Kategorie: Investment Know How

  • Too good not to share! I…AM…THE…CFO!!!

    [youtube=http://www.youtube.com/watch?v=vOgiu0m2c80]

  • What to do with all this liquidity…?

    Encouraged by Alexander Graf and his critical analysis of the current digital environment I asked myself why so many irrational business seem to get an almost unlimited amount of funding. In Germany there is always Zalando as a great example of this trend. The business is so far not profitable and investments that by now are topping over a billion Euros will never be recovered but international money is being thrown at Rocket Internet with an ever increasing speed. Its business model is not closely examined and investors push new capital into the firm without even asking some of the most basic due diligence questions. Is it really a plan to buy up the fashion market and pray that your proprietary brands and size will eventually lead you to break even? How are logistics organized behind the shiny technology and TV commercials?  Why is there such an irrational rush to throw more money at these kind of businesses? Since we are now starting to talk about investments going into the billions I am going to take a macro economic perspective to create a possible explanation.

    Due to the current monetary crisis money has been pumped into our economic environment – if printing presses would still be responsible for monetary supply we would be running out of ink.

    Source: http://commons.wikimedia.org/wiki/File:Eurozone_M3_money_supply.png

    As you can see from the graph above monetary supply has increased substantially. In Europe it is a fairly even growth story but it becomes even more drastic if you look at monetary supply expansion in the United States.

    Source: http://commons.wikimedia.org/wiki/File:U.S._MZM_money_supply.png
    Source: http://commons.wikimedia.org/wiki/File:U.S._MZM_money_supply.png

    What are investor to do with all this capital that has been pumped into our economy? There is no substantial growth in the „real“ economic output within the developed word – in fact there is a decline based on the recession the European Economic Area and the United States are currently going through. In addition there is only so much capital that can be invested in „traditional“ economies in rapidly growing markets e.g. BRICS countries. On top of these factors investors are also scarred – the ongoing EURO crisis, horribel US economic data, emerging conflicts in the Middle East and Asia … all this has impacted the ability to invest large amounts of capital. Investors now have less opportunities and more importantly have come to terms with lower return expectations, while taking higher risks.

    What does this mean for digital investments?

    Based on the above described trends we will continue to see irrational capital allocation in digital growth projects such as Zalando. Investors will increasingly accept long-term returns that are barely above inflation just for a chance to allocate some of their access capital. It does not mean that it will become any easier to raise growth capital below EUR50 million but it is becoming easier to collect amounts above EUR250 millions for growth projects.

    Entrepreneurs THINK BIG!

    So in conclusion tech-savvy entrepreneurs: stop thinking about running a business on EUR10 million start to think how you could allocate EUR500 million!

  • Due diligence – what is important for digital acquisitions?

    Over the last month we have supported a wide range of acquisitions in Germany with eTribes. On the one hand we have worked with our clients to identify targets on the other hand we are constantly asked to evaluate business ideas by VC/angle investors or by entrepreneurs who are looking for feedback. In addition, we also have to work with the CEOs of our equity participations to create new business models and to react to a digital environment that has really picked up speed. Through these various mandates and evaluations a range of points have come up again and again – so I am now publishing a quick summary. I am hoping that some of it will save me from hearing the same catch phrases over and over again e.g. if I had a dime  for every time a marketing plan consist of „it will go viral“  I could probably buy Apple.

    Team

    Probably one of the most overused catch phrases is „team is everything“ but again it is absolutely true. Give me an A team with a B idea anytime over a B team with an A idea. Therefore, we pay  lot of attention to the skill set of the founds and team – are they complementary? Can they cover the entire needed range from business skills to online marketing expertise? Will they be good at sales? How do they deal with stress? How well do they talk to investors? Here, we do not only look for solid CV credentials but also talk to people they have worked with in the past to get a good understanding of the work they have done historically.

    Additionally, I would argue that not only having a certain skill set is key but that implementation trumps credentials every time. What do I mean by that – some people will have worked in corporates and gained substantial experience in a field (on paper) without ever actually doing the work. Supervising an add agency that prepares an online campaign is not the same as running your own web project with a marketing campaign you have to set-up and optimize. Often people will be surprised by the difficulty that is in between theoretically understanding a concept and implementing it.

