Ari Levy and Lee Spears of Bloomberg Newsroom write clearly about the impact of the Facebook public offering, offering little in the way of condolences for those buying at $42 in the opening confusion.
Instead, they rightly focus on how liquidity, locked up for years in quiet ponds (some bigger than others), is soon to be released to roll through this happy Valley. Will the waters be gently channeled to water what can become the latest great vintage of new firms? Or will it be dumped, Tsunami like, on an already well watered and well-tended field, to erode out random arroyos of havoc?
Contemplating this question, I like being Bullpen. We have a nice seat on the arc.
As everyone knows, there has been a venture revolution. It was fueled by two things: First, a massively funded set of incubation factories that churn out the earliest stage start-ups. In these factories, there is room and money for even the wackiest of ideas. Second, and working in tandem with the incubators, is a well-organized infrastructure of lean investors called microVCs, who sift through the thousands of nascent ideas emerging from the factories, blessing a certain number by buying options to see what might develop out of the madness.
In the refining of this process…we call it the lean investing model…the old timers, the name brand VCs everyone reveres, have been cut out of the early stage game. The process hasn’t been pretty, but it has been effective. The big boys, with too much money, finally realize they can’t play small-ball anymore. Writing little checks…lean investing requires the early checks be really small…doesn’t move their needle. So they have learned to wait for the option buying process of the microVCs to finish its work, then pouncing big on the winners that emerge. This new regimen is just stabilizing. It waters the vines well.
The coming flood can’t be expected to be contained within proper channels. The Facebook graduates will want to be angels. They will want to help, to be involved, to play at the front end. Who can blame them? Yet, there isn’t a good argument to be had that more money helping the earliest stage entrepreneurs is needed. Making such a case would be wishful thinking. The new money has to be at least somewhat disruptive. The question is…how and whom will it disrupt?
Bullpen’s modest but crucial role in this food chain gives us a unique perspective on this situation. The “Bullpen Round” helps the microVCs extend their option period, allowing longer looks at the more promising deals, at the same time giving them the chance to pour more money into a chosen few.
Our perspective comes because it is that we come later to the party. The microVCs sort through thousands of deals per year, forced to make decisions on meager evidence. Bullpen’s later entry allows us to sort through only those few hundred where the accumulated evidence of potential success is better advanced from the option period, yet not so solid as to yet attract big money. We and our microVCs friends, who feed us these deals, make collective judgments as to who should get “the Bullpen Round” and who shouldn’t. The collaboration makes for pretty high powered judgments about the selection process. The evidence is that it is working well.
What Bullpen observes is that the ratio of deals entering the incubation factories to the deals considered worthy of support past the option period is on the order of twenty to one. We bid on maybe one in twenty of these. Here’s the key insight: If the input to the incubation process rises by a factor of two or three because of the coming FB liquidity, the ratio will adjust and there will be little or no net increase in post option funded deals.
It is important to understand that the output of the system is clamped not by how many deals come in the front end, but by how many really viable slots for big ideas exist at the back end. Silicon Valley’s goal, after all, is to fill the big idea slots, not maximize how many entrepreneurs get to be shoved through the process to do it. We need sufficient deals of sufficient diversity at the front end to fulfill the back end. More deals, without more diversity, accomplishes nothing. The input to output ratio shows we’ve reached more than sufficiency in this regard.
Given that Bullpen is not impacted by whatever increases in front end inputs occur, we can be relaxed and welcome the Facebook winners into our world. There will no doubt be singular black swan events from one or two of them that proves we needed these guys after all.
Yes, I think there will be a price to be paid in disruption, likely taking the form that some of the earliest stage deal structures will become distorted by being chased by too much money. But this always happens anyway. How much worse will it be? Not much. It will make for lively discussions in the press about deal overhang, or a Series A cash crunch, etc.
Keep in mind that it is already the case that the ratio of deals that come into the system compared to deals that make it to liquidity is very high. This ratio is not a function of available money. It is a function of the fact that most deals do not fulfill the relatively few big idea slots at the back end of the process. While the ratio of input to output may change somewhat over time, it has always been the case that many come, few are chosen, and shoving more duplicative aspirants into the front end has no effect on that.