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Series A Investing is Not a Market Driven Pursuit

Stuart Ellman

“Is your fund crashing?” is the question my mother will ask after seeing the front page of Wednesday’s New York Times.  “Dizzying Ride May be Ending for Startups” is the name of the article. DropBox and Snapchat have both been marked down by mutual funds. Square is going public at a price significantly below the last private round.  Every banker pitchbook now has a page showing how late stage venture valuations are dropping. So, how does this affect Series A investors? My answer: Not as much as you think. 

At first glance this contention may seem counterintuitive. Of course there is a certain frothiness when the late stage markets are riding high. Boundless enthusiasm infects the venture community at large, and people assume that we too are swept up in the hype. The reverse is true as well. Tremors shaking the public markets yields a certain amount of fear throughout the ecosystem. But the truth is this: Series A investing is not a market driven profession, and late-stage pricing fluctuation doesn’t change how we run our business or how our portfolio companies run theirs.

At RRE, we are primarily Series A investors, which means that we lead the rounds after the Seed Round (which is the first money in a company).  Series A funding is usually raised once the product or service starts to ramp and show initial traction.  Usually, the valuation range is between $20mm and $50mm and the amount raised is between $5mm and $15mm.  

This is different from late stage investing in many ways. But one difference is critical when thinking about valuation. Series A rounds are priced up from what the company has achieved since it started (ground up approach) whereas late stage rounds are priced at a discount to what could be in the market (top down approach).  Series A gets a richer valuation, up to a limit, based on the quality and background of the CEO, the amount of traction the product or service has been able to achieve with the seed money, and the market opportunity. 

Late stage is done in reverse. Companies are valued at a discount to where they would be priced in the public markets.  If a company is expected to trade at $3 billion, a late stage round might price at a 15% to 20% discount to account for risk and illiquidity. 

The implication of this is obvious. The share prices of publicly traded companies are variable. Tremendous price fluctuations are common even in stable markets. If late stage venture valuations are based upon constantly shifting public company share prices, then one would expect pricing for late stage venture deals to be highly variable as well. 

Consider Box and Dropbox.  If Box is the publicly traded competitor to Dropbox, then similar multiples must be applied to both.  If Box drops by 30%, it would only make sense that the same should apply to the late stage rounds for Dropbox.

But here’s the thing--this is not true for Series A valuations. While there is certainly some upward price pressure when the markets are very high, as well as downward pressure in times of economic turmoil, we never price a $1mm revenue company off of a discount from public markets.  First of all, there is almost never a publicly traded direct competitor to a Series A company.  But moreover, it would (and does) seem ridiculous when a company says, “even though we have almost no revenues, assume we have $200mm in revenues and price us like our publicly traded competitors.”  It simply wouldn’t make sense.

When I make late stage investment decisions, I pay close attention to public market comparables. But when I do my bread and butter Series A investing, I remind myself that the company I am funding is 5 to 8 years away from a public offering. Rather than worry about the headlines, I focus on what each company has achieved and on what it has the ability to achieve. 

So, Mom, my fund is not crashing.  My job, first and foremost, is to find great entrepreneurs building exceptional companies, to fund them, and to help them grow. If I get that right, the rest will take care of itself. Great companies will cash out when the markets are ready to receive them. And while share prices of publicly traded securities are constantly moving, there will always be market appetite for great new companies.

Against The Tide

Stuart Ellman

Sometimes things just break the right way. Within a three-day period last week, we closed the sales of two of our portfolio companies—Business Insider and Kroll Bond Ratings. The checks have cleared, and everyone is happy. Our founders, our limited partners, and our firm have all made money. But in an industry easily distracted by exit multiples and sale prices, it can be tempting to lose sight of everything that comes before deals are closed and funds are wired.

Henry Blodget, cofounder and CEO of Business Insider (BI), recently published a post thanking everyone who helped BI along the way to their $450mm acquisition by Axel Springer. His description of our initial investment was perfect: “I’ll never forget the look of excitement and trepidation on RRE Ventures partner Stu Ellman’s face when he decided to buck conventional wisdom and lead our first major institutional round.” 

Trepidation is a nice word. I was scared.  At the time, companies like this were not sexy. It was 2010, Buzzfeed (another RRE portfolio company) was not yet close to being a household name, BusinessWeek was being sold for almost nothing to Bloomberg, and investors were very skeptical of content deals. The BI team had trouble getting meetings.

Kroll Bond Ratings, which sold for $325mm last week, was no sure thing either. Jules Kroll was a proven CEO, but investors argued that KBRA was not a venture deal.  We had just gotten over the crash of 2007 and, while the reputations of Moody’s and S&P were in tatters, they still had extraordinary market power. I remember well the quizzical reactions of other VCs when RRE decided to co-lead  KBRA’s first institutional round. “Its just another rating agency”, “It can’t compete against the big guys”, “the investment banks will not let another player in” and “this is not a tech deal”, is what I heard in response. While we believed strongly in the idea of using technology to disrupt the ratings industry, this thesis was not universally accepted.