    Customer Acquisition Cost

    This key variable is often connected to the marketing section shown below. 9 out of 10 entrepreneurs we talk with have not thought scalability and customer acquisition cost through. Every time we are surprised by this – online business models collect an amazing amount of data and so determining a rough estimate of customer acquisition cost very early one is not very hard. How much does it take to get a customer to buy your product? How often do you need to be in contact before a purchase is made and what does each contact cost? How often will your customer come back e.g. what is your customer lifetime value? I do not expect to get a formula that is absolutely correct but I do expect the entrepreneur to have thought about this!

    Marketing (Viral does not work!)

    Marketing is expensive. Even in times where zalando clearly spends millions and millions on advertising most business models still think that if there product is strong enough customers will just be running through the (non existent) doors of their website. Here we most often see horribly wrong assumptions about marketing costs. These days it is incredibly hard (and expensive!!!) to differentiate yourself online and to get a customers attention long enough to place your product. There are very few viral models that have worked historically and generally these work only in the United States and not in Europe.

    An accumulation of hype phrases is not a business model

    Oh my – have you seen my newest mobile optimized app that through geo location really adds value in the social media space through its gaming characteristics … 🙂 Going to a digital conference and adding all the seminar titles together does not create a business. Where is the differentiating value? How do you plan to make money? How do you acquire your customers? What problem do you solve? These are questions that are not answered through hype phrases but through well thought out business plans!

    Money & Billing 

    So often I see entrepreneurs who sit here and tell me that they have already several very happy customers – my next questions always is: great, what is your revenue? Unbelievably enough I often get the reply: well we are using a freemium model and are not actually charging anything. If you do not value your product enough to charge money for it, why would or even should your customer value it? How honest is feedback for something you get for free? Make money right from the start – get a billing system and send out invoices!

    Hockey Stick (but only in sales)

    Never missing is the famous hockey stick for sales projections – customers will love the product after 6 months and make you rich. Unfortunately, lots of business plans show this trend but neglect to create a sensible cost to revenue ration. I do not believe that you can either increase revenue by 10x without hiring additional people nor do I think that additional people will not need new / bigger office space etc. Often business plans will have a strong cost /revenue correlation for 6-12 months and in month 18 show entirely surreal ratios.

    Team

    Is key! So here it is a second time 🙂

  • Conclusion: Venture Capital – does it still work?

    …finishing of my post series in regards to VC industry changes …

    Will prices for start-ups significantly change?

    In my opinion most start-ups will continue to raise the necessary funds in Germany. Firstly, venture capital never played a significant role here and secondly a large range of new capital sources have been developed over the last years. Corporate investors have become much more active and crowd funding offers a new way to raise initial proof of concept financing. Universities and government agencies have also been offering additional financing sources. So I believe that in terms of start-up financing there will not be a significant impact from the declining venture capital funding. Internationally, this will probably be a different story.

    But what does it mean for valuations? Again I believe that most German start-ups would not have been sold/continued financing rounds to/with VC funds in any case. Trade exits are the normal route to go for start-ups here and most corporates are not only willing to invest in start-ups but have been allocating significant amounts of capital. In terms of pricing I also believe that Germany is looking at incredibly low valuations anyhow and that equity markets are not an exit route for start-ups due to depressed listing outlooks. Hopefully corporate capital availability will actually help to increase pricing levels here.

    In my experience …

    Overall, I believe that corporates will play a significantly larger role in the German start-up scene than VCs ever had, have and will. The OTTO Group alone has an early phase incubator (Liquid Labs http://www.liquidlabs.de/), later stage incubator (Project A http://www.project-a.com/) and a later stage VC funding partner (eVentures http://www.eventures.vc/). Most other large German corporates are following this trend and are establishing their own teams.

    In addition, I am pretty sure that we will start to see an increasing number of more specialized incubators that offer additional guidance and support as well as follow-up funding through corporate buyers. Here an interesting trend from the US are specialized healthcare incubators like Rockhealth or Medstartr.

