The Fein Line

Here's the next chapter in my 'What happened to Sempre' series.  If you haven't been reading along, the previous posts described why we decided to pull the plug, a look back at how we got started, building the team, and a discussion of our initial strategy of VC-style investing in public microcap stocks.

Once the market melted down in September 2008, we had to re-trench.  Our investor traction was gone, and we felt that we had to re-examine our proposed strategy in light of changing times.  As you may recall, there were a lot of people thinking that our economic world was coming to an end in the fourth quarter of 2008.  We decided to not do much fund raising during this time due to the high level of uncertainty.  Instead, we thought about alternative strategies.

First of all, our strategy of investing in microcap stocks had to go.  Although still economically viable (and remaining so today), there was no appetite for this type of strategy on the part of investors.  They were worried about continued downside risk and didn't see a lot of upside in a straight equity-only strategy.  That was coupled with increased risk aversion on the part of investors.  If we continued to pursue that strategy, we were dead in the water right then.

As some of our potential investors pointed out, one of our partners, Tim O'Loughlin, had an extensive background with venture debt.  This type of financing was very much lacking in the marketplace, particularly for later stage companies that may have trouble borrowing from banks.  We spent some time investigating this strategy and decided to pursue it.  Here's why:

First of all, most venture debt funds focus on lending to very early stage companies that have strong VC backing.  As a company, I never understood this.  If I am so early that I have no revenues, why would I borrow money to finance my product development?  Shouldn't my equity investors put more money into the company rather than use their funds to pay interest on a loan?  Here's the rationale that a venture debt firm will give you:  We will give you additional money so that you can get more work done on your Series A funding, hopefully earning you a higher valuation on Series B.  In exchange for that, we'll earn some interest and take a small warrant (option) position in the company in preferred stock.  If everything works out fine, that's all true.  The initial investors and management team will end up somewhat better off in this scenario.

But, not enough people think about what happens if things don't work as planned.  And, how often do things work as planned at a start-up?  If you fall behind plan, your lenders will get nervous and perhaps consider taking your last amount of cash in order to satisfy their loan.  At the least, they'll take up a lot of management and Board bandwidth getting reassured that additional capital will be coming into the company to service the loan.  Hopefully, the investors will realize that the lenders are expecting to get repaid and won't try to force them to convert their loan to equity.  This can lead to a game of 'chicken' being played with the company.  No one really wins these games. 

Why do venture debt players do this?  Because they are essentially loaning money to the venture capital firms and not the individual companies.  This 'off balance sheet' leverage can be helpful to a VC firm, and the risks are pretty low as long as the lender and VC investor have a good working relationship.  Despite this, I don't think that companies should borrow very much money until they have revenues to pay the loans back.  The issues and risks of the downside scenario don't balance out the upside opportunity.

That's where Sempre's Capital Access strategy fit in.  We were going to loan money to companies that had revenues and were at or near cash flow break even.  Most venture debt firms don't loan to these companies because they perceive the warrant upside to be smaller than with the early stage companies.  However, because capital is scarce, the interest rates you can charge are very attractive.  And, the risk of loss is likely to be lower.  Even if the company fails, they have a real, revenue-producing business that is more likely to have salvage value than an early-stage pre-revenue start-up.  Tim's track record bore this out, with consistent IRRs that would rival that of any tippety-top tier venture fund.  The money is returned to the investors (or recycled into new investments quickly), so the investment multiple might be lower than a venture fund.  But, assuming you can put the money to work again and again, an high IRR is the way to measure investments.

I won't go into the nitty gritty details of our strategy, but we certainly found a very strong deal flow of companies that had $4-$40M in annual sales and were at or near cash flow break even.  They were, in most cases, 'equity worthy' but couldn't or didn't want to raise additional equity capital.  Maybe their exsiting synidcate didn't have sufficient capital reserved for the deal.  Or, maybe the company had never raised venture capital and didn't want to start now.  In any event, we proved to ourselves very quickly that this was a viable strategy, and probably with higher caliber companies than we had at first anticipated.

Fund raising in 2009 was, of course, difficult.  Most investors had very limited liquidity to allow them to make new commitments.  And, first time funds always come under scrutiny.  We did find some investors who liked and were looking for venture debt, liked our strategy, our team, and our track record.  But, as chronicled in my 'pulling the plug' post, we couldn't get this over the finish line.  Traditional venture debt strategies tend to have returns that go up and down with VC returns.  They have been out of favor for many investors.  Sempre's strategy has been shown to be much more consistent, but it turned out to not be a benefit to be in the venture debt bucket.

