ANGEL: Insight's Deven Parekh on venture tourists, cleaning cap tables & winning investments | E1679 | Summary and Q&A

TL;DR

Insight Venture Partners' Devin Perez shares his experience as an analyst during the dot-com bubble, the 2008 financial crisis, and the current speculative asset bubble, providing valuable insights for startups and angel investors.

Key Insights

• 🥺 The reduction in friction during the pandemic may have led to overestimating consumer behavioral changes in areas such as e-commerce and remote work.
• 🤙 The current market environment calls for increased focus on business model viability and cost reduction.
• 👨‍💼 Experienced investors should actively work with portfolio companies, assisting with rethinking business models and cost structures.
• 👶 Clean cap tables and simple recapitalization structures are essential for attracting new investors and facilitating future fundraising efforts.

Transcript

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Questions & Answers

Q: How did the 1999-2000 dot-com bubble compare to the current speculative asset bubble?

The dot-com bubble primarily affected tech companies, while the current speculative asset bubble has broader market implications. The number of companies with viable business models is higher today than in 1999, thanks to improved access to capital and stronger economic models.

Q: How did Insight Venture Partners tackle the challenges of the 2008 financial crisis?

Insight Venture Partners had a well-diversified portfolio, including growth equity and buyout investments. They focused on reducing costs and helping portfolio companies navigate the downturn. The firm's emphasis on recurring revenue models provided stability during the crisis.

Q: What role does liquidity play in navigating economic downturns?

Insight Venture Partners focuses on maintaining healthy liquidity levels, reducing costs, and helping portfolio companies find sustainable business models. Liquidity gives companies more flexibility and allows them to weather economic downturns more effectively.

Q: How can startups and investors navigate the current market environment successfully?

It is crucial to reassess valuations and make realistic growth projections. Startups should focus on cost reduction and building recurring revenue models. Investors should actively participate in triaging their portfolios, providing support, and restructuring cap tables if necessary.

Summary

In this episode, Jason interviews Devin Perez from Insight Venture Partners, who has experienced three boom-bust cycles in the technology industry. They discuss the lessons learned from each cycle and how they apply to the current speculative asset bubble. They also talk about the impact of the COVID-19 pandemic on the market and the challenges faced by startups and investors during this time. Devin emphasizes the importance of having a strong capital structure, a well-capitalized portfolio, and a dedicated team to navigate difficult times.

Questions & Answers

Q: How did the dot-com burst in 1999 impact the technology market?

The dot-com burst had a significant impact on the technology market. Many companies without solid business models or product-market fit failed, and the stocks of publicly traded internet companies experienced a massive decline in value. This period highlighted the importance of having a viable business model and sufficient capital. Additionally, the broader market held up well until the 9/11 terrorist attacks, which further affected the economy.

Q: How did Insight Venture Partners approach the 1999 dot-com burst and subsequent challenges?

Insight Venture Partners had a portfolio that provided stability during the dot-com burst. While many companies struggled, Insight's portfolio was able to weather the storm. They focused on reducing costs and supporting the companies to find a sustainable path forward. Although their fund had below-average performance, returning only 1x to LPs, it was a valuable learning experience for the firm. They realized the importance of going through tough times and learning from them.

Q: How did the COVID-19 pandemic impact the technology market and startups?

The COVID-19 pandemic created significant challenges for startups and the technology market. Many companies experienced a decline in revenue and faced uncertainties about the future. Investors predicted a reduction in capital deployment and limited liquidity. However, some behavioral changes, such as increased e-commerce adoption, were overestimated, and the market reacted by overvaluing certain companies. The government stimulus and low-interest rate environment also played a significant role in shaping the market dynamics.

Q: How did the reduction in friction during the pandemic affect deal-making and investment decisions?

The reduction in friction, such as the ability to conduct meetings virtually, accelerated the deal-making process. It became easier for investors to communicate with multiple companies and make investment decisions faster. However, it also resulted in reduced opportunities for relationship-building, which is crucial in times of turbulence and crisis. Having strong relationships with portfolio companies is essential for providing the necessary support and guidance during challenging times.

Q: How did the influx of venture tourists impact the market and traditional venture capital firms?