    “Rockhealth is one of the growing incubators in the healthcare industry. They help teams with venture capital, advice and their network to find proper healthcare business models & help to scale them. The startup industry is just starting to innovate around healthcare and those incubators are likely to be in the centrum of this development.” http://rockhealth.com/

    These significantly more specialized funds will take over start-up financing and provide industry trade buyers for growing start-ups. Entrepreneurs who are looking to grow their business should therefore forget about impressing VCs and start building their corporate contact network.

  • What are the implications for start-ups?

    cont’d from last post VC funding…

    Does it matter whether venture capital is a failed asset class or not? Yes, some capital restrictions will apply but I would argue that there are sufficient alternative sources of capital to not significantly restrict new venture creation. Smart entrepreneurs can bootstrap, rely on angle networks or newly emerging crowd funding platforms in order to bring a venture through the proof of concept phase.

    Additional follow-up capital rounds can then be financed through trade investors who are currently committing significant amounts of capital. There is a significant interest from trade, publishing and pharma companies to invest in digital start-ups. These companies have hundredth of millions available for new venture creation or “corporate innovation” outsourcing. Almost daily new funds, initiatives or deals are announced by corporates who are looking to mitigate the impact of digitalization on their core investment business. These sources of funds should be able to replace venture funding (at least in Europe). In addition, German/European entrepreneurs are also cashing out and are ready to invest in new ventures. In Hamburg there is a wide range of angle / VC money available from successful industries partners e.g. HackFwd – Lars Hinrichs. 

    Therefore, I would argue that especially in Europe the decline of the venture capital industry does not create significant problems and is compensated through alternative sources of capital.

  • What consequences does this bring for VC funds, which have fully invested their current capital?

    As discussed in the previous post – times are tough for VC funds – but what implications does that bring? Funds need to start lasting value creation to attract new capital! As a first step I think that VCs need to reevaluate how they select investments. So far the industry has a way too high failure quote – I even think that VCs with their general herd behavior often miss interesting opportunities. Secondly, they need to increase their target range. There are lots of successful start-ups outside of the Silicon Valley and SV like hubs that would present interesting funding targets. Thirdly, they really need to develop beyond pure capital providers. Almost all of them will tell you that they are really value add above and beyond capital – that is generally just a statement but far from reality. Increasing number of start-up accelerator programs indicates that pure venture capital financing is not successful. More skills, support and knowledge are necessary. Investing in a VC environment is incredibly hard and finding the right investment criteria and sticking with them is quite a challenge. This is nicely described in Paul Graham’s “Black Swan Farming” article. Source: http://paulgraham.com/swan.html

    Small is beautiful

    VC firms should also stop raising larger and larger funds. Even if they successfully invested their smaller funds it does not meet that they should now double or triple their fund size. In several articles and also in the conclusion of the Kauffman Foundation report the authors argue that only smaller VC funds are able to provide decent returns. In addition, they focus a lot on the compensation structure and clearly show that having a significant amount of “skin in the game” is necessary to get solid returns from a VC management team.

    „The incentive for small funds is aligned with investors and more achievable. A $100 million fund could buy 20% of 25 startups and handily outperform the public markets by building four to five companies into $400 million exit values, or a broader set of successes across the most typical venture exit values of $50 million – $500 million. Annual fees keep the lights on in the meantime, while the potential profit share from generating 300­400% gains provides the prime incentive.“

    Source: http://venturebeat.com/2012/08/18/lean-vc-why-small-is-beautiful-in-venture-capital/

    Compensation for the industry should also be changed. Funds will have to proof that their management team is not only investment savvy but also resourceful and has significant skin in the game.

    While we agree on Kauffman’s recommendation on looking beyond large funds, a deeper analysis suggests the need to look at the risks and returns in the fund structure — the profit share of each partner, the spread of capital committed per partner, and so on — and remove the reliance on a heroic grand slam as the only, yet unlikely, path to outsized results. Other qualitative factors include structurally leveraging all partners’ expertise across the portfolio, and garnering meaningful returns from more than just a few deals. These are among the many critical and structural advantages of the smaller venture fund.

    Source: http://venturebeat.com/2012/08/18/lean-vc-why-small-is-beautiful-in-venture-capital/

    If these challenges are met successfully VCs will continue to play a significant role for start-ups – if not it looks like the industry’s funding sources will dry up and soon start-ups will have to look for funding elsewhere.

