An initial public offering (IPO) occurs when a private company is publicly listed on the stock exchange. It means the public can buy or sell shares (ownership) in a company. An IPO is a liquidity event favored by founders and venture capital firms because it gives them the liquidity of an auction-driven market that they don’t have when a company is private. Their ownership in a company can be easily sold or added to with a few clicks. And the funds from a sale are usually available instantly. That’s much more efficient than a private transaction.  

I was curious about IPO historical activity. Here’s what I found for the number of IPOs annually:

• 2018: 255
• 2019: 232
• 2020: 480
• 2021: 1,035
• 2022: 181

The number of IPOs in 2021, in comparison with other years, was huge. That year didn’t just have the highest number of IPOs in the last five years (by a large margin), it saw the highest number of IPOs in in more than twenty-five years (I didn't find reliable data before this). And that includes the internet bubble of the late nineties.

This data was eye-opening—2021 was gargantuan. It was the best year in the last quarter century in terms of companies accessing liquidity via public markets.

Number of annual IPOs is a stat I’ll begin watching more closely.

Negative sentiment about certain types of companies has caught my attention. Some of it feels extreme. When people say things like all companies in a particular sector should be avoided, that doesn’t make sense to me. With interest rates rising and funding for companies harder to come by, it’s reasonable to assume that companies will struggle and may even fail. But expecting all companies (in a sector or segment) to fail or not grow isn’t reasonable.

When sentiment is negative, that’s a sign that the market has negative expectations of a company’s future results. Said differently, negative sentiment is a prediction that the probability of a negative outcome is high.

Sometimes negative expectations don’t align with what’s happening within a company. It may have hit a rough patch, but its leaders have done things to get back on the right path. For example, they were focused exclusively on growth, which resulted in extreme negative profitability and a high burn rate. But now they’ve taken correction actions, examples of which could be focusing on more profitable customer segments or reducing headcount.

If the company continues to focus and take the right actions, eventually this will be reflected in their results. Then, market sentiment and expectations will become less negative (or even positive).

I’m curious to see how many companies will make this transition and prove the current market sentiment wrong.

I was exchanging thoughts with an investor friend about other seasoned investors. These are investors with many decades of experience. They’ve typically been through multiple cycles and navigated them successfully.

My friend said he doesn’t believe in reading about the thoughts of seasoned investors. He wants to know what action they’re taking and what their strategies are—not principles or concepts. Because they don’t share their current actions or strategies, he doesn’t read any of their writings; to him, they’re not interesting or insightful.

I disagree with my friend. I don’t think it’s realistic to expect an investor to share his strategies or real-time investments. Doing so would likely mean more capital being deployed into those investments, which would raise prices and reduce returns. Why would anyone want that?

I also think there’s value in understanding the frameworks other people use to inform their actions. How they view and think about the world may be different and worth considering, even if you disagree with it. Lastly, there’s something to be said for the wisdom accumulated during decades of success. It’s taken these people a long time to figure out some of their insights. Even if you don’t agree, it’s worth listening them—it might take you decades to reach the same conclusion on your own.

I may disagree with elder investors’ views, but I actively seek out material in which they share their insights because I have respect for the wisdom they’ve accumulated over their successful careers. The wisdom might not be valuable at the moment, but it could be priceless at some point.

Some companies are fortunate enough to have large cash positions. To figure out the true value (or, for public companies, market cap) of the underlying businesses, you must take the cash into consideration. Enterprise value is an approach to understanding a public company’s value. Here’s the simplified formula:

      Enterprise value = market cap + total debt – cash

Let’s use an example. As of this writing, here are Zoom’s numbers:

      Market cap = ~$19 billion

      Debt = $0

      Cash = $5.41 billion

*Note: I included cash, cash equivalents, and marketable securities (treasuries and bonds) in the cash figure.

Here’s the enterprise value of Zoom:

      $19 billion (market cap) + $0 (debt) – $5.4 billion (cash) = $13.6 billion

This means the company itself is worth $13.6 billion.

Founders and investors talk about increasing the value of a company by executing. What they really mean is they want to increase the enterprise value of the company.

I was listening to friends talk about a particular segment of the start-up market. They said it’s a bad market. All the companies operating in this market won’t make it. Because it’s a bad market and the companies in it are unprofitable, none of the companies are worth anything, and they should be avoided at all costs. They all agreed. It seemed harsh. I thought, The sentiment on this market is bad.

I believe that the market my friends were discussing is near the trough in its market cycle. They’re likely right that many of the companies won’t make it. But they shouldn’t throw the baby out with the bath water. Some companies are risky but promising. Their upside is more probable than their downside, given how bad sentiment is.

I’m going to spend some time trying to find these companies.

The venture capital world has changed a lot in the last year or two. The good times when money was free flowing are no more. To better understand what’s happening, I decided to zoom out a bit. I’ve been reading about cycles in the investing world across various asset classes.

I’m not an expert on this. I’m still learning, but from what I’ve read so far, a simple concept describes what happens. When a strategy generates outsize profits, it attracts attention. Investors take notice. More capital is invested in the strategy. As more capital is invested into the strategy, it becomes institutionalized and has more capital to deploy than there are good investment opportunities. When that happens, returns (risk-adjusted) go down. As things perform poorly, attractive investment opportunities that generate high returns (risk-adjusted) can be found.

The public markets were hot in 2020 and 2021. Lots of venture funds saw their portfolio companies IPO (or do a SPAC) or get acquired, which allowed funds to return cash to their limited partners. Those returns didn’t go unnoticed. Over the last two-and-a-half years, venture funds raised larger funds—just before public markets began declining. It’s much harder for funds to raise today, but the capital already committed to those funds likely hasn’t been fully deployed (for a variety of reasons).