The last chapter of my Sempre story will cover what I am thinking of doing next and why.  Stay tuned.

Posted by Mike Feinstein at 09:57 AM | Permalink | Comments (0) | TrackBacks (0)

Back to my series documenting the story of how we tried to raise a new, innovative investment fund in a historically bad climate.

I wrote earlier about how we got started and how we put our team together.  After a short time, we settled on a strategy.  We decided to do something that hadn't really been done before:  we would take the venture capital model to the public stock market.

What does that mean?  First of all, I think of the venture capital model as one of being an active, engaged investor who works with a company to build value.  You need to have a significant stake in the company and perhaps a board seat to ensure that your interests and the company's remain aligned.  This is usually applied to private companies where the VCs own a controlling stake in a company.  They usually buy a preferred class of shares to ensure that they get their money out first in the event of a sale or liquidation.  Most of these private company ideas wouldn't work in the public markets.  More on that below.

Our targets were public information technology (IT) companies that had market capitalizations between $50M and $250M.  These stocks are largely ignored by public market investors and have low trading volumes.  Until a company is worth about $500M, most money managers won't buy the stock.  Public investors value their liquidity -- the ability to sell quickly.  Like venture-backed private companies, these smaller public companies were not very liquid.  You could definitely get in and get out, but you had to do it carefully and over time.  Too much buy side or sell side pressure, and the stock could move a lot.  Not good for your investment strategy or your reputation.

We wanted to be constructive and have a positive reputation with companies.  Our approach was to identify companies that we felt were significantly undervalued in the public market as measured by both their financial metrics and their product offerings.  This required more than typical public market diligence -- you had to evaluate their financials and look at their business and how it could be restructured or improved to increase value.

Once you find such a company, you have to approach management to see if they were receptive.  Since we were 'constructive activists', we needed to get management, the existing board, and perhaps some of the larger investors to buy into our strategy for the company.  We generally found a very positive reception, but sometimes the companies wanted to keep doing what they were doing, despite the lack of appreciation by the public market.

The companies we liked best usually didn't need more cash.  So, we didn't invest directly in the companies.  Instead our plan was to purchase shares in the company in the open market to build up a position.  We found that we would have to work with trading partners who specialized in this type of transaction.  They could buy stock in illiquid companies without driving the price up (or sell without driving it down).  If we liked a company, our strategy was to buy 5-10% and perhaps take a Board seat.

We were planning to be long-term owners.  We'd own the stock for 2-3 years.  We didn't plan to short stocks -- we were 'long only.'  This kept us on the same side as management and differentiated us from hedge funds.  In fact, we were more like a late stage VC -- buying a position in a company that had revenues but had the potential for significant value creation. We'd hold onto the stock until we had built some value, which helped all the stakeholders.

The benefit of doing this in the public market was that you always had the opportunity to change your mind if you wanted.  Although not always easy to sell your position, it was sellable.  VCs generally can't sell their position in private companies at prices near the market value.  When they do sell, there is generally a significant discount.  Being able to control the exit timing was a critical element to this strategy.

Another benefit of investing in public companies is that you could chat with other investors to get their thoughts on a company.  This isn't collusion, just a discussion of what you thought of a company's public information.  We learned a lot by talking to other public market investors, particularly as we were new to the game.  Our VC skills would help us once we invested, but there were nuances of the public market side we had to learn.

Our historical analysis showed that there have always been significantly undervalued public IT companies, independent of the overall market cycle.  During down markets, there are just more of them, and they are even more attractive.  We did put some money to work in some companies we liked, and we did very well.  We struck up some constructive relationships with some management teams, but without outside capital, we couldn't build up a big enough position to have a real say in the companies.  We'd need about $12-15M per deal and a $250M fund to make it work.

It was tough getting investors to appreciate what we were doing.  One of our biggest problems was the 'bucket' problem.  Most institutional investors have buckets, or categories, for their investments -- venture capital, buyouts, international stocks, real estate, etc.  Our firm was a cross between late stage venture capital and public market investing.  Some investors couldn't do any public market investments.  In other firms, the two buickets were managed by different people.  And, our public market strategy was different than what they wanted -- they valued liquidity in public stocks even while they tolerated illiquidity in private company holdings.  It was rare to get an investor who understood VC and was willing to consider public stocks.