  • Venture Capital – does it still work?

    Previously, venture capital as an asset class has been critically discussed by Jochen and Alex in their respective blogs excitingcommerce.de and kassenzone.de.

    Source: http://www.excitingcommerce.de/2012/09/vcs-und-die-hohe-wahrscheinlichkeit-des-unwahrscheinlichen.html and http://www.kassenzone.de/2012/09/12/venture-capital-funktioniert-nicht/

    In his last blog Alex already hinted that I am working on a more detailed analysis of the subject. Why do I find this interesting? Well, after having worked in the PE and VC industry I always wondered how it would feel to change sides – become an entrepreneur and learn the nuts and bolts of daily operational challenges. It has been very interesting and I am tempted to claim that “professional” VCs who have been in banking or consulting all their lives and therefore represent the favorite MBA trained elite that joins VC/PE firms on a junior level – know next to nothing except how to draw pretty slides, talk in “investor” slang at fancy conferences and run after hypes like a crazy bunch of headless chickens. This is clearly an exaggerated view but overall the question remains if  venture capital is an asset class with a future. The question is, if the more experienced senior staff has the ability to find deals and make investments that are profitable. In addition, I am wondering if only a select few sometime „get lucky“ or if this is a sustainable industry with a risk/reward ration that should be attractive to investors.

    In addition, Germany has seen a significant increase in venture capital through the Berlin „hype“. Now, with the entire industry under fire it becomes extremely interesting to see how the industry is going to develop. Even more importantly I am certain that these new analysis will have an impact on the rapidly developing European start-up environment.

    Based on a range of studies it has become clear that the venture capital industry in general simply sucks at being investors and even more importantly sucks as an investment vehicle for their Limited Partners (“LPs”). Returns of venture capital as an asset class are simply not sufficient to continuously attract new capital.

    How bad are returns?

    The Kauffman Foundation, a highly reputable Limited Partner in many venture capital firms, has published the following facts based on their significant, long-standing venture capital investment history.

    “Only twenty of 100 venture funds generated returns that beat a public-market equivalent by more than 3 percent annually, and half of those began investing prior to 1995. 

    The majority of funds—sixty-two out of 100—failed to exceed returns available from the public markets, after fees and carry were paid.

    There is not consistent evidence of a J-curve in venture investing since 1997; the typical Kauffman Foundation venture fund reported peak internal rates of return (IRRs) and investment multiples early in  a  fund’s  life (while still in the typical sixty-month investment period), followed by serial fundraising in month twenty-seven.

    Only four of thirty venture capital funds with committed capital of more than $400 million delivered returns better than those available from a publicly traded small cap common stock index.

    Of eighty-eight venture funds in our sample, sixty-six failed to deliver expected venture rates of return in the first twenty-seven months (prior to serial fundraises). The cumulative effect of fees, carry, and the uneven nature of venture investing ultimately left us with sixty-nine funds (78 percent) that did not achieve returns sufficient to reward us for patient, expensive, long- term investing.”

    Source: http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf

    There are also other articles and reports that are based on the Kauffmann analysis and the inability of venture firms to raise new funds. Limited Partners have finally woken up to the reality that blindly investing in larger and larger venture capital funds no longer makes sense. Why is that? As Fred Wilson states in a recent MIT technology review interview:

    “Because the returns haven’t been very good in the venture capital industry for a long time. I think if you talk to the investors in venture capital partnerships, they’ll tell you that they’re very much on the fence on venture capital, and if venture capital continues to put up mediocre returns, they’re not going to stick with it forever.”

    Source: http://www.technologyreview.com/qa/428869/fred-wilson-on-why-the-collapse-of-venture/

    At the moment Berlin delivers a wonderful live case study to prove my point. The current hype, number of horrible investments and general herd behavior of investors in Europe’s new venture capital “capital”. Where are the actuals businesses that are supposed to generate lasting returns in the current “hype-cycle”? Where are the returns, exists or just simply lasting value creation? A small elite group of investors such as the Samwer Brothers are highly successful but from my impression the overall industry does not generate lasting value.

    The Kauffmann report goes on to argue that actually LPs should re-evaluate their investment behavior and focus on other key value drivers within the VC industry.

