The most active global VC firm on deal terms, fatality rates and the drawbacks of credit lines

The most active global VC firm on deal terms, fatality rates and the drawbacks of credit lines

Yesterday we had the opportunity to meet Fabrice Grinda, a serial entrepreneur from France, New York, who co-founded the free classifieds website OLX, now owned by Prosus, and has been building his venture company in recent years. FJ Labs. He often compares the outfit to an angel investor “at size”, saying that, like many angel investors, “We do not lead, we don’t price, and we don’t take board seats.” After two one-hour meetings, we decide whether to invest or not.

Jose Marin, an entrepreneur, and Grinda co-founded the outfit. It has been very busy. Although the fund’s debut was small, it raised $50 million from a variety of investors. One limited partner Grinda states that FJ Labs was founded in 2016 and is backed by many investors. She has written checks to $250,000 to $500,000 for stakes of 1% to 3% each.

PitchBook, a data provider, recently ranked FJ Labs as the No. most active venture outfit Globally, just ahead SOSV. (Pitchbook’s rankings are at the bottom of this page.)

Yesterday, Grinda suggested that FJ Lab could be more active in 2023. This is because the market has cooled, and founders are more interested FJ Lab’s greatest promise to them — that they will get follow-on funding through its worldwide connections. Below are excerpts from our lengthy chat with Grinda, edited lightly to reduce length.

TC: You are placing so many bets on very small stakes. You’re betting on Flexport, which has raised a lot of money. These deals are not going to disappear as investors continue to invest.

FC: Sometimes, you can go from 2% to 1.1% to 0.5%. It’s fine as long as the company exits at 100x that value, e.g. $250,000, and it becomes $20,000,000, I don’t mind if the company gets diluted along the way.

Conflicts of interest are inevitable when you make as many bets like FJ Labs. What is your policy regarding funding companies that might be in competition with each other?

We do not invest in competitors. Sometimes, we may bet on the wrong horse or the right horse. That’s okay. We placed our bet. It does not happen if we invest money in two companies doing different things but one pivots into the market. We have a very Chinese Wall policy. We don’t share data between companies, not even the abstracted ones.

We Will You can invest in the same idea in different regions, but we will first clear it with the founder because there are many companies that target the same markets. If there are seven companies doing the exact same thing, we might not make a call if a company is in the preseed, seed-stage, or A stage. We are like, “You know what?” We don’t feel comfortable placing a bet right now because if we do, it will be our horse in the race for ever.

You mentioned that you don’t want or have board seats. Why is this your policy, given what we see at FTX and other startups with insufficient experienced VCs?

First, I believe most people are trustworthy and good-intentioned so I don’t worry about the negative. The downside to a company going to zero is that it will never be there again. However, the upside is that it will go to 100 or 1000 and pay for its losses. Do you know of any cases in which fraud was committed? Yes, but would it have been possible to identify it if I was on the board? The answer is no. VCs rely on numbers from the founders. What if they give you numbers that are incorrect? It’s not like the board members of these companies would recognize it.

My personal history is also a factor in my decision not to serve on boards. While I felt they were useful for reporting purposes, they weren’t the most interesting strategic conversations. I ran board meetings as a founder. Many of the most fascinating conversations took place with founders or VCs who had nothing to do my company. Our approach is to make sure founders get the advice and feedback they need. However, you must reach out. This leads to more honest and interesting conversations than when you are in a formal board meeting which can feel stifled.

The market has changed and a lot of late stage investment has dried up. How active would you think some of these investors are in earlier-stage deals.

They are writing a few checks, but not many. It’s not competitive in any way. [FJ Labs] These guys can write a Series A check worth $7 million or $10 million. The median seed [round] We see $3 million at a premoney valuation of $9million and $12 million post [money valuation]We’re writing $250,000 checks to that fund. You won’t be playing in that pool if you have a fund of $1 billion or $2 million. There are too many deals to make to deploy that capital.

Is the wider downturn finally having an impact on the size and valuations of seed-stage companies? It was evident that it hit later-stage companies more quickly.

We are seeing many companies that would like to raise another round, but don’t have the traction to justify an outside round. Instead, they have to raise an internal round to extend their last round. We just invested in the A3 round of a company — three extensions at the same time. These companies sometimes get a 10%, 15%, or 20% bump to reflect their growth. These startups have grown 3x-4x, 5x and 5x since their last round. They are still raising flat so there has been significant multiples compression.

What about fatality rates. Many companies raised money at excessively high valuations last year and the previous year. What are you seeing in the portfolio of your company?

We’ve made profits on approximately 50% of the deals that we’ve invested in. This amounts to 300 exits. We’ve also made money because our price sensitivities have allowed us to make money. But the rate of fatalities is rising. We are seeing more ‘acqui-hires’, and companies selling for less than they raised. Many of these companies have cash until next years, so I expect that the real wave will arrive in the middle next year. Consolidation is the main activity right now. It’s the weaker companies in our portfolio that are being bought. One of the deals I saw this morning was for 88%, another delivered 68%, and one where we got 1 to 1.5x our money back. That wave is coming, but it will take six to nine months.

What are your thoughts on debt? I worry about founders thinking it’s relatively safe money, and getting in over their heads.

Startups don’t usually do this. [secure] Until their A and/or B rounds, there is no debt. The issue is more credit lines which you should use depending on your business. Factoring is a way to lend against the balance sheet if you are a lender. This is not sustainable. You would need infinite equity capital to grow your loan book. This would wipe you out to zero. If you are a lender, you lend the balance sheet first, then you get family offices, hedge funds, and finally a bank line. It gets cheaper and scales.

The problem is in a rising rate environment and an environment where the underlying credit scores of the models you use may not be as high or as successful as you think. If those lines are pulled, your business could be at risk. [as a result]. As a result, I believe that many fintech companies that rely on these credit lines could be at risk. It’s not that they took on more debt, it’s because the credit cards they used might be revoked.

In the meantime, inventory-based businesses [could also be in trouble]. Direct-to-consumer businesses don’t need to use equity to purchase inventory. Instead, credit is used. People will lend you debt to finance your inventory if you have a viable business model. The interest rates are increasing, so the cost of this debt is going up. The underwriters are becoming more cautious, which may result in a decrease in your line. In this case, your ability to grow is actually shrinking. Companies that depend on this to grow quickly will be severely constrained and will have a difficult time going forward.

Image Credits PitchBook

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