📱Is Tech in Trouble? Part 2.📱

Short Hefty Seed Rounds

ICYMI, in “📱Is Tech in Trouble?📱,” we asked whether…well…tech was in trouble. We aren’t alone.

A few weeks ago Brad Feld of Foundry Group wrote the following in a piece entitled, “Early Stage VCs — Be Careful Out There”:

Yesterday, in one of the quarterly updates that we get, I saw the following paragraph.

“Historically, the $10 million valuation mark has been somewhat of a ceiling for seed stage startups. But so far this year, we’ve seen that a number of companies, often times with nothing more than a team and a Powerpoint presentation, have had great success raising capital north of that $10 million level. Furthermore, round sizes continue to tick up, with many seed rounds now in the $2.5 million to $4.0 million range.”

We are seeing this also and have been talking about it internally, so it prompted me to say something about it.

I view this is a significant negative indicator.

It has happened only one other time in my investing career – in 1999.

Man. There’s so much money out there looking for some action.

Read the piece. It’s short. He closes with this:

For anyone that remembers 2000-2003, this obviously ended badly. By 2002 investments at the seed level had evaporated (there were almost no seed financings happening). In 2003 the angels started to reappear (some of the best angel deals of all time were done between 2004 and 2007) and the super angel language started to be used around 2007.

All the experienced finance people I know talk regularly about cycles. If you believe in cycles, this one feels pretty predictable. Of course, there is an opportunity in every part of the cycle. But, be careful out there.

The kinds of companies he’s talking about aren’t in the same zone as those that we wrote about last week. These early stage companies are too early to have any of the characteristics (i.e., public equity, advanced IP, leases, exposed directors) that we noted might qualify a company to leap outside of the sphere of an assignment of benefit of creditors and into bankruptcy court. But still. This piece could just as easily slide into our “What to Make of the Credit Cycle” series.

To put a cherry on top, read this piece from Jason Calacanis. We typically think Mr. Calacanis is too high on his own sh*t but this cautionary letter to the founders he’s invested in is, in fact, instructive. We particularly liked his link to a Sequoia Capital presentation circa 2008. It’s a must read for anyone who wants a primer/refresher on what the hell happened back in the financial crisis and some insight into how investors thought about the time.

The upshot: he instructs his founders to do everything they can to ensure 12-18 months of runway.

So, where are we in the credit cycle? The part where a number of folks are starting to exercise and advise a bit more caution.

Like #Tech, Corporate Restructuring Has a Gender Imbalance

Unless you've been hiding under a rock, you've probably noticed the controversy that embroiled Silicon Valley over the July 4th weekend. In a nutshell, some super brave and bada$$ women came forward and accused a variety of high-powered men of sexual harassment and improper behavior. First, The Information reported (firewall) a story backed by the accounts of six women recounting the behavior of Justin Caldbeck of Binary Capital. He soon stepped down (as did his two partners, thus thwarting the close of BC's second fund). Then The New York Times published a piece implicating Chris Sacca (of Shark Tank fame) and Dave McClure of the venture capital firm, 500 Startups. The former had already given up on investing (and Shark Tank); the latter first stepped down as CEO of the firm, then, in a matter of days, stepped down as General Partner as well. Silicon Valley's gender imbalance has been in the spotlight for some time now. Now we're learning more and more why that imbalance exists in the first place. 

Before we get ahead of ourselves, we'll be upfront here: what we're about to say is in no way meant to imply that sexual harassment and inappropriate behavior runs rampant in the restructuring community. But, let's be honest: there is a wild gender imbalance in firm partnership ranks, conference room negotiations, and bankruptcy courts. The industry's most lucrative and prolific restructuring law firm has exactly one woman partner. One of the industry's top restructuring advisory IBs has exactly zero women partners and, yet, that didn't stop the leader of that group from being honored by Her Justice, an organization that provides legal services to NYC women in need. And those are just two examples. Suffice it to say, there are many.

Now there are exceptions to the general rule: AlixPartners LLC, for one, and Greenberg Traurig LLP, for another (see below), in that they are led (or co-led as the case may be) by women. Weil Gotshal & Manges LLP, as another example, includes a number of women partners on its roster. But there should be more. Industry-wide. And charity honorees should be the women who have risen through the ranks - despite the odds - AND cultivated other women to follow in their footsteps. Overall, the industry can do much much better.

Want to tell us we're morons? Or praise us? Cool, either way: email us. 