Today, with our companies making headlines, these theses seem obvious. But it’s easy to be a contrarian once you’ve been proven right. What’s harder is sticking to your philosophy in the weeks, months, and years that lead up to the actual outcome. After being in this industry for two decades, I’ve learned to fight for companies and ideas I believe in. BI and Kroll are just the two latest examples.

Of course I’m proud of our companies. But I’m prouder still that our firm is able to place bets on companies we believe in, even when the prevailing wisdom is against us. RRE is a place where we swim against the stream, even when to do so gets uncomfortable and scary. No matter how strong the pull of the latest trend, we pride ourselves on eschewing groupthink. We continue to bet on companies that can’t get meetings elsewhere, and we stay away from deals we don’t believe in, even when the buzz around them becomes deafening. Moreover, knowing who we are as investors makes the inevitable losses easier to stomach, and makes the wins all that much sweeter. 

A Different Kind of Training

Cooper Zelnick

At around seven o’clock last night, Jason Black and I were pulled into a conference room to meet an entrepreneur seeking seed-stage funding for his new venture. Raju Rishi (our boss) introduced the entrepreneur, who shared an overview of his idea. Then Raju asked the two of us a simple question: “Do you believe in this?” So started our final meeting of the day. 

My name is Cooper. I’m a (relatively) new Analyst at RRE Ventures, a New York City-based venture capital firm. And despite being a 23-year-old kid with basically no work experience or marketable skills, I get paid to think creatively, to have informed opinions, and to argue with people who have been working in this industry longer than I’ve been walking this earth. 

If that seems odd or incongruous, then I’ve made my point. Its an old cliché that my peers—ambitious, talented recent graduates of relatively fancy colleges and universities—are lured into traditional “Analyst” programs only to spend years staring at screens, suffering through eighteen-hour workdays, building spreadsheets, and warming swivel chairs. 

Ostensibly, these programs offer formal training, invaluable work experience, and handsome pay. But what do they actually teach? To be clear, my issue is not that many of our generation’s best and brightest minds go into such roles. My issue is that high-paying, prestigious institutions spend huge amounts of time, energy, and money turning smart, passionate, and engaged young people into glorified calculators and copy editors. My issue is that the enterprises that recruit our generation’s best thinkers all too often seem to favor conformity over creativity, and that those who want to be successful in traditional terms have no choice but to acquiesce. 

No industry is perfect (VC is no exception) but this is an industry that must by definition be open to new ideas. Innovation, agility, and a forward-looking mentality are the keys to a firm’s success, and young people have fresh and valuable perspectives. So it’s not all that shocking that VC Analysts are recruited to do more than demonstrate proficiency in Excel and run on low levels of sleep. 

What I can’t understand is why our industry seems to be relatively unusual in this respect. It’s no secret that technology is changing the world. Even the stodgiest of incumbents now acknowledge the threat of disruption, and hardly a day goes by without another major corporation initiating a startup accelerator, licensing a new technology, or buying an innovative, year-old competitor outright. 

Yet for all the ways that these companies espouse progress and innovation publicly, they stifle innovative thinking within their ranks by demanding conformity and limiting opportunities for expression among their own young employees. Too many firms forego an opportunity to innovate from within, failing to tap a deep well of new ideas backed by intelligence and enthusiasm.  

Perhaps they don’t want to indulge youthful idealism.  Perhaps they are afraid of impinging a culture of seniority.  Perhaps innovation isn’t really that important to them after all.  Whatever the reasons, the truth is that while bleary-eyed Analysts across the country sit idly behind their desks hoping to be observed “applying themselves”  by Managing Directors, I am being asked a simple, direct question: “Do you believe in this?” And I am asked to answer.

Introducing RRE's Director of Platform

Steve Schlafman

Over the summer RRE kicked off a search for a Director of Platform. After reviewing hundreds of resumes and meeting with more than a dozen candidates, we were fortunate to find a candidate with deep operational chops, a innate passion for the startup ecosystem, a strong willingness to help founders and a super positive, team-first attitude. This candidate also demonstrated tremendous hustle, drive and raw emotional intelligence that our founders and partners deserve and expect in this role. With that being said, I'm incredibly excited to welcome Maria Palma to the RRE family and community. 

Maria brings a wealth of operations, strategy and business development experience to the RRE community. Prior to RRE, Maria, was Executive Director of Business Development and Chief of Staff at NYC-based Eyeview. There she was involved in numerous aspects of the business including strategy, partnerships, and revenue to name a few. Before she joined Eyeview, Maria received her MBA at Harvard Business School, where she found her passion for working with early stage entrepreneurs. She kickstarted her career at General Electric in their prestigious Operations Leadership Program and Global Supply Chain Group. Not only does she have a wonderful mix of business experience but she also has an engineering degree from University of Wisconsin-Madison. We believe this blend of skills will greatly benefit RRE's founders, portfolio executives and partners in the community.  

Maria will be tasked with building the RRE platform, growing our community and expanding our presence in the NYC ecosystem and beyond. She outlined an ambitious blueprint that supports RRE's founders across five key dimensions -- infrastructure, community, business development, best practices and talent. There's certainly a lot of work ahead but Maria is up for the challenge and already hard at work. Please join me in welcoming Maria to the RRE family! We couldn't be more thrilled to have her supporting and adding value to our founders and their companies.