We did start to build some traction but were stymied by the market maltdown in September 2008.  Our traction went to zero, and we waited out the worst of the market to evaluate our plans.  Even so, it was frustrating to not get further before the meltdown.

In addition to the bucket problem, we also faced the first-time fund, first-time team problem.  Investors are very wary of backing new teams (will they stick together?) and new funds (do they know what they heck they are doing?).  These are valid concerns, and we had our strategy for overcoming them.  But, it took a long time with each investor, and we didn't make it over the finish line before the race stopped with the market meltdown.

In looking back, perhaps we were wrong to try to do something new.  However, it was also clear that investors weren't looking for 'more of the same.'  That fickleness was frustrating and explains why it's so tough to get a new firm off the ground.  There is still an opportunity for this type of microcap venture-style investment.  Some VC firms dabble in this now, and perhaps someone will take our strategy and make a lot of money with it.  That would be satisfying.

Posted by Mike Feinstein at 11:24 PM | Permalink | Comments (2) | TrackBacks (0)

I'm not a difficult customer to please.  In fact, I'm pretty loyal.  I tend to stick with vendors who treat me right.  And, having been on the vendor side of customer relationships multiple times, I have sympathy for companies that deal with challenging issues.  To me, the best support happens when the company gets the right person on the issue, listens well, works hard to solve the problem, owns the issue until it's solved, and communicates very well.

Then, there's Yahoo.  I've been a Yahoo hosting customer since I started The Fein Line back in 2006.  I had no idea what I was doing and just signed up with Yahoo because they had my personal email.  I figured that I could make it work and, at the time, had the time and interest in digging in to the details.

At the time, Yahoo gave you a choice of Movable Type and Word Press.  I don't recall why, but I chose Movable Type.  I got my blog set up and, over time, customized the sidebar.  After a while, I realized that Yahoo's Movable Type implementation was missing some things I wanted, but I was never motivated to move.

Inertia set in.  I just stayed put.  I blogged away and went about my day.  Then, late last year, Yahoo sends me a notice saying that they were discontinuing their support for Movable Type and suggested I switch to Word Press.  I could continue to keep my Movable Type blog, but they wouldn't offer updates, etc.  I got the hint and started the process of moving things to Word Press.

With some design help, I got the new version of The Fein Line set up in a sub-directory of The Fein Line.  I contacted Yahoo and asked them what procedure I should follow to move this to my top-level directory so it would be at www.thefeinline.com.  They sent some simple instructions, but I was worried that they were too generic for my specific situation.

Nevertheless, I gave them a try.  And, they didn't work.  My Word Press blog was no longer accessible, including access to the admin interface.  I sent Yahoo a support email and was told that, although they confirmed my problem, they don't support Word Press technical issues.  I was stuck.

Luckily, various friends from Facebook, Twitter, and LinkedIn stepped forward and offered to help.  With help from a few people, we determined that the problem had to do with some configuration problem between Yahoo's hosting software and Word Press.  So, I downloaded my Word Press installation to make sure I had a backup.

Yahoo still refuses to help.  So, I am taking my blog elsewhere.  I've got some suggestions on some good hosters and will start checking them out.  I'll post later with the outcome, but I'm sure I'll be happier than I am right now.

What should Yahoo have done?  Cut out the automated replies and, after their first automated suggestion isn't applicable, have a real human look at my issue.  Send me a reply that is customized to my situation.  If you don't have enough info to do that, then ask for more info.

Next, don't tell me at the end of the process that you won't support the procedure you asked me to do.  Give me that warning up front.  They started the process of getting me to switch blog platforms, but they wouldn't own the resolution.

Lastly, when it was clear I was not happy, escalate the issue to someone who can do something.  Don't just fall back on the last thing you told me and say 'sorry'.

Soon, The Fein Line will have a new home.  And, both my blog and I will be much happer.

Posted by Mike Feinstein at 08:05 PM | Permalink | Comments (2) | TrackBacks (0)

Last night, we saw Gatz at the American Repertory Theater.  When you hear about Gatz, your first reaction may be "Huh?"  Other than a few murmurs and mumbles, the only spoken words during Gatz consist of the complete text of F. Scot Fitzgerald's The Great Gatsby.  Most of it is read by Nick, the narrator of the novel.  But, the other characters speak their lines and act out their parts as it gets going.

