January 27, 2023

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The Most Active Global VC Firm on Business Terms, Mortality Rates and the Drawbacks of Lines of Credit • Eureka News Now

Yesterday we had the chance to catch up with Fabrice Grinda, a serial entrepreneur who co-founded the free classifieds site OLX – now owned by Prosus – and has built his venture company FJ Labs over the last few years. He often likens the company to an angel investor “at large” and, like many angel investors, says, “We don’t run, we don’t set prices, we don’t sit on the board. We decide whether to invest or not after two one-hour meetings over the course of a week.”

The outfit, which Grinda co-founded with entrepreneur Jose Marin, has certainly been busy. Though his first fund was relatively small — raising $50 million from a single limited partner in 2016 — Grinda says FJ Labs is now backed by a wide range of investors and has invested in 900 companies around the world by sending checks to them between $250,000 and $500,000 for an interest of typically 1% to 3% in each.

In fact, data provider PitchBook recently ranked FJ Labs as the most active venture company in the world, just ahead of international company SOSV. (You can see Pitchbook’s rankings at the bottom of the page.)

Yesterday Grinda suggested the company could become even more active in 2023 after the market has cooled and the founders are more interested in FJ Lab’s biggest promise – that it will provide them with follow-on funding through the ties of Grinda and its partners . While that promise was probably less compelling in a world teeming with capital, it’s likely become more compelling as investors pull away and founders have fewer options. Following are excerpts from our wide-ranging conversation with Grinda, edited slightly for length.

TC: You make so many bets for a very small stake. In the meantime, you’ve bet on companies like Flexport, which have raised a lot of money. You don’t get flushed out of these deals as round after round they are collected by other investors?

FC: It’s true that sometimes you go from 2% to 1% to 0.5%. But as long as a company exits at 100x, let’s say we invest $250,000 and it becomes $20 million, that’s perfectly fine. I don’t mind if we get watered down on the way up.

When you make as many bets as FJ Labs, conflicts of interest seem inevitable. What is your policy on funding companies that may compete with each other?

We avoid investing in competitors. Sometimes we bet on the right horse or the wrong horse and it’s okay. We made our bet. The only case where it happens is when we invest in two companies that aren’t competitive and do different things, but one of them dives into the other’s market. But otherwise we have a very Chinese wall policy. We do not pass data from one company to the other, not even abstracted.

We will invest in the same idea in different regions, but we will clear it first from the founder because you think there are many companies that attract the same markets. In fact, we may not take a call when a company is in pre-seed or seed stage, or even A-stage when seven companies are doing the same thing. We say, ‘You know what? We don’t feel comfortable betting now because if we make a bet now, our horse is in the running forever.

You mentioned that you don’t have or want any board seats. Given what we’ve seen with FTX and other startups that don’t seem to have involved enough experienced venture capitalists, why is that your policy?

First off, I think most people have good intentions and are trustworthy, so I don’t focus on protecting the downside. The downside is that a company goes to zero and the upside is that it goes to 100 or 1000 and will make up for the losses. Are there cases of fraud when filling in the numbers? Yes, but would I have recognized it if I had sat on the board? I think the answer is no because VCs rely on numbers given to them by the founder and what if someone gives you wrong numbers? It’s not like the board members of these companies would recognize it.

My decision not to be on board actually reflects my personal history as well. When I chaired board meetings as a founder, I felt they were a useful reporting function, but I didn’t feel that they were the most interesting strategic conversations. Many of the most interesting conversations took place with other VCs or founders who had nothing to do with my company. So our approach is that if you’re a founder and you want advice or feedback, we’re here for you, even though you have to reach out to us. I find this leads to more interesting and honest conversations than a formal board meeting, which feels stifled.

The market has changed, many late-stage investments have dried up. How active would you say some of these investors are in early-stage deals?

They write some checks, but not very many checks. Anyway, it’s not competitive [FJ Labs] because these guys write a $7 million or a $10 million Series A check. The middle seed [round] We see $3 million on a pre-money valuation of $9 million and $12 million post [money valuation], and we’re writing $250,000 checks as part of that. If you have a fund of $1 billion or $2 billion, you will not play in that pool. There are too many deals you would have to do to put that capital to work.

Are you finally seeing an impact on seed stage sizes and valuations due to the broader downturn? It obviously hit the later companies much quicker.

We see many companies that would have liked to raise a subsequent lap — who have the traction that a year or two or three years ago would have easily justified a new outside lap — must instead raise a flat, internal lap rather than an extension of their last lap. We’ve just invested in a company’s A3 round – so three upgrades for the same price. Sometimes we add a 10%, 15% or 20% premium to these companies to reflect the fact that they have grown. But these startups have grown 3x, 4x, 5x since their last round, and they’re still increasing flat, so there’s been massive compression of multiples.

What about the death rates? So many companies have borrowed at inflated valuations in the past year and the year before. What do you see in your own portfolio?

Historically, we’ve made money on about 50% of the deals we’ve invested in, which is 300 exits, and we’ve made money by being price conscious. But deaths are increasing. We see a lot of acqui-hires, and companies may sell for less money than they raised. But many of the companies still have cash going into next year, so I suspect the real death wave will hit mid-next year. The activity we are seeing right now is consolidation and it is the weaker players in our portfolio that are being taken over. I saw one this morning where we got about 88% back, another that delivered 68% and another where we got between 1x and 1.5x our money back. So that wave is coming, but it’s still six to nine months away.

how do you feel about debt I sometimes worry that founders will outgrow themselves and think that it is comparatively safe money.

Typically, startups don’t do that [secure] Debt up to their A and B rounds, so the problem isn’t usually risk debt. The problem is more the credit lines, which you should definitely exhaust depending on the industry. For example, if you are a lender and you are factoring, you will not lend off the balance sheet. This is not scalable. As you grow your loan book, you require infinite equity, which would take you down to zero. What usually happens when you’re a lending company is that you first lend off the balance sheet, then you get some family offices, some hedge funds, and finally a bank line of credit, and it gets cheaper and cheaper and growing.

The problem lies in an environment of rising interest rates and an environment where perhaps the underlying credit scores – the models you use – are not as high and not as successful as you think. These lines are being drawn and your business can be at risk [as a result]. So I think many of the fintech companies that rely on these lines of credit could be at existential risk as a result. It’s not because they took on more debt; That’s because the lines of credit they use could be revoked.

Meanwhile, inventory-based businesses [could also be in trouble]. Even with a direct-to-consumer business, you don’t want to use equity to buy inventory, so use credit, and that makes sense. As long as you have a viable business model, people will owe you to fund your inventory. But again, the cost of that debt is increasing because interest rates are increasing. And as insurers become more cautious, they can lower your line, essentially shrinking your ability to grow. So companies that rely on it to grow fast will find themselves extremely constrained and have a hard time moving forward.

Photo credit: PitchBook