Does Price Matter in Venture Investing?

There is an interesting (albeit disjointed) discussion out there in venture-land over the issue of price in venture investing. It started with a recent comment by John Doerr of Kleiner Perkins who said the following:

“If you like the founders and you like the technology, price doesn’t matter.”

To which Fred Wilson has replied:

“The only price you know is the price you pay.”

To summarize, John is apparently arguing that price is far less important than most venture investors think. It may not be vanishingly unimportant, but it is not worth all the niggling you get from a typical VC. Fred is rightly pointing out that you never know what something is going to be worth when you raise the next round, let alone when you sell it, so if you want to get the best chance of returning money to your investors you better pay close attention to the price at which you initially invest.

I’m tempted to do the polite thing and say both guys are right, because both John and Fred have a point – but I think there is more to this discussion than might first appear. It is, in a sense, a variant of the old “people vs. technology” argument in venture capital, with some people arguing that good management can make something out of almost anything, while poor (or even average) management can screw up the best technology.

To turn it around, Doerr is saying that you just need to optimize the people/technology factor, and then stop worrying. Smart people with good technology will find a way, and people will pay. Fred demurs, saying that both people and technology are so darn risky that you’d be a fool to believe that people are going to pay a higher price than you did.

Of course, even Doerr would concede that in the limit his view falls apart, as it does in momentum-crazed periods, like the late-1990s. Pay too high a price and you’re more or less screwed. You’ll never get much of a return and you’ll never get out.

A cynic, of course, would argue that KP doesn’t have that problem — the partners there see all the best deals, and entrepeneurs will accept a price discount to get KP money, so KP doesn’t have an over-paying problem.

Fair enough — there is a grain of truth to that view. But speaking as someone who has sat in on more than a few venture deal post-mortems, most times when partners dissect why they missed out on a good deal it was over price. Not only that, they usually were only low by 10% or so, and by being low they missed a deal that did a 7, 10, or even 20x return. A hell of a price to pay for the night-time comfort of knowing you rule at price discipline.

So, who do I think is right? While I’ll never recommend venture investors pay any price, and momentum strategies (hoping that someone will buy something from you for more than you paid) are almost always losers in venture capital, my sense of the data I have seen is that the opportunity cost of missing out on the best deals outweighs the financial cost of intermittently paying too much for a deal and not getting a high enough return.

Your mileage may vary, but I’m giving this round to John Doerr over Fred Wilson, but only on points.

Related posts:

  1. Venture Investing: Riding the Ups and Downs
  2. Key venture investing terms
  3. NatPost Column: Vonage Doesn’t Matter
  4. The Perils of 1999 Venture Funds
  5. Are Consumers the Undiscovered Venture Country?

Comments

  1. Brent Buckner says:

    Fred Wilson won the round.
    As best I can tell, KP has historically delivered super-economic returns on its venture funds, well in excess of 1.1 times the required returns. I don’t believe that’s the case for the venture capital industry overall.
    For the deals KP selected, it would have been better for KP to pay 10% more than to not do the deals. For the industry overall, I doubt that’s the case.
    The next consideration would be the deals that *nobody* did. I expect that if all bids on those deals had been 10% higher, some of those deals would have closed. I further expect that the results would have been sub-economic returns.