A Call to Action

Last week we complained about a dearth of bankruptcy filings. This week we got a handful of cases: two retail, one healthcare, one oil-and-gas servicer, and two "tech" companies. Because this week's case summaries (see below) are longer than usual, we'll rest on those laurels in lieu of a substantive feature (you can find the summaries here: Answers Holdings Inc., California Proton Treatment Center, Vanity Shop of Grand Forks Inc., BCBG Max Azaria Global Holdings LLC, EMAS Chiyoda Subsea Limited, Lily Robotics Inc.). Gotta keep things tight, time-wise, you know? Trying to keep the time you're billing clients to read our kicka$$ newsletter down to 0.1 hours. 

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A Look Forward

Right before the holidays, Benedict Evans of the venture capital firm Andreesen Horowitz released a fascinating presentation called "Mobile is Eating the World." It's a long presentation - roughly 31 minutes - but well worth reviewing if you have the time. We here at PETITION think there are a lot of nuggets within it relevant to the restructuring industry. After all, technological advancement and disruption help create the industry's client pipeline. Here is a brief summary with some editorial mixed in:

Overview

• We are halfway to connecting everybody. There are 5.5 billion people over 14 years old, close to 5 billion people with mobile phones, and about 2.5 billion smartphones. The latter number is quickly headed to 5 billion.
• Mobile has accelerated past the PC, which is now flat-lining at around 1.5 billion units.
• Each new technology follows an S-curve (creation-to-deployment) and is then passed by a new technology. Mobile is transitioning now from creation to deployment. 
• With this transition comes a new kind of scale. Google, Apple, Facebook and Amazon ("GAFA") have 3x the scale ($450b annual revenue) that Microsoft and Intel had in their heyday ($150b annual revenue). Microsoft saw 14x growth when it was dominating tech in the 90s and subject to mass regulatory scrutiny; GAFA's growth is 10x that now. 
• In 1995, Microsoft was not even the biggest company on the stock exchange. Now Microsoft and GAFA are the top five companies on the exchange. 
• This size drives more capex: $1b of capex in 2000 vs. $30b of capex in 2015. Tech has so much more scale now: GAFA are giants of the ENTIRE economy, not just tech. 
• Which has implications: Apple is the 10th largest retailer in the world with $53b in revenue across e-commerce and 500 stores. Netflix has the fourth largest entertainment production budget in the world. Amazon has the sixth - even though its content is just a feature to drive its core product: Prime. These "tech" companies, therefore, are fundamentally impinging upon other industries. Another example: Google, Amazon and Apple are now making custom chips for their own products rather than sourcing externally from the likes of Intel. 

New Ways to Compete - Artificial Intelligence & Machine Learning

• The scale of 5 billion mobile users and the scale of GAFA are leading to new ways to grow and compete.
• And machine learning is steroids. As just two examples of the rapid progress in machine learning, image recognition has gone from a 28% error rate to 7% and speech recognition from a 26% error rate to 4%. This is all enabled by mass data and more powerful computing power. 
• And so everything in tech is being refocused from mobile to mobile+AI, particularly with the realization that there are cameras everywhere, capturing images that serve as data that are now more intepretable than ever.
• GAFA is rushing to build the engineering and cloud storage systems to enable optimization of this data. 
• Meanwhile, technology design is removing friction, questions and administration which, in turn, changes choices. Think Amazon Echo. So, better design and frictionless decision-making is feeding more and more data.
• All of this gives GAFA the power to (further) change other industries...

Example 1: E-commerce

• Everything the internet did to media will happen to retail, where there'll be a breakup of old bundles and aggregators (albums, magazines, newspaper, store, shopping district, mall). And so now we consume in different ways.
• So far ecommerce mostly just gives consumers stuff we already knew we wanted.
• E-commerce is 10-12% of US retail revenue, with Amazon representing at least 2-6% of that: but it mostly just gives you what you already know you want. Despite this limitation, Amazon is now the fourth largest apparel retailer in the USA: not online, OVERALL. Walmart, Macy's, TJ, Amazon, Gap, Kohls, Target, L Brands, Nordstrom, JC Penney (by '15 revenue). And those reading PETITION regularly know how well some of these names are faring - or NOT. 
• The internet lets you buy, but it doesn't let you shop. No real suggestion or discovery.
• To fill this gap, the first response to this is advertising and marketing which is $1 trillion a year, $500mm is ads (digital and Google ads).
• But now we ask the Amazon Echo to buy more soap and this means we may never make a brand decision again. This disintermediates the ad agency, Walmart and P&G, etc, and changes the whole chain of how something gets to you, the consumer.
• Meanwhile, new businesses can get something to you with way less investment.
• Machine learning can give you "scalable curation" based on the data that you feed it.
• Today you have to go to a store to know what you'd like without seeing it. Now you can use machine learning to give this to you.
• Data is working through retailing: supply chain and logistics moved to advertising and digital metrics and then demand based on data, social, etc. Walmart used logistics to change what retail looked like. Amazon now doing that with AI. $20b retail opportunity potentially disrupted. 

