I am back in Boulder after spending much of the last week in San Francisco at Dreamforce.
I’m glad to be back, as I find the current climate in the Bay Area somewhat amusing. The tech media writes and talks breathlessly about Unicorns. Startup employees get obsessed with valuations, rather than per share price value. FullContact investor and board member Brad Feld recently wrote a great post titled Unicorpse which I think is a good read for any founder.
As I was taking a long walk with a fellow Foundry portfolio founder around San Francisco, we lamented what we perceive to be the lack of long term thinking in many startup founders these days. In our view, many founders seem to be looking for the 12-18 month exit and the “quick flip” of a company if they can’t achieve meteoric growth rates immediately. It’s pretty cool and trendy to be a startup founder, but I don’t think many appreciate the long term amount of work and effort it will truly require to build a business of value with a deep economic moat.
This rubs me the wrong way, as I’ve always agreed with Warren Buffet’s approach that you’ve got to measure performance in five year chunks. I wrote about my personal five year check point earlier this year.
This got me asking the question: How would the performance of Warren Buffet, Charlie Munger and Berkshire Hathaway be judged in today’s tech venture climate?
So, I decided to explore this by doing some math using a few assumptions:
1. Berkshire’s 50 year annual report lists Berkshire Hathaway returning a 21.6% compounded annual growth on the market price of its stock. For the sake of argument, let’s assume that a startup founder named Jane, CEO of a company named LongCo, was able to achieve these kinds of returns for her shareholders over a long period of time.
2. Lots of startups are valued around $5M coming out of an accelerator like Techstars (don’t even get me started about Y-Combinator valuation levels). So, let’s say Jane’s startup LongCo raised some $1M in capital at a $5M post-money valuation.
3. For the sake of simplicity, let’s assume that LongCo never needed any more equity capital for the business.
Using these assumptions, I answered the following questions:
At a 21.6% annual growth rate, how long would it take for LongCo shareholders to reach a simple cash on cash shareholder return of 3X? 5X? 10X? 100X? 200X? 1000X?
To answer this question, I created a simple table (depicted below)
- A cash on cash return of 3X would be achieved in Year 6.
- A cash on cash return of 5X would be achieved in Year 9.
- A cash on cash return of 10X would be achieved in Year 12.
- A cash on cash return of 100X would be achieved in Year 24.
- A cash on cash return of 200X ($1B valuation) would be achieved in Year 28.
- A cash on cash return of 1000X would be achieved in Year 36.
As Albert Einstein said, ‘The most powerful force in the universe is compound interest”
Now, there’s different strategies out there, and I certainly don’t want to over simplify, but many venture investors will tell you that a 3X cash on cash return is ok. 5X is a good. 10X is great, and beyond 50X, it’s in crazy awesome territory. As the table above illustrates, you can achieve pretty good shareholder results if you’re patient – especially if you have a portfolio where all of your investments that are just grinding along over a ten or twelve year period and growing steadily.
But in the tech venture world today, we’re not in an industry that is known for patience or Berkshire style of value investing. Because of venture portfolio dynamics and a “swing for the fences” mentality of VC backed founders, we are all all aiming for 100-200% YoY growth rates. This dynamic adds more risk to a business and often can prevent a company from building a strong moat at the beginning of its life. It also causes a dynamic where companies take on more equity capital and dilute their shareholders (which decreases the cash on cash return multiples).
My point is not that we should change how we do business – I just find the data enlightening and interesting. There a lots of strategies to create shareholder value – playing the long game is one of them.
Warren Buffet initially took a controlling interest of Berkshire Hathaway with an $8.3M investment in 1965 at a market valuation of $16.6M. How long did it take Berkshire to reach Unicorn status?
I pulled the data below directly from Berkshire’s 50 year annual report and did some math comparing Jane’s LongCo to Berkshire.
A few notable things stood out.
- At Berkshire’s same growth rates, LongCo would reach $1B Unicorn Status in 18 years.
- Coincidentally, in 1983, 18 years after Warren Buffet took control, Berkshire was worth just north of $1B in market capitalization.
I find the answers to the questions above to be very interesting and revealing.
On a personal level, I’m 36 years old. Can I imagine running FullContact for another 30 years, until I am 66 years old? Yes, I actually can. I enjoy the people and I find it intellectually stimulating. I enjoy the job of allocating capital. Of course, our early investors would likely want some sort of liquidity event (IPO, secondary transactions, or even dividends) along the way to realize the appreciation in shareholder value.
And right now, we’re making investments to grow at over 100% YoY, not at 21.6%. Obviously, we can’t sustain those growth rates indefinitely, but it’s an interesting thought experiment to consider what would happen if suddenly the market shifts and values profit over growth. Could we dial back our growth and focus on steady growth and profits? Absolutely. As the data above shows, we could still get some crazy awesome returns to shareholders that are patient and understand the long game we are playing.
So my message to founders is this: don’t compare yourself to the Unicorn or achieving that mystical $1B number. That’s not the goal. The true goal is creating shareholder value in the long run, and there’s lots of ways to get there.