There’s this line I love in Jerry Colonna’s Reboot, and I’m loosely paraphrasing just because I’m travelling and I don’t have the book in front of me, “The saying is buy low, sell high; not buy lowest, sell highest.”
The reason I bring up that line is that I’ve been hearing a lot of investors talk about timing the market. At least that was the case before this wonderful trip I’ve been taking across the Pacific, as I sip my hojicha atop my hotel in the backdrop of the Kyoto evening metropolis. When’s a good time to sell? What price makes sense on the secondary market? Should I be investing now? When’s a good time to re-up? Is it a good idea to re-up? Should I be generating DPI for my investors now? Or should I hold? When should I start my fund? When should I begin fundraising?
Now, I don’t pose the above questions as if I have all the answers. In fact, I don’t. I try to. But I don’t. Although I’ve heard 50-60% is the discount secondary buyers have been able to get for great companies that became overvalued in the pandemic days. On the flip side, while Dave and I did published a blogpost not too long ago on early DPI, the truth is there are different ways to make money. Ed Zimmerman shared some of his investments’ data recently to illustrate that exact point.
Another obvious truth is that as investors for an alternative asset class — hell for any asset class, our job is to make our LPs money. Ideally, more money than we were given. For other asset classes, it’s measured in percentages. For venture, it’s multiples. And because of that raison d’être, it’s our job to think not only about the upside, but also the downside protection. Hence, why early DPI matters in some of your best outliers. It always matters.
But from what I’m seeing and hearing, it matters more in a bear market, like today. Than the bull we were in yesterday. Why?
- Liquidity is a differentiator.
- Because of the point 1, giving LPs some liquidity back makes it easier to get to conviction as you raise your next fund.
- Point 2 holds the most weight if you’re an emerging manager on Funds I through III, or have sub $100M AUM. Although Funds I and II, you have little to go off of. As such, sticking to your strategy may be more important to some LPs. In other words, consistency.
- Also seems to matter more if your LPs are investing off balance sheet. For instance, corporates.
While I was in Tokyo earlier this trip, I caught up with a colleague. We spent the evening chatting about fund managers and current deployment schedules. (In case you’re wondering, no, we didn’t spend the whole time talking the biz.) And we see a lot of folks slowing down their pace of deployment. Could be the case of deal flow contraction, as Chris Neumann recently wrote about. Could be the case of loss of conviction behind initial fund strategy. We’ve also seen examples of VCs stretching their deployment schedule as their fundraises have been extended to 2024. All in all, that means VCs’ bar for “quality” has gone up.
But let me explain in a bit why I put “quality” in quotation marks.
So, timing comes down to two things:
- Entry point
- Exit point
I’ve seen a plurality of investors consider exit options as a means to *crossing fingers* convince existing LPs to re-up to the next fund. Debatable on how effective it is. As many LPs I’ve chatted with are “graduating” a lot more of their GPs than years prior. In other words, fancy shmancy word for they’re not re-upping on certain existing managers. Some LPs say it’s an AUM problem (but I’ve also seen them make exceptions). Others say it’s strategy drift. But more so say that certain GPs haven’t been a good fiduciary of capital, which ends being a combination of:
- High entry points
- Faster than promised deployment schedules (i.e. 1-1.5 years instead of 2-4 years)
- Investing in a company where the preference stack is greater than the valuation of the company (similar to the first bullet point)
- Reactive communication of strategy drift, instead of preemptive and proactive
- Logo shopping which led to strategy drift
All that to say, there are a good amount of LPs who, though appreciate the extra liquidity from partial exits, are not re-investing in existing managers. In addition, they’re holding off until on new ones till earliest Q1 next year to build the relationship earlier. Especially those $5M+ checks.
So, quality, for both GPs and LPs, is this new sugar coating of a term to account for time it takes to figure out where they want to put the next dollar. Investors on both sides are waiting to pull the trigger at 90% conviction, instead of the usual 70%. And realistically, for pre-product market fit companies and firms (i.e. pre-seed, seed startups and Funds I-III), 90% usually never comes until it’s too late. Meaning one misses their entry point.
I have no doubt (as well as many if not all my peers) that the greatest companies of the next generation are being built today. But only a small handful will make it out the gauntlet of fire. Even good companies won’t make it, unfortunately.
So, for the one building, the importance of communicating focus and discipline will be more powerful than ever. My buddy Martin also recently tweeted by an unrelenting focus on a niche audience may serve more useful than targeting a seemingly large TAM.
For the one investing, there is no good time. Our job is to buy low, sell high. Not buy lowest, sell highest. Waiting for the right moment will only have you miss the moment. In the surfing analogy, where the market is the wave, the product is the board, the team is the surfer, and you need all three to be a great surfer, you don’t want to be on the shore when the wave hits. It is better to be paddling in the water before the wave hits than on the shore when the wave does hit. Timing is only obvious in hindsight, never in foresight.
There’s also a great Chinese proverb that the best time to plant a tree was 20 years ago, the next best time is today.
So in this flight to quality, consider what quality actually means. Is it a function of you doubting your original thesis? Then re-examine what caused the doubt. Was your thesis founded on first principles? For consumer, which is where I know a little bit more about, is it founded on the basis and habits of the human condition? Is it secular from technological and hype trends?
Is quality waiting on numbers or external validation? That’s fine if you’re a growth or late stage investor. You’re never going to get it if you’re a true pre-seed and seed. If you’re waiting on a large amount of traction, you’re not an early-stage investor. Round-semantics aside.
You built a fund around a 10-15 year vision. Deploy against that. Or… although we don’t see this much these days, return any remaining capital back to your LPs.
Photo by Alex Perez on Unsplash
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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.