Example 2: Cars

• Cars are becoming like phones with all of the important aspects becoming commoditized and the key being the software.
• Removing the engine and transmission destabilizes the car industry and its suppliers - but it doesn't change how cars are used much.
• Autonomy, however, changes what cars are and changes cities.
• Electric is about the battery cost curve. Complex proprietary gasoline engines and transmissions disappear and replaced by simple commodity batteries and motors, 10x fewer moving parts: all aspects of auto manufacturing and energy use are implicated by this development. 
• Scale, design and brand still matter but the real value moves up the stack into the software and move to autonomy. Leading tech companies now spend as much on capex as car OEMs. 
• Where are we now on the 1-5 autonomy scale: we are at Level 3. Level 5 is 5-10 years away. Batteries and sensors increasingly are commodities. The key is the software and the AI-powered data to feed it.
• Once you have that and take the steering wheel and engine out you have totally new types of vehicles and new uses. Obvious impacts: oil production and safety (1.25mm annual road deaths). Second order effects: what happens to engine servicing industry, machine tooling industry, storage, gas stations, gasoline taxes, municipal parking revenues, police forces? What happens if there's no parking or congestion? What happens to housing, logistics, commercial real estate, trucking, ownership of cars, insurance? 
• And what incumbent companies and municipalities file for bankruptcy as a consequence? This is not science fiction: society will soon need to address these questions...

Will the VC & PE-backed Tech World Converge with the Restructuring World?

At some point, the tech bubble will burst.  When it does, there'll be a fast and furious convergence between the worlds of (venture capital and private equity backed) tech and corporate restructuring. Expedited 363 sales of intellectual property are coming.

Why highlight this now? First, a recent Bed Bath & Beyond (*click for ticker) public filing highlights that the brick-and-mortar retailer purchased once-popular e-commerce retailer One Kings Lane for a mere $11.78mm. This easily makes OKL one of the largest VC-backed failures EVER. Approximately $200mm had been invested in it at a presumed valuation of nearly a billion dollars. Certainly NOT a successful exit for a near-unicorn. 

And second, Jason Goldberg re-emerged on a new Bloomberg podcast discussing the epic failure of his unicorn startup Fab.com. 

Now, to be fair, neither of these e-commerce platforms ended up filing for bankruptcy. But that is only because they effectively sold for parts before having to. 

Other tech companies, however, haven't been so lucky. There is a growing roster that have filed for bankruptcy lately:

1. NJOY - $145mm raised mostly from PE (incl. Morgan Stanley, Sean Parker)
2. Quirky - $176mm raised mostly from VC (incl. A16Z, Kleiner Perkins, Lowercase Capital)
3. Karmaloop - $19mm raised mostly from PE (Comvest Group).
4. Jumio - $50.3mm raised mostly from VC (incl. A16Z, Eduardo Saverin)
5. Fuhu - $49.7mm 
6. Filip Technologies - $8mm 
7. Homejoy - $39.7mm raised mostly from VC (Google Ventures, First Round Capital, A16Z)(note: also a unicorn and Y-Combinator darling)

Next up: Jawbone. Unlike most tech/startup companies, Jawbone actually has debt on it (via Blackrock and Kuwait Investment Authority) on top of VC (incl. A16Z, Kleiner Perkins, Khosla Ventures, Sequoia Capital).

Note, also, that Air Fast Tickets is another recent bankruptcy filing; it sought an asset sale under the fog of fraud. This brings to mind Theranos & Hampton Creek, two other high-flying startups currently plagued with fraud-related scandal. 

We'll spend more time on these topics in the future but, for now, any restructuring professional who thinks there's no business emanating out of the Silicon Valley frenzy ought to think again...