1999 was a year that rewarded almost any technology bet, including ours, and almost no skepticism, including ours. We will try to tell the truth about how much of this year's good news we believe is durable, and how much of it we suspect we will look back on as a kind of collective hallucination. This letter will not be a comfortable one to write. We expect it to be a less comfortable one to read in three years.
On the Numbers We Cannot Trust
The NASDAQ closed the year up eighty-five percent. Companies twelve months old are being valued in the public markets at multiples of revenue we have never seen for a private business. The IPO calendar is fuller than at any point in the post-war record, and the average first-day price increase is higher than the highest we ever underwrote in a private round. The volume of capital flowing into venture in 1999 alone exceeds the total venture capital deployed in the United States in the entire decade before our firm was founded.
We do not believe these numbers. We participated in some of them, and they made us money this year, and we still do not believe them. The simplest test of a price is whether you would buy the asset at that price tomorrow with no expectation of selling. By that test, we own assets we would not buy. This is uncomfortable enough that we have considered, at several points this year, taking advantage of the prices to liquidate positions we would not buy. We have not done so, partly because doing so would breach our long-hold philosophy, and partly — we should be honest — because the prices have continued to climb each quarter we have considered it.
The discomfort we feel is the right kind of discomfort. A framework that produces no discomfort in conditions like 1999 is a framework that will be useless in conditions like the year that follows it.
On the Founders Who Have Stopped Listening
The most expensive change in 1999 has not been valuation; it has been founder behavior. Operators who, two years ago, listened to skeptical questions in a board meeting now treat skepticism as evidence that the questioner does not understand the new economy. We sympathize with the temptation. We do not endorse the practice. The founders we backed in 1997 and 1998 — the ones who began their careers in the crisis — continue to listen carefully. The founders we are being asked to back in 1999 — many of whom began their careers in the past eighteen months — do not.
We have, as a result, declined more rounds this year than in any year prior. The rejections are not based on the businesses, which are sometimes interesting, but on the founders, who are increasingly resistant to the kind of conversations we expect to have over a decade-long partnership. A founder who will not take a hard question in the first meeting is a founder who will not take one in the seventh year either. The seventh year is when we will need them to.
On What We Are Buying Anyway
We continue to commit capital, at lower pace than the market and at higher cost than we would prefer. The companies we are funding share three traits: their products work today, their unit economics are visible today, and their founders take questions today. None of these are sufficient. All of them are necessary.
We have written checks in 1999 at valuations that, in a more rational market, we would consider excessive. We have done so where the alternative was missing the company entirely. The discipline question we have been asking ourselves is whether the missing-the-company cost is greater than the over-paying cost. In four cases this year we have concluded that it is. In nineteen cases we have concluded that it is not. The proportion is healthy by the standards we set ourselves; it would be considered scandalously low by the standards of our peer firms in 1999.
On What We Are Refusing to Buy
We have turned down nine investments this year that, by year-end paper performance, would have been our best returns of all time. We do not regret a single one. The framework that justified declining them — that price discovery in 1999 has been corrupted by the supply of capital, not by improved business quality — is the same framework we will need on the day the market reverses. A framework you can suspend in good times is a framework that will not survive bad ones.
We will list, briefly, the categories we have declined to participate in this year: business-to-business marketplaces with no clear path to take rate; consumer internet companies whose unit economics required user growth to never decelerate; supply-chain companies whose business case rested on the durable existence of e-commerce volumes that have not yet been demonstrated; and, in five cases, companies whose only differentiator was the speed at which they could deploy the capital they were raising. We will, we expect, look back on this list in 2002 and find it familiar.
A Closing Note Before Whatever Comes Next
We do not know when this will end. We do not know how steep the reversal will be. We do know that the families who emerge from the next correction in the strongest position will be the ones whose discipline now is indistinguishable from their discipline a decade from now. We intend to be among them.
The most useful thing about a long-hold philosophy is not what it lets us buy. It is what it makes it impossible for us to do — namely, to participate in pricing distortions whose only justification is the expectation that someone else will pay more later. We are grateful, this year, for the structural inability.
The Partners
Winzheng Family Investment Fund · December 1999