    • “Invest in VC funds of less than $400 million with a history of consistently high public market equivalent (PME) performance, and in which GPs commit at least 5 percent of capital;
    • Invest directly in a small portfolio of new companies, without being saddled by high fees and carry;
      • Co-invest in later-round deals side-by-side with seasoned investors;
      • Move a portion of capital invested in VC into the public markets. There are not
enough strong VC investors with above-market returns to absorb even our limited investment capital.”

    The Kauffmann report also has an interesting title:

    “MET  THE  ENEMY…  AND  HE  IS  US” – Lessons  from  Twenty  Years  of  the  Kauffman  Foundation’s   Investments in Venture Capital Funds
and The Triumph of Hope over Experience“.

    They consider the problem the be the LPs – they need to change their asset allocation in order to substantially alter industry behavior and subsequently the return rate for the industry as a whole.

    The previously listed investment recommendations are only one side of the equation. I think that there is a general consensus that due to the lack of returns and the issues outlined by the Kauffmann Foundation the VC industry will change.

    Therefore, there are a lot of questions that remain:

    What are the implications for start-ups? What consequences does this bring for VC funds, which have fully invested their current capital? Will prices for start-ups significantly change?

  • (b) Digital real estate investments

    Google Insights for Search:

    Address: http://www.google.com/insights/search/?hl=de

    Preparation: Estimate a number of key words for your vacation rental

    There are a couple of important variables you can see here:

    1. Seasonality – if the search volume is impacted by seasonality you will see it going up and down as shown in the screenshot above. So your property will be more likely to be fully utilized when search volume is up.
    2. Regions – with the second screen shot you can see where most of the search volume comes from. This is important for advertising purposes and to understand if demand is driven regionally or through other factors.
    3. You can add other variables and compare it to your search volume. You can see that ice cream has seasonality (screen shot 3)

    Google Keywordtool

    http://adwords.google.de/

    In order to check which specific key words people are searching for you can use Google’s keyword tool.

    Enter an initial keyword such as “Pocono Mountains” and add a “#” symbol. Google will not only provide the specific search term, but show a range of suggestions based on what people have been searching for. Here you will see the monthly search volume and also see if competition for advertising based on these search terms is either low, medium or high. Play around with this tool for a little bit to get a feeling for numbers – for example compare the screen shots looking for “Pocono Mountains” with a search for “Marthas Vineyard”.

    Local digital competition analysis

    Access a range of online booking agencies (Wimdu, AirBnB, etc.) and find out how many properties are listed in the region. Note down certain differentiating aspects (number of bedrooms, proximity to regional attraction points, coast/lake etc.) and the average weekly/monthly prices. This should provide you with a good understanding of regional pricing.

    Depending on the time you want to spend you can also check their calendars and available opening for the next two months to see if there is a high demand for rental properties.

    Local booking/vacation agencies

    Call local vacation rental agencies and tell them that you have a property you would like them to manage. Find out how many bookings they are willing to guarantee on average and what they charge as a management fee. In addition, ask them about regional aspects, seasonality and their experience of managing local rental properties. Use these factors to improve your online research and analysis.

    Investment decisions can now be supplemented with free and easily accessible data that only a couple of years ago was only available to sophisticated large investors. Now you can use this data to make better investment decisions!

  • (a) Digital real estate investments

    Aside from being an eCFO I am also interested in personal investment decisions. Working with start-ups probably means that you are equity “rich”, cash poor and have plenty of private equity/capital exposure. In order to balance that exposure I personally invest in more “traditional” investment classes such as real estate, ETFs and large public company shares. Nevertheless, I do ask myself how my experience and current occupation can support my private investment decisions. Therefore this post outlines how digital tools can improve “old school” investments and help to build a balanced investment portfolio.

    Imagine you are looking to buy a vacation home and want to find out what the optimal location would be. Is it by the sea, mountains, country, city? Obviously buying a property will always depend on several “micro” factors. It has to be well-maintained and should a good “micro” location e.g. close to attractions, far away from highways, etc.

    Google search & maps:

    Google maps and research about the actual location on Google search will provide you with a solid understanding of the region and the micro location of your vacation property. Only 5 years ago it would have been pretty expensive to get a satellite image of your property (unless you had contacts within the CIA) and to search through all local newspapers to see if there is a nuclear waste facility next to your property. Today this can be researched and evaluated within minutes.

