cdixon blog

The time to eat the hors d’oeuvres is when they’re being passed

The efficient market hypothesis is a widely taught financial theory that states, roughly, that under certain generally-held conditions, asset prices are an accurate reflection of the information available at the time. The arguments underlying it are mathematically elegant and have been widely popularized. Its hardcore proponents argue that financial bubbles do not (indeed cannot) exist and that government intervention in financial markets is unnecessary. While efficient market theory is dominant in academic circles, it is very hard to find active participants in financial markets who believe in it. In financial markets – like most complex human systems – the closer you get, the more nuance you discover.

Venture capital markets are perhaps the most inefficient of mainstream financial markets. Complicating factors include: heavy reliance on comparables for valuations, desire of VCs to be associated with “hot” companies, tendency to overreact to macro changes, illiquidity of startup financings, illiquidity of financings for VCs themselves, perverse financial incentives of VCs, inability to short stocks, extreme uncertainty of startup financial projections, vagaries of the M&A market, dependency on moods of downstream investors, concentration of capital among a small group of VCs, the difficulty of developing accurate financial models, rapid shifts of supply and demand across sectors and stages, and non-uniform distribution of accurate market data.

The title of this post is an old venture capital adage (via Bill Gurley) that reflects a hard-earned truth about financing and M&A markets. For social consumer startups, the hors d’oeurves were being passed in the build up to the Facebook IPO. They are being passed now for B2B and e-commerce companies. In the M&A markets, the most extreme example is probably in adtech, where there were waves of acquisitions in ad exchanges (DoubleClick, RightMedia, Avenue A), then mobile ads (AdMob, Quattro), and then social advertising (Buddy Media, Wildfire). If you didn’t sell during these M&A waves, you’re suddenly stuck with lots of powerful competitors and few potential acquirers/partners.

It is common to hear entrepreneurs say things like “I am waiting 6 months to raise money/sell the company, when we’ve hit new milestones.” Of course milestones matter, and companies are ultimately valued based on fundamentals. But along the way you’ll likely need capital and sometimes need to exit, and for that you are dependent on highly inefficient markets.