What's interesting is that the play takes place in an office.  Nick finds a copy of the book and, when his computer doesn't work, starts reading the book aloud.  His coworkers barely seem to notice, but in short order start to join in by speaking the dialogue of their characters and acting out the descriptions in the text.  There really isn't a plot to the office portion of the play, but by their dress and actions, you figure out whos the boss, who's the IT guy, who's the maintenance guy, etc.

Gatz is performed in two parts, each with a separate admission.  You can see it all in one day, or break it into two days.  We saw it all in one day yesterday, but it was a marathon.  Part 1 started at 3 PM.  Part 2 didn't end until 10:50 PM!  There was an intermission during each part, and a one hour break for dinner.  The longest segment is the first half of Part 1, which is 2 hours long.  After that, the sections are between 1:10 and 1:25 long.

Despite the challenge of sitting in a theater for 6 1/2 hours out of an almost 8 hour stretch, the time zipped by.  You might tihnk that listening to a book being read would be tedious.  But, like the best audio books, the reading is done with fantastic expression.  Some of the language used to describe the characters is ironic, and this often gets laughs from the audience.  But, while listening to the text, you gain an incredible appreciation for the language used by Fitzgerald in The Great Gatsby.  I hadn't read it since high school, but I enjoyed hearing every word.  In fact, as my friend commented, you wouldn't have wanted it edited at all.  It's a great piece of literature, and, since it is written as a narrative, it works very well to have a character read it aloud, even with the "he said" and "she said" descriptives.

We all agreed that it was better to see it all in one marathon rather than splitting it up between two days.  But, many people can't carve out this much time, or don't want to sit so much in one day.  So, I think it would still work when split up.  One thing you get by seeing the marathon is an appreciation for the hard work put in by the cast, particularly Scott Shepherd who plays Nick.  Shepherd reads the large majority of the book while also acting out the character of Nick.    Incredible effort.

A word on logistics:  The schedule is very tight.    The 10 minute intermission isn't sufficient for everyone to use the rest room, despite the best efforts of the staff and the repurposing of one men's room as a ladies room to accomodate the audience.  Make sure you use the rest room before the show starts and don't drink a liter of water on the way over to the show as my wife did!  If you need to use the rest room, and you will at some point, don't linger.  With such a long show, it's good that the ART staff keeps things on schedule.

Also, if you see both parts back to back, there is an hour break for dinner.  You can pre-order a box dinner at the theater, or make a special Gatz reservation at Upstairs on the Square.  We opted for the latter.  It was good to get out and stretch our legs.  But, the one hour is very tight to walk, eat, and walk back.  We were the first to make it to the restaurtant, the first to leave, and still only made it back with seconds to spare. 

Like every other production this season at the ART, Gatz is a must see.  You won't see anything else like it.  The novelty carries you into the flow of the show, and the strength of the plot and wonderful language of the work keeps you going all the way through.  At the end, we were tired, which you would expect from being intellectually engaged for hours and hours.  But, it was certainly worth the effort to really dig into one of the most important works of literature of the 20th century.

Check out this Gatz video which gives you a sense of the action.

Posted by Mike Feinstein at 02:09 PM | Permalink | Comments (0) | TrackBacks (0)

Yesterday was just one of those games during an NBA season.  The Celtics won on the road, although they had no right to win the game vs. the Miami Heat.  Check out the stats:

The Heat took 31 more shots than the Celtics because they Celtics had 24 turnovers (vs. only 11 for the Heat) and gave up a whopping 17 offensive rebounds (vs. only 5 for themselves).  The Celtics did shoot better, and got to the free throw line more often.

Nevertheless, the Cetics were not playing well and were down by 11 with about 7 1/2 minutes to play when they turned around their offensive and defensive execution.  It was capped off by an amazing out of bounds play (below) with 0.6 seconds left that tied the score and forced overtime.

After watching games like this, you have to think that Rajon Rondo deserves to be an All-Star.  He played 50 minutes in that game, coming back from a thigh injury.  He led the C's balanced attack with 25 points, barely missing any shots.

