We Play Hockey, They Play Golf

The revival of the venture capital industry coupled with the propensity for companies to delay their IPOs in a post-Sarbanes-Oxley world has led to outsized private market valuations for outstanding companies. As a result, I get more questions than ever regarding the opportunities in public market investing from Silicon Valley executives. The standard queries are “Why don’t you invest in privates? Isn’t all the money made before the IPO?”

The answer to the first question is simple. While the skill sets of a public and private market investor have some overlap, the cultural and time frame differences make co-existing difficult in the same firm.

Just like a venture capitalist, I invest in CEOs. Do I agree with his or her strategy? Do I like the management team? Am I optimistic about the prospects for the business? Do I think he/she will execute? But the similarities end quickly. A portfolio manager friend once said “We play hockey, they play golf”. The metaphor is perfect. We both swing at a small round object with a stick. But in our game, the small round object is always moving. Our game is timed. We play both offense and defense. We get hit. We wear skates, not cleats, and our surface is ice.

VCs operate inside companies. They work with entrepreneurs to shape strategy, build a management team and connect with their network of contacts. If they don’t like the outcome, they work to improve it, change the CEO or sell the company.

I operate outside companies. While I may offer insights to management, ultimately if I expect a company to underperform, I sell the stock. I do competitive and industry analysis in order to evaluate the CEO, product competitiveness, business opportunity, and company strategy. I can measure the company’s results quarterly and I have the benefit of knowing the management team’s track record before investing.

Most of all, I understand public markets a lot better than I am able to judge whether an entrepreneur will successfully build a company from the ground up. How can I possibly compete with Benchmark Partners or Andreessen Horowitz?

The second part of the question about when all the money is made is ridiculous. Facebook went public on 5/18/12 with the largest IPO valuation ever – a market capitalization of $81 billion. Twenty-six months later, the company has a market value of $193 billion – an increase of $112 billion.

These are the top ten pre-IPO technology industry valuation leaders with 2014 financings or exits of note:

Clearly, from a rate-of-return standpoint, nothing compares with being an angel investor in the next Facebook. And congratulations if you’ve got a portfolio full of angel investments that all reach IPO. However, there’s a winnowing out process as a company goes from angel round to Series A, B, C and IPO. Most companies fail, some get acquired, some get additional financing in down-rounds and a few make it public.

But, in terms of market value creation – are you kidding me? Any stock that doubles from its IPO valuation has created more market value post IPO than pre-IPO – that’s the math. With the similar advantage of public market survivorship bias, let’s look at two companies: 1) Apple went public on 12/12/80 with a market value of $860 million. Today’s market cap of $601 billion represents $600 BILLION of market value creation. 2) Google went public on 8/19/04 with a valuation of $23 billion, a mere $377 billion below today’s $397 billion capitalization. At nearly $1 trillion in post-IPO value creation, I have to believe these two companies alone dwarf the entire VC industry’s cumulative capital distributions since the beginning of time.

See below for a select, but by no means exhaustive, list of value creators from different technology eras:

Finally, don’t forget the hockey metaphor. As a public market investor, I can score on offense and defense. While on offense, I participate in the market value accretion post-IPO. On defense, I benefit from valuation destruction by shorting stocks. In fact, the table below highlights 10 companies that actually lost more combined market value than was created in the table above.

In sum, great VCs will have a great rate of return – they need a few big winners to offset the losers in their portfolios. But I like my opportunity as a public market investor participating in both the value creation and destruction that occurs after the VC’s are long gone.