCs&list=PLQ-uHSnFig5OyY5JWSQrl_gESiEUJxe1m&index=6 https://www.youtube.com/watch?v=8-pJa11YvCs&list=PLQ-uHSnFig... starting around 8:10. TL;DR: Sequoia didn't get that deal just by random chance.
      - AndrewKemendo 10y ago
        Great link thanks. I had no idea they were that effusive about venture money. Really hammers home the idea that if you have a killer tool, money will find you.

noahmbarr 10y ago

"Mark" as in "mark-to-market"

jboydyhacker 10y ago

So I agree with the sentiment that marks are not useful however you can do an analysis of the "non-realized gains" and the age of each fund then compare that to benchmarks of other funds of the same year. That's basically a backend way of figuring out how much of their returns are pie in the sky. One other thing to keep in mind to give a16z the benefit of the doubt is their funds are MASSIVE. Putting that amount of capital to work is hard- and relatively harder than Bessemer and the other funds they are compared to. That said, the % of Fund III in particular that is non realized is fairly scary. I'd take a wager that it does not return capital. Note also A16z pretty quickly raised a new fund before a lot of these returns for 3 become clearer. That's just guessing on my part but I'd def bet III is not gonna be good. That said I still love a16z and the partners and their approach...I actually hope I'm dead wrong.

mason55 10y ago
> you can do an analysis of the "non-realized gains" and the age of each fund then compare that to benchmarks of other funds of the same year. Just so I'm clear, the idea here is to look at all funds that started in the same year, average the non-realized gains, then compare that to the non-realized gains of the fund you're evaluating? How do you know whether the difference is how they mark vs. actual alpha?
- jboydyhacker 10y ago
  Look at the funds a specific "vintage" year, then look at: 1) Realized Returns/ Total Size of Fund 2) compare above to prior vintage years of same partnership/ similar funds 3) Look at unrealized returns as a percentage for this vintage across funds and for same partnership for prior funds for same years out. The bulk (like 80%) of unrealized gains can disappear in a quarter if you have a large market correction. Some of the variance is going to just be market conditions but in general the weaker those numbers that's a pretty bad sign.

pbreit 10y ago

"does nothing to tell an LP what a company’s ultimate value at exit will be" "nothing" is the wrong word here. My experience is that the "marks" are indeed quite helpful and for the most part, reasonably accurate. My experience is also that many portfolio company valuations are not particularly sophisticated. The hedge fund comparison is odd since many hedge funds investments are as illiquid or more.

jonstokes 10y ago

I read the title and I thought "mark" as in "the target of a scam". I was super excited to read a post about how VCs scam founders but get away with it because they're, well, VCs, and on a VC blog, no less! Imagine my disappointment on clicking the link...

everly 10y ago

The lady doth protest too much, methinks.

johnwheeler 10y ago

The big takeaway from the journal article is a16z charges 30% of profits. Top hedge funds are known for 2 & 20, and Berkshire Hathaway doesn't charge anything. 30% is murder. Scrutiny is justifiable.

randomname2 10y ago

With all the talk about a16z money, important to remember that partners give half their earnings to charity: http://fortune.com/2012/04/25/andreessen-horowitz-to-give-half-their-earnings-to-charity/ http://fortune.com/2012/04/25/andreessen-horowitz-to-give-ha...

PaulHoule 10y ago

I dunno. Whenever I mention "mark to market" to anybody involved with swaps, their blood runs cold, black people turn white, etc.

jgalt212 10y ago

I don't buy it. They assign value when then invest (which of course is a very rough estimate). What's so hard about assigning a value a few months or years down they road when they presumably have a lot more info about the biz than they did on day 0 (the initial investment/mark).

grandalf 10y ago

One thing that the article doesn't really elaborate on is why different valuation strategies exist (and are allowed to exist) within GAAP. Accounting should be done in a way that maximizes the usefulness of financial reporting for strategic and management decisions. In some cases, firms are required by regulators to adopt specific practices, but there is a fair bit of freedom given to the CFO. VC firms must make wise financial decisions and satisfy their LPs with some degree of transparency. The accounting strategy chosen must accomplish both goals. In many cases, it makes sense to be very pessimistic about valuations, and doing so often reduces tax liabilities. On a side note, the whole "mark to market" scandal from the 2008 financial crisis was a case where firms typically marked assets in a way that matched their management goals, but at times failed to reflect short-term price fluctuations. Regulators thought that forcing firms to mark assets to a known market price would result in better financial reporting. The problem was that the balance sheets containing those assets were also used as underwriting capital. So a market price increase (or bubble) in the assets was suddenly leveraged into a lot more risk capital by the firm (whereas before the rule, the CFO would not likely have wanted to mark the assets that high). This resulted in industry-wide increases in risk capital for "free" because of asset price spikes, and following that it led to increased investment. The problem was, when the price fell back down, the firms were over-leveraged. It's generally a bad idea to use highly volatile assets as underwriting capital. So while "mark to market" sounds good, it can enhance natural fluctuations (minor boom/bust cycles) in a destabilizing way. The art of being the CFO of a VC firm is likely a very interesting thing, and it would be fascinating to learn more about how this happens across the industry.