Consider an alternate universe – Bizarro world for the Superman super-geeks among you – where the failure rate is 4 out of 5. 80% of the time you turn on the lights, the TV, walk into the elevator and… nothing. Doctors would confuse kidneys, accountants would have you pay someone else’s taxes (The Donald’s please), your phone would misconnect the vast majority of time, 80% of the news would be fake instead of the other way around.
Bizarro, right? But not for Venture Capital. VCs admit to a success rate of 1 in 5 but will confess to 1 in 10 while under the influence. This causes huge problems of a fundamental sort. Foremost is the cost of capital. Rare winners carry the mighty burden of many losers plus VC overhead (Harvard educations don’t come cheap) plus VC profits (neither does detached housing in Menlo Park). All this gets baked into the cost of a deal and those sneaky terms (spoiler alert: they slay with terms).
Another problem is the mega-hit driven mentality. Like a homerun hitter who insistently swings for the fences, it is the four-baggers (or four-hundred baggers) which maintains the venture-adventure. Even the most renowned names in the business have a ghastly batting average, but a respectable ROI because of a dash of Uber or a whiff of Airbnb. Neither of which, it serves to remind, have yet to make any profit but rather bountiful mark-to-market gains for VCs and with luck, genuine financial gains for early investors.
What wrong with all this, you ask? Plenty. Whatever happened to the low risk, reliably returning startup that only has the potential for a (measly) 9-figure valuation? Plus, the rush to the entrance to buy into the big one also accounts for the Bizarro valuations: so much money, so little equity to spread around. To wit, the pundits say Uber will soon go public with a value of $120 billion, about the market cap of Mercedes, Ford, and GM combined. The difference: the autocos produce over half-a-trillion in revenue and tens-of-millions in profits. By contrast, Uber may record $10bb from rides and lose over $4bb. Nutz I say.
Which leads me to the model a la Loeb and our approach to launching and scaling our twenty-something start-ups. We started with the VC conundrum: with all the talent and access, why do as few as 1 in 10 VC funded startups have the type of return you’d write your accountant about? We parsed the missing 90% into 3 buckets – Bad Idea, Bad Execution, Bad Money – and came up with a solution for each.
First, Bad Idea. Do we have better judgment than VCs? I demur. But instead of debating the point, an object lesson on fund construction. Venture money committed by investors is drawn down as it is put to work in startups. Until a deal takes shape, the capital sits on the sidelines in an asset class that is sure, liquid and thus low returning; in short, the other end of the asset spectrum from the illiquid and risky venture. Professional money managers obsess about asset allocation and a slow-moving VC gets them wiggy. Thus the pressure for deals – even bad ones. At Loeb.nyc, we work for our own account, on no one’s schedule, and invest our own capital. The pressure? Make great decisions… or don’t make them at all.
We mitigate the executional risk with our shared services group, equal in number to the denizens of the companies themselves. Metaphorically, they are the shed of tools that all builders need: research, strategy, legal, sales, finance, accounting, M&A, patents & trademarks, tech (lots of tech), UI/UX and every DTC marketing channel from new school (digital: SEM, SEO, content, social, programmatic, email, messaging, etc.) to old school (direct mail, inserts, field force, phone, TV and more).
Bereft of the typical withering startup odds – with our broad portfolio, somethin’ got to work – but with a heavy dose of the startup vibe, we get great, super-qualified people. Motivation? Why equity of course. The startups contribute a vig to the ‘house’. And the price is right – shared services cost our startups nothing. Our thinking is that timesheets are not a good use of time and are often the source of friction. And when all are working on the same team with a common purpose – to successfully build and scale new companies – who wants to argue?
About that last bucket, capital. Ours is very patient … and convenient. In the normal course, entrepreneurs confess that they spend half their time raising money or keeping the investors they just raised capital from happy. We give them that time back by being their only (or at the very least go-to) source of capital. Instead of funding companies for a few months (incubators), or for a round or two (VCs), we’ll fund for years and years.
Shared services give yet more of founders’ lives back. Consider finance and accounting. It is a universal truth that entrepreneurs are God awful at coding and paying bills. Founders get that time back too, as well as all the time that other shared services can win back for them.
As entrepreneurs and operators, we know first hand that no two startups are alike. Liftoffs are not smooth and sh*t happens. Every time. No one forecasts meltdown in their budgets, but near-death experiences have occurred in every startup I have ever been associated with. VCs don’t suffer these accidents well – if you haven’t experienced this yourself, you simply can’t foresee the unforeseen. When these events happen, capital dries up, particularly if the event is coincident with a recession (and one has to be coming soon).
Consider this calculus: by cutting the risk of each of the buckets in half (Idea, Execution, Money) the odds of success increase 5.5 fold, to over 50%. Is the performance proving out the theory? We’ll know in the fullness of time, but we are pleased as punch with our progress thus far. Watch this space.