Fabrice Grinda

Mois : novembre 2008

Beijing and China: 14 years later

Even though I have been to China many times in the past 14 years, my last trip to Beijing dates back to 1994. I was already fascinated by the economic reforms China was undertaking and wanted to live them firsthand as opposed to writing about them from my ivory tower in Princeton. I decided to spend the summer of 1994 at Beijing Normal University (Beishida) to study mandarin.

It’s hard to describe the incredible transformation the city has undergone in the past 14 years. In 1994, the various highway rings within the city were still under construction. Bicycles were the primary mode of transportation and there were few cars on the streets. At times, I felt that the cab taking me from the airport to the university was the only car in town!

My accommodations were Spartan. I shared a small room with another student, slept on a rice mattress and pillow no more than an inch thick. We shared a desk, a chair and a lamp that barely emitted any light! The building had communal Turkish-style toilets which had seemingly not been cleaned in 10,000 years. They were so filthy I threw up every time I entered them!

Classes were intense lasting from morning to evening with extra classes at 10 pm for bad students (e.g.; the foreigner who did not speak a word of the language before showing up there!). There was an exam every day on the previous day’s material which required intense studying after the extra night class. I would typically start studying around midnight, holding the lamp no more than 2 inches from my notes to be able to see anything! I would collapse of exhaustion at 1 am to ready myself for the daily 6 am wake up time.

The water was not drinkable and we all carried a thermos full of hot water all day, not the most pleasant drinking experience in 90 degree extremely humid weather. To add a bit of flavor to the water, we would put tea leaves in the thermoses – which became my explanation for why the Chinese drink tea 🙂

The university was in a relatively poor neighborhood and the food quality was rather low. Everything was extremely spicy with very little meat and invariably made you terribly ill. I don’t think there was a single day I was not sick!

Very rapidly, I realized that the safest and cleanest source of nutrition were watermelons. There were watermelon stalls at virtually every street corners brought daily by farmers. Despite the watermelons, I still lost over 40 pounds during the summer going from my usual 180 pounds down to less than 140 pounds!

My experience in Chinese hospitals was just as scary. As I was giving directions to someone, I pointed my finger in the direction they were supposed to be headed not realizing there was a metallic electric fan there. The fan had no protective cover and severely severed my index finger. Blood readily spurted from it in a cartoonish way. What truly frightened me was the sight of the hospital. It was extremely filthy and overflowing with patients. The doctor wore no gloves and I was convinced they would reuse needles and manage to kill in the process of fixing my finger!

Despite the challenges, it was a fantastic experience. Having pledged to speak only in Mandarin (and frankly no one spoke any English or French), I picked up the language in record time. I really felt it was “learn or die”! This led to fantastic interactions with locals which are amongst my most cherished memories from this trip. I spoke with famers, cab drivers and dozens of entrepreneurs who ran small shops or stalls across the city. I could not but admire their enthusiasm. They were all so happy and optimistic about the future. They all dreamed of a better tomorrow and were convinced their children would have much better lives. The American Dream was alive and well … in China! In fact, once you interacted with them in their own language, most of the Chinese I met reminded me of Americans – though maybe the less civil harder working 19th century Americans (or at least my vision of them) – extremely hard working, ambitious, optimistic, capitalist, individualists desiring to succeed for their family and themselves above all else.

I also took advantage of the opportunity, especially the time after midterms, to explore rural China and discover some of its wonders. Waiting for the train in the middle of nowhere was always an interesting experience as many of the locals had never seen a Westerner and kept expressing amazement: “You are so tall! You have so much hair!” My body hair seemed particularly fascinating to them and was repeatedly touched and pulled!

You would not believe how inexpensive the trip was. The three months I was there cost me $362 all included (except for the flight there and back) – including various gift purchases in the silk market, food and the hospital visit – which means I lived on $4 per day!

Beijing today is unrecognizable from the city I left in 1994. Everything that was under construction has been built and then some! The city now has all the trappings of modern city with a burgeoning middle class. Cars abound – in fact bicycles have virtually disappeared from the streets. All the watermelon stands are gone as well! There are beautiful and distinctive skyscrapers. The airport is extremely modern. The Olympics left their imprint with an amazing stadium and much improved sports facilities.

The food, while remaining distinctively Chinese, is much richer. Meat and fish are a much more prominent part of meals. As in many American towns Pizza Hut, McDonald’s and to a lesser extent Starbucks are omnipresent. Most incredible, the tap water is now drinkable!