Credit the whole team, including coach Doc Rivers, for this play that tied the score at the end of regulation.  Perfect execution, particularly the pass from Pierce, the pick by Glen Davis to free Rondo a bit, and, of course, the layup to actually put it in by Rondo.

The Celtics have tons of talent when they are all healthy.  But, even more, they have heart, unselfishness, and determination.  Looks like another championship run!

Posted by Mike Feinstein at 10:14 AM | Permalink | Comments (0) | TrackBacks (0)

Although shows are selling out quickly, it's not too late to go see each of the shows of the ART's Shakespeare Exploded festival: Best of Both Worlds (closing January 3, 2010), Sleep No More (closing February 7, 2010), and The Donkey Show (continued through the summer, 2010).  All three of these shows have received fantastic audience and critical acclaim.  The ART web site has lots of links to reviews of each of these shows.

Starting right on the heels of Shakespeare Exploded is our next festival, America: Boom, Bust, and Baseball:

America: Boom, Bust and Baseball explores the hopes, disappointments, and triumphs of the past American century from the roaring twenties to the Great Depression to the Boston Red Sox's stunning 2004 World Series victory. We begin with the boom - Gatz brings every word of Fitzgerald's novel The Great Gatsby to life in this once-in-a-lifetime marathon theatrical experience. The bust is Clifford Odets' Paradise Lost, a powerful drama about an American family that loses everything in the throes of economic crisis. Spring is baseball season, and we'll be staging the world premiere of JOHNNY BASEBALL, The New Red Sox Musical, an exhilarating new musical that explores the source of the infamous Curse and the secret to its end by blending fiction, fact, and the mystical power of the game.

Gatz is up first, starting on January 7.  It's a big deal as there have been some issues around having the rights to perform it.  It will end up in NYC, but this is a chance to see it first.  Gatz is a theater marathon -- six hours, split into two parts, each with its own intermission.  I'll see both parts on January 16th and will post a review after that.  You can see the two parts on different days if you prefer.  Reviews of previous productions of Gatz are here.  The ART is partnering with Elevator Repair Service on this production, too.

Gatz sounds really interesting:

One morning in the low-rent office of a mysterious small business, one employee finds a ragged old copy of The Great Gatsby in the clutter of his desk and starts to read it out loud. And doesn't stop.

At first his coworkers hardly seem to notice, but then weird coincidences start happening in the office, one after another, until it's no longer clear whether he's reading the book or the book is doing something to him. . . .

We all know that Boston beats NY on most things (except in baseball this year).  So, beat all your New York friends and go see Gatz during its run in Cambridge.

PS - If you are Twitterer, you can read The Great Gatsby 140 characters at a time.

Posted by Mike Feinstein at 10:38 AM | Permalink | Comments (0) | TrackBacks (0)

I've had fun this year doing my online bets on the weekly Patriots games.  The bet was simple:  the loser vs. the point spread had to display the winning team's cap (or later, logo) in their online profile for the following week.  After pumping some money into our local economy with a few purchases at Lids, I decided to back off and focus strictly on online humiliation rather than forcing the loser to keep buying caps.

I'm not doing the bet this week.  The Patriots are playing the Houston Texans, a potential playoff team.  In theory, it should be a good game.  But, I think that the Patriots will hold back a lot of their starters to rest them and avoid injury.  The game will be more like a pre-season game for the Pats.  I always thought that betting on games that don't matter was a waste of time.  The Texans do need to win the game.  The current line has the Texans favored by 8 points.  This is reflective of the Patriots likely stance, in my opinion.  So, no bet this week.  And, no bets during the playoffs as the loser will have their season over in any event.

Here's the recap of my bets:

Wins (vs. spread): Falcons, Ravens, Titans, Buccaneers, Colts, Jets, Dolphins, Jaguars

Losses: Bills, Jets, Broncos, Dolphins, Saints, Panthers (but no one took my bet)

Push (tie vs. the spread): Buffalo

So, the point spreads are, on average, correct.  I won 8 times in 15 bets.

I do think that the Patriots have shown that they can play well.  If they play like they did against the Jaguars, they can beat anyone.  But, they have also had some disappointing efforts, such as against an excellent Saints team.  Let's hope they stay hot and do some damage in the playoffs.  Go Pats!

Posted by Mike Feinstein at 09:57 AM | Permalink | Comments (0) | TrackBacks (0)