The year of September, the year of Enron's first signals, the year of the dot-com winter. Three different categories of crisis arrived in twelve months, and they have forced us to ask, more seriously than before, what we mean when we say we invest for the long term.
On What September 11 Asked of Us
September 11 did not change our framework. We say this not to minimize the day but because the framework was already constructed to absorb shocks of unknown character. What it did change was the conversations we are willing to have. Boards that had been spending agendas on optimization began spending them on resilience; founders who had been measuring themselves against quarterly velocity began asking whether their businesses would survive a year with no new capital. Neither shift was strategic; both were appropriate.
The most consequential conversation we had this year was in the third week of September, with one of our 1998 founders, who asked us — over the phone, from an apartment in lower Manhattan — whether his business was meaningful enough to be worth continuing. We told him that this was not a question we could answer for him. We also told him, after listening for an hour, that we believed it was. He continued. Several of his employees did not. Both decisions, we believe, were correct in their respective contexts.
We have, since September, rebuilt our continuity planning at the firm level. The plan we had before that day was a document. The plan we have now is a set of practices. We will not publish the practices. We will say only that we now operate as if we expect to be unable to access any one of our offices, on any given month, with two weeks' notice. The 2008 letter will, we suspect, validate this practice.
On the Companies That Are Quietly Building
The IPO market, effectively closed since the second quarter, has produced an unexpected gift to the companies we have funded — time. With no plausible path to public markets, the founders who matter to us have stopped optimizing for the road show and started optimizing for what we have always wanted them to optimize for, which is the business itself.
The product velocity in our portfolio over the last six months is higher than it was during the boom. Boom conditions, we now suspect, were a hidden tax on builder energy. The taxes were not financial; they were attentional. A founder who is being told, every Tuesday, that her company is worth twice what it was the previous Tuesday, has a harder time spending Wednesday on a customer-experience problem that will not affect the next funding round. Now that the funding rounds are not arriving on a weekly cadence, the customer-experience problems are being addressed.
We have, in three cases this year, increased our positions in companies whose stated valuations are now lower than the prices at which we initially invested. We were not the only investors offered the opportunity; in two of the three cases, peer firms declined. We do not understand the declines. The companies are objectively better than they were at the higher prices.
On the Quiet Failures No One Reads About
This year produced a kind of failure the press has not reported well. Companies that did not declare bankruptcy, did not lay off staff in headline numbers, did not have flameout founders. They simply stopped growing, then stopped raising, then quietly closed. We have lost, this year, three companies in this manner. None of them will be remembered. All of them taught us things we needed to know.
The first taught us that a market we believed had a billion-dollar TAM had, on closer inspection, perhaps a fifty-million-dollar TAM at the price points its customers would tolerate. The second taught us that a founder we had backed for his technical ability could not transition to running a company that required commercial leadership; the technical ability was real, the commercial gap was wider than we modeled, and the founder himself recognized the gap before we did. The third taught us that a category we had treated as durable was, in fact, an artifact of the previous capital cycle; without that capital, the category did not have natural commercial demand.
We have written each of these lessons into a permanent internal memo. We expect them to be more useful in 2009 than they have been in 2001.
On What We Now Know We Will Hold For Twenty Years
One company in our portfolio, this year, crossed an internal threshold for us — a category of conviction we had described in the abstract since 1997 but never actually applied. We will not name it; we want to be wrong slowly if we are wrong. The point is that this conviction is what the firm exists to underwrite, and we needed a difficult year to identify it cleanly.
The threshold is the simple question of whether we would, given a hypothetical opportunity to liquidate the position at any price the public markets might support, decline. The answer for almost all companies is that we would liquidate at some price. For this one, this year, we found ourselves unable to construct the price at which we would liquidate. The construction failed not because we were stubborn but because the company was, in our reading, the kind of asset that a family ought not to part with. We will know, in twenty years, whether the reading was correct.
A Closing Note
What we mean by the long term, we now think, is the willingness to make decisions the right way during years in which they do not matter, so that we are still capable of making them the right way during the years in which they do. This year was a year in which several of our decisions mattered more than usual. We were, in retrospect, prepared for them. We were prepared because the previous three years of practice — even the easy years — had been spent rehearsing.
The Partners
Winzheng Family Investment Fund · December 2001