Individuals’ attitudes are also changing in reflection with their increased income. They remain individualistic, optimistic, hard working and ambitious and still believe in the Chinese version for American Dream, but they are also discovering the pleasures of indulgence and enjoying the now! They now take vacations and spend their disposable income on gadgets, cars and various consumer goods.

I feel terribly privileged to have been able to observe the rise of China. 400 million people came out of poverty in less than 20 years – the largest increase in welfare in the history of humanity – singlehandedly responsible for the decrease in global income inequality during the past two decades.

Beijing and China face tremendous challenges in the coming decades. They have to deal with an ethnically and linguistically fragmented population, rapid urbanization, rural poverty and difficult environmental challenges as illustrated by the quasi-permanently grey smoggy skies of Beijing. As ever, I remain an optimist believing in human ingenuity to surmount all these challenges!

I can’t wait to see what happens next!

Change in angel investment strategy

Over the past few years, my angel investing strategy has been to be very selectively aggressive. I would invest relatively large amounts of capital in very few companies and typically sit on the board as well. I believed that my ability to identify unique companies and help them out would lead to outsized returns. Over the past few months, I have fundamentally revised this strategy.

I have had the pleasure of interacting with a large number of angels with numerous investment strategies. Without fail, the companies that succeeded for them were never those they might have expected to succeed the most at the time of investment. Their success as investors most often came down to luck and did not seem correlated with the intensity of the due diligence they had conducted or a priori quality of the management teams they had backed.

Given the hit driven nature of the angel investing business, it’s important for angels to have at least one hit in their portfolio to cover the losses from the duds. Angels who, on average, had invested in less than eight companies lost money on their investments, while those who invested in more than eight companies on average made money on their investment.

By May 2008, I had invested in 6 companies and sat on the board of 4 of them. Since then, given how busy I am with OLX, I have scaled back my existing board involvement dramatically, divided my average investment size by a factor of five and I am now invested in 15 companies. I have not joined the board of any of the new portfolio companies and don’t intend to for future investments either.

I invest mostly in early stage startups at the seed level as I think it’s the least efficient and most fragmented stage of the investing process. Series A rounds and beyond are well covered by venture capital and private equity firms and are much more competitive. I focus on direct to consumer businesses both because I understand the space better and the due diligence is significantly easier to do (why active entrepreneurs mostly invest in consumer internet companies). I also often invest in companies off the beaten path (outside of Silicon Valley and often outside of the US) reflecting a small comparative advantage in international sourcing because of my background.

In the past few months, I added another constraint. Given the likely dearth of venture capital investments in 2009 (why VCs invest less in downturns), I am currently only investing in companies with very low capital requirements that are likely to reach profitability on the seed funding. I also insist on very low valuations (often much lower than $1 million pre-money) to compensate for the likely increase in default rate caused by the lack of funding and potential acquirers.

VCs are not sheep – why VCs invest less during downturns

As an entrepreneur, I often find myself defending venture capitalists. For some reason, they have acquired a terrible reputation. During downturns, I often hear first time entrepreneurs complaining that VCs are sheep: “like everyone else they get frightened and run for the exits.” There is some truth to the charge as illustrated by the number of me-toos that typically get funded when market conditions are good. However, the reality is much more complex. There are two major reasons VCs invest less during downturns: their sources of capital dry up and entrepreneur valuation expectations take time to adjust creating a time lag before the market clears.

1. VCs need to hoard cash in downturns

Venture capital firms are structured as partnerships. Their investors are Limited Partners “LPs” which are typically university endowments, pension funds and wealthy individuals. These investors commit to a sum they are willing to invest, but don’t pony up the cash immediately. They only provide the funds when the venture capitalists make investments and issue a “capital call” requiring their investors to send their pro-rata share of the investment. Often, if successful exits happen relatively rapidly the investors don’t need to put in their full commitment as the cash from the exits funds the remaining commitments.

Eventually, when the full fund is allocated the VCs raise another fund – before the prior fund is fully exited given that it takes 3-5 years to fully invest a fund and another 3-5 to obtain exits for the portfolio. As a result, VCs are typically raising new funds every few years.

VCs make money by charging 2% management fees annually of the money under management and 20% of the returns.

In downturns, multiple things happen:

  • Given that there are fewer exits at lower multiples, VCs end up calling more of the capital contribution from their LPs.
  • At the same time, LPs often face cash constraints in downturns are credit tightens and they need to de-lever.
  • Pension funds and university endowments usually don’t want to allocate too much of their capital to alternative investments. If the rest of their portfolio is down 20%, what they thought was a 10% allocation to venture capital now becomes a 12.5% allocation which they might want to pare back.
  • Liquidity comes at a premium and investors want to pare back illiquid investments like those in venture capital firms which are typically locked for 7-9 years.