The presence of venture tourists, who invested heavily in late-stage companies without taking board seats or providing governance, created intense competition in the market. Some venture tourists made aggressive moves, outbidding traditional venture capital firms and winning deals based on favorable terms. However, this strategy didn't always lead to successful outcomes, as some venture tourists left their firms when the investments didn't perform as expected. Traditional venture capital firms faced the task of cleaning up the aftermath and providing support to struggling companies.

Q: What will happen to companies that raised money at high valuations but are now experiencing slower growth and lower valuations?

Companies that raised money at high valuations but are now facing slower growth and lower valuations will face challenges. For companies still experiencing significant growth, even if the valuation is too high based on current market conditions, they may still be able to achieve favorable outcomes. However, companies where the growth assumptions were wrong and the valuation is no longer justified will face more significant hurdles. The preference stack, the amount of preference ahead of common shares, will play a critical role in determining the potential outcomes for management teams and common shareholders. Restructuring of cap tables may be necessary to provide management teams with incentives and align interests.

Q: How can companies with high preference stacks and low valuations motivate and retain management teams?

To motivate and retain management teams in companies with high preference stacks and low valuations, carve-outs can be implemented. Carve-outs involve earmarking a portion of the sale proceeds specifically for management and employees, taking into account the preference stack. This ensures that management teams have some participation in the exit, even if the common shares hold little value. It aligns incentives and recognizes the importance of their contributions to the company.

Q: What is the opportunity for buyouts in the current market environment?

There is an opportunity for buyouts in the current market environment, particularly for companies with slower growth but favorable profitability potential. These companies can be attractive for private equity-like investments and roll-ups. By acquiring and consolidating similar companies, these businesses can achieve stability and potentially create value. This presents a unique opportunity that wasn't as prevalent in previous market downturns.

Q: How are technology companies with high revenue multiples being affected by market conditions?

Companies with high revenue multiples are being affected by the contraction of multiples in the market. While the valuations of these companies may still be too high compared to current market conditions, it's important to assess their long-term growth potential rather than just the price paid. The key is whether the growth underwriting assumptions were accurate. Companies that can sustain high growth rates, even if the valuation is lower, have the potential to perform well over time. However, those that cannot meet growth expectations or have unfavorable preference stacks may face significant challenges.

Q: How should investors approach the current market conditions and navigate the challenges ahead?

Investors should take a realistic view of the long-term growth potential of companies in their portfolios. They must reassess valuations and adjust their strategies accordingly. It's crucial to have a well-capitalized portfolio and a dedicated team that can provide support and guidance to struggling companies. Additionally, investors should consider opportunities for buyouts and restructuring cap tables to align incentives and motivate management teams. The ability to adapt and learn from previous market cycles is paramount in successfully navigating the challenges ahead.

Takeaways

The technology market has experienced multiple boom-bust cycles, including the dot-com burst, the financial crisis, and the current speculative asset bubble. Each cycle brings specific challenges and lessons. In the face of adversity, companies need strong capital structures, well-capitalized portfolios, and dedicated teams to navigate difficult times. The COVID-19 pandemic has further complicated the market dynamics, leading to overestimated behavioral changes and increased competition among investors. Companies that raised money at high valuations but are experiencing slower growth and lower valuations may face significant challenges. Restructuring cap tables and providing incentives to management teams can help them stay motivated and aligned with shareholder interests. The current market presents opportunities for buyouts and consolidation of companies with slower growth but favorable profitability potential. Investors must reassess valuations, adapt their strategies, and focus on supporting portfolio companies during tough times. Learning from previous market cycles and having the ability to adapt are essential for long-term success.

Summary & Key Takeaways

• Devin Perez, an analyst at Insight Venture Partners, shares his experiences from three boom-bust cycles and reflects on the importance of staying committed during difficult times.

• The dot-com bubble in 1999 saw tech stocks losing significant value, while the 2008 financial crisis impacted the broader economy. This current cycle, characterized by a speculative asset bubble, has unique challenges as well.

• Companies during the dot-com era faced the challenge of finding viable business models, while current startups have more solid economic models and better access to capital.