    Once you have made certain that your property has the correct “micro” factors it boils down to a pretty easy formula: will you be able to rent out the property at a price and for an occupancy rate that justifies the purchase price and related costs? What is our utilization rate and revenue?

    In order to evaluate these individual metrics within your formula Google offers some fantastic FREE tools that will help you to determine the following factors:

    Overall demand & supply: where does it come from? What are people looking for? How many properties at what utilization rate are already present in your market?

    Seasonality: when are people searching for a property in your area? How high is the search volume compared to markets you are familiar with?

    Advertising costs: how much is being spent on advertising in your local market? Will you be able to attract a substantial amount of visitors through Google/Facebook advertising?

    Regional trends: what is happening in your region? What other search terms are relevant? How much are existing properties being rented out for?

  • (b) Bankers, accountants, lawyers, consultants, fund raisers – how to deal with eCFO service providers

    Lawyers

    Depending on your business you should consider building a junior legal presence in your business to avoid having to pay high hourly rates for all legal related questions. This is especially important if you deal with legal questions, contracts etc. on a regular basis.

    If you do have to hire a lawyer always go for the best and somebody with specialized knowledge. If your counter party has to negotiate with a highly qualified lawyer it will save you more money in the long term compared to paying a slightly lower hourly rate. I would not engage one lawyer for everything but instead get an expert for each topic and use them as needed. That means a lot meetings and time spent on searching for various lawyers but it also means that you will get expert advice for each questions you might have. I would advice against large firms since work will usually be done by junior associates and you will only meet the partner for sales negotiations and billing purposes. Stick with small, specialized firms that know what they are talking about and do not have a deep hierarchy. Also note that lawyers will never tell you yes or no – they will always give you options so that you cannot blame them later on. If you know this, always make them spell out the costs, benefits and problems associated with each option so that you can make a well-informed decision.

    Consultants

    I am not a huge fan. They will generally tell you what you already know and bill you without mercy. Often an outside perspective can be very valuable but try to get that initially from new employees or hire individuals for specific projects, if you feel you should have an outside perspective. I am very hesitant to believe that someone else knows your problem better than you, if you are truly honest with yourself. Consultants also have the tendency to give advice and to not stick around for the execution of their brilliant plan – they are also not accountable for any of it. Would you work with an unaccountable, extremely expensive employee who does not like to execute? Why should the same not apply to consultants?

    Fund raisers and financing partners

    As a start-up you will get a lot of requests from these generally well connected senior industry players. They are generally great contacts and very valuable. If you are asked to pay without performance e.g. a retainer or similar up-front payments, I would suggest that you do not work with them. Performance-based pay is the only way to go and it shows that they are confident that they will deliver real value (deals, financing, clients).

    eCFO Tips: Remember your consultants/advisors will only be as good as the information you share with them. You should regularly update your advisors and MOST IMPORTANTLY the people who do the actual work on a daily basis (junior staff) at least once every quarter. Invite them over to your company and give them a general update on how things are going. This will ensure that they will provide you with sufficient advice. It will also save you money since advice will generally be better and you will not need as long to bring them up to speed if an urgent matter arises. Throw in some nice food and drinks and I am sure your work will always end up on the top of the pile 😉

    Even if you have built a good network of advisors make sure that they can grow with you. From time to time you should review if they still have sufficient scope to giveyou good advice. Sometimes you will outgrow advisors very quickly – you should replace them if it becomes obvious that the relationship no longer works. If you have chosen your advisors carefully and maintained a strong and communicative culture, it is most likely that your advisors will grow with you and continue to be valuable assets throughout the growth cycle of your business.

    eCFO Tips: Pricing – often it is going to sound like the hourly rates of your advisors are set in stone. This is not true – make sure that you negotiate not only the hourly rates but also yearly accumulated fees e.g. if you go above EUR50k you get an overall discount on all accumulates fees for next year. In addition, ALWAYS ask your advisors if they are willing to take some risks and enter into a performance agreement. Even if they do not end up doing it, you will find out how convinced they are with regards to actually being successful.