As a result, during downturns VCs, especially second tier firms, find it almost impossible to raise new funds. We even see university endowments seeking liquidity putting part of their venture allocations or portfolios on the secondary market (as Harvard has recently done) at discounts of up to 50%! When things turn really ugly you can also see LPs default on their commitment or tell VCs to slow down their investment pace to prevent that from happening.

Knowing they can’t raise funds for a while second tier VCs decide to stretch out the capital they already have a few more years as they live off the management fees. They slow down their investments and become much more selective. In addition, as other sources of capital have dried up for their portfolio companies, the VCs reserve a larger share of their remaining capital to support their existing investments.

All of the above factors severely restrict the capital available for new entrepreneurs to raise money.

2. Valuation mismatches lower transaction volumes

In a previous post, why the startup market is like the real estate market, I explained that it takes time for entrepreneurs to adjust to the new reality and reset valuation expectations. As a result, transaction volumes fall for many months and only start to recover once valuations fall enough for the market to clear.

In the current market, valuations might have to fall a lot given how cheap public companies have become. There are many profitable micro and mid cap tech companies trading at 1.5x to 2x their cash on hand and/or EBITDA. In this environment, most VCs are probably better served by trying to take them private rather than doing series A rounds for new startups.

Conclusion:

Unfortunately for entrepreneurs there are many good reasons for VCs to dramatically scale back their investments in downturns. As a result it’s time to be scrappy. Focus your resources on the essential. Get to profitability as fast as you can. All throughout rejoice in knowing that the market will be much less competitive and that if you can survive, you will be in great shape to thrive!

Quantum of Solace is underwhelming

Despite its unrealistic poker scenes, I loved Casino Royale. I loved its dark, gritty tone. I loved the dialogue, especially between Eva Green and Daniel Craig and I felt the character development was interesting.

Quantum of Solace disappoints on all fronts. The dark, gritty tone remains, but everything else seems to have been lost. The characters are barely fleshed out and as a result the movie remains a one note revenge movie. The villain’s objective does not seem evil or grandiose enough and the setting for the final battle lacks the scale or glamour we have come to expect from Bond movies. Even the action sequences left a bit to be desired as everything seemed too blurry and close up (though that might be an artifact of being in the front row – I only arrived 45 minutes early for the 12:01 am showing on opening night).

For now Jason Bourne remains the 21st century’s James Bond! I hope the next Bond movie focuses more on good storytelling and character development!

Tom Stoppard on Chekhov

On Tuesday, I had the privilege to attend an interview with Tom Stoppard at BAM by David Remnick, an editor at the New Yorker. The event epitomized what I love about New York – an erudite audience, an amazing setting, and brilliant presentation.

Stoppard was quintessentially Stoppard – extremely eloquent despite the overuse of the phrase “as it were”, constantly taking us in unexpected directions through the joys of free association. David Remnick, a Russian specialist who won the Pulitzer in 1994 for his book Lenin’s Tomb, asked amazingly well researched and interesting questions.

The conversation ranged from whether the world needs another translation of Chekhov to the potential advantages of being a thinker in a censored society.

As Remnick put it: “Even truck drivers read Dostoyevsky in Soviet Russia”

Stoppard: “Yes, but if porn was available what do you think they would be reading?”

Stoppard’s version of the Cherry Orchard is being written with a specific focus on how it will be acted and played rather than read. He has made himself available to the producer and actors to tweak it as needed. It will be interesting to see how it comes out when it open at the BAM in January.

If you go see it, take the opportunity to eat pizza at Lucali, supposedly the best pizza in New York, a short cab ride away from the BAM in Brooklyn. Make sure NOT to go on Tuesday as it is closed that night!

Command & Conquer: Red Alert 3 is disappointing

I was a huge fan of the original Command & Conquer and Red Alert games. When they came out they were truly innovative. Westwood who had invented the genre with Dune 2 redefined it with C&C by introducing competitive multiplayer games and truly dominated the real time strategy game genre alongside Warcraft and Warcraft II during the 1990s until Age of Empires showed up.

Unfortunately, the last few games have been forgettable and Red Alert 3 is no exception. The over the top single player story is fun and the actors are great, but the game lacks the depth of the best real time strategy games of the past few years.

The units are too fragile, there is only one resource type, way too few unit types and the pace is too quick. As result, the game lacks the depth of a richer game like Rise of Nations and the fine tactical control of a game like Company of Heroes. A game combining the strengths of those two games would be truly innovative.

I guess I will have to wait. I hope Stracraft II does not disappoint!

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