Sentiment in venture isn’t as hot as it was in 2020 or 2021. But it isn’t negative. Many funds probably have ample undeployed capital. Fund managers still have enough cash flow from management fees on committed capital to fund their lifestyles and firm expenses, and they can stay busy trying to deploy their uninvested capital. Limited partners likely haven’t seen markdowns on venture fund investments yet because many portfolio companies have been putting off raising.

I’m wondering when we’ll move into the next part of the cycle, when sentiment in venture will be negative. I’d imagine a few things will have to happen first. Limited partners will have to see their venture fund investments performing poorly (i.e., funds marking down their investments). Fund managers will have to run out of capital to invest, see their cash flow from management fees reduced or close to running out, and face difficulty raising new capital from limited partners. When (if) this happens, I think venture sentiment will be negative and closer to a low point. This will make people rethink careers in venture and limited partners rethink investments in venture.

We’re not there, but I’d imagine we’re headed that way if the current macro trajectory continues. Again, I’m still learning, so these thoughts may (and likely will) change. But that’s my thinking as of today.

I shared a few days ago that I’m reading the letters Warren Buffet wrote to the limited partners in his Buffett Partnership, Ltd. This partnership, basically a start-up focused on investing, was the precursor to Berkshire Hathaway. I wanted to learn more about those early days and Buffet’s mindset as a founder.

I found an interesting fact that most people don’t know. Buffet is known for investing in public companies and large, established private companies. What people don’t know is that Buffett has done early-stage investing too.

Buffet had most of his wealth tied up in the partnership to make sure his interests were aligned with those of his limited partners. But in 1960, he made an investment, using his personal capital, in Mid-Continent Tab Card Co. He invested $60,000 initially.

The partnership annual letters don’t discuss this investment, so I did some digging. Alice Schroder, who wrote The Snowball: Warren Buffett and the Business of Life, learned more about this obscure investment by reviewing Buffett’s private files. She shared what she learned about his thought process regarding this investment and the outcome in this video.  

At first, because of concern that IBM would be a too-formidable competitor, Buffett didn’t invest. But the founders persevered, and the company was able to compete against IBM. The founders approached Buffett again and shared their traction and metrics (40% net margins, turning capital 7x yearly, etc.).

Alice did a great job in the video of detailing Buffett’s analytical process and how he came up with his target return. Interestingly, he relied on historical data and made no projections. He ended up making the investment, invested an additional $1 million over time, and owned his position for 18 years until the company was sold. Buffett’s early-stage investment earned him a 33% annual compounded return, which is amazing.

I was talking to a friend who’s a big Warren Buffett and Charlie Munger fan. He shared his views on their long-standing habit of buying cash-flow-generating companies and holding them forever via Berkshire Hathaway and the Daily Journal. I’m familiar with both and with their styles of investing, but my conversation with my friend made me want to dig a little deeper.

Before Berkshire Hathaway, Buffett was investing in publicly traded companies with money from limited partners. It was 1956. He was twenty-five years old when he became an investor entrepreneur by starting Buffett Partnership, Ltd. with seven limited partners (almost all of whom were family) and raising $105,000.

Buffett is well known. He went on to have a wonderful track record as an investor. But what really intrigues me is the fact that he didn’t want to work for anyone else. Deciding to bet on himself, he started his investing partnerships. That’s strong entrepreneurial spirit combined with an investor’s mindset.

I want to learn more about his mindset in those early days and how he went about building his partnerships and investing in other companies. Buffett regularly wrote letters to his limited partners. I’ve decided to read all those letters to learn more about his early days, his entrepreneurial spirit, and, hopefully, what led to his outsize success.

I listened to Mark Leonard, founder of Constellation Software, share his thoughts. His company buys small software companies—it has acquired hundreds since it was founded in 1995. The software companies it targets are profitable and growing.

Mark spent over a decade as a venture capital investor before founding Constellation. He compared the venture model to Constellation’s model, and here’s what jumped out to me:

• Venture capital – The goal is to create companies you can sell either through an IPO or outright sale. The focus is on preparing the company to be sold to someone else, not necessarily building a business that can last a lifetime. He didn’t say this, but most funds have a ten-year life cycle—they’re liquidated at the end of the cycle and proceeds are returned to investors.
• Holding company – Holding companies like Constellation are built using permanent capital. The goal is to keep the capital invested in portfolio companies long-term. There’s a buy-to-hold mentality. This changes decision-making. You build relationships with founders and managers that will last a lifetime. You’re building a business with the intent that it will be around for decades, generating cash.

I love hearing origin stories, and Mark’s makes it clear that he wanted to build companies he could hold forever, not a decade. Given the current interest-rate environment, I wonder if we’ll start seeing more investors embrace the holding-company approach to investing in smaller technology companies.

I’m a big fan of people who share their thoughts publicly. I enjoy reading how others think about certain topics. I’m an even bigger fan of investors who do this. I recently read a memo by Howard Marks, founder of Oaktree Capital, titled “bubble.com.”

The piece is just as you would expect, given the title: Howard shared his thoughts about what he viewed as a market bubble. I’ll describe my takeaways from it in another post, but I want to highlight something else today. Reading the memo, you’d think it was written recently (if you ignore the company names he references). Howard’s insights are accurate and help explain some of the things we’ve seen in the markets over the last three years. The interesting thing is that this isn’t a recent memo. Howard wrote it over two decades ago in 1999 and released it publicly on January 2, 2000.

Howard did a great job of explaining why he viewed the market as a bubble. He clearly had great comprehension of what was happening during a frenzied period in history, and his insights appear to have stood the test of time.