The Macro Economic Themes that are Driving the Lion Fund Investment Thesis

This post originally appeared on‘s website.

This is part three of a four part series of essays.

In part one, we discussed What is Lion Fund.
In part two, we discussed Lion Fund’s Investment Principles.

In this essay, we are talking about the macro-economic themes that are driving the Lion Fund Investment Thesis.  Essentially, we are answering: ‘what spurred your investment thesis,’ ‘why now’ and ‘why will this work’ when it comes to Lion Fund’s approach…

We’re at a very unique point in time that is going to be looked back on in history as one of the major shifts in how businesses operate akin to the industrial revolution: that era is the ‘rise of mobile devices’ – both smartphones and tablets.

1. Mobile Device Adoption

As of this year, personal computers no longer consume the majority of the world’s memory chip supply.  For the first time last year, smartphone sales exceeded PC sales.

In coming years, smartphone sales will dwarf PC sales.

And in 2-3 years tablet sales will also pass PC sales.

This mobile revolution is already underway: in quarter three of 2012, Smartphones and tablets outsold PCs 2:1 (source: Asymco).

Watching the iPhone 5 announcement, the biggest take away for us was that 94 percent of Fortune 500 companies are testing or deploying the iPad, and many of those enterprises are deploying custom apps.  This speaks mountains about how the future is a ‘Post-PC’ world oriented around mobile devices in workplace and the internet, which has primarily been about websites and going to someone’s website, is growing to include more than just websites.

2. Declining Mobile Device Prices

If 94% of the Fortune 500 are testing or deploying the iPad, why aren’t 94% of SMB’s testing or deploying the iPad?  We think it has to do with tablets (and to a lesser extent smartphones) being cost prohibitive.  However, the cost of mobile devices is being driven down.  Let’s look at two examples of the many downward cost drivers: one on the software side and one on the hardware side.

Google acquired a small mobile operating system startup named Android back in 2005.  Fast forward to September 2012 and there are 1.3 million daily activations of Android devices.  What’s led to this staggering growth? Well, Android is “less than free” – not only is the operating system free (and open source) but Google gives carriers / hardware manufacturers a percentage of the advertising splits on search.  That’s right; Google will pay you to use their mobile OS.

All of a sudden OS licensing fees are gone and more manufacturers are competing to supply consumers with a smartphone: this competition not only benefits the consumer by giving them choices but also forces innovation and drives down prices.  There is also an emergence of products build with Android but have a layer on top of them that makes it indiscernible like the Amazon Kindle Fire.

On the hardware side, twelve months ago if you wanted to deploy an enterprise tablet – it was shelling out $499+ for iPads or nothing. However, since then we have seen this price point be driven down.  Google released the Nexus 7, a $199 tablet that is getting rave reviews (even from MG Siegler who has traditionally been a hardcore Apple fan boy and Android’s biggest critic).  Rumors are already swirling of a $99 version before the end of the year from manufacturer’s supply chains.

Apple has joined the ranks of cheaper, smaller tablet providers with the release of the iPad mini, which is something Steve Jobs was adamantly opposed to.  It also cannibalizes their current iPad business (but Apple has always skated to where the puck is going and never been afraid to cannibalize existing businesses).

Jay Goldberg’s article on VentureBeat raving about the non branded tablets available in China for $45 helps solidify that “hardware is dead”

At these levels there is almost no profit margin left in the hardware business. A $45 tablet is cheap enough to be an impulse purchase at the check-out line in Best Buy. A $45 price puts tablets within reach of a whole host of other activities not traditionally associated with computers. Tablets could be used by waiters in restaurants. By mechanics in auto body shops. By every nurse in a hospital. By pretty much any category of work that today needs a computer but where PCs are too expensive to be deployed. These are also devices built entirely for commercial reasons, no government backing, no academic sponsor, no proof-of-concept.

We agree with Goldberg and believe the trend in hardware is quickly becoming just a gateway to access content.  For example. if I smash my iPhone, I can just replace it with another one and not notice a difference because I’m not emotionally attached to the hardware – just the content that the hardware allows me access to do.

Now, one of the key barriers to entry for both enterprises and SMB’s – the price of a tablet – is being driven down and become much more manageable.

3. Infrastructure Improvements


Mobile is fastly becoming the way more and more people access the internet (and doing more things on their phone).

We see this mobile usage only continuing to increase in coming years.  The infrastructure for mobile is still developing: cellular coverage is improving, blazing fast 4G networks are being rolled out, wifi hot spots are becoming more prevalent (with providers like Boingo expanding), and cellular carriers are adopting plans to better account of mobile data usage.

Web Infrastructure

Bandwidth is increasing

Ad networks are improving to better target (and re-target) customers and more and more customers are becoming comfortable with using eCommerce offerings.

Metrics are now able to be collected in real time which means decisions can now be based on measured user behavior.

Distribution Infrastructure

Software is no longer distributed via CD’s or flash drives.  Software is distributed online and through app stores.  Why is this important?  Updates can be sent over the air (OTA) so we can constantly be pushing updates.  This update cycle allows us to continually improve our product instead of forcing users to keep using an old or outdated product.  What was once a static software bought on CD is able to be constantly improved (with a different price model).

4. Cheaper than ever to start a company

Startups are no longer dependent on raising millions of dollars from VC’s to start building a product.  What used to cost millions now costs thousands (as demonstrated from this graph from Mark Suster’s blog):


There are four downward cost drivers identified by Paul Graham, and we a fifth one we have added.

  1. Open Source has made software free (e.g. MySQL, PHP, etc.)

  2. Moore’s Law has made hardware cheap, and it will continue to get cheaper in following years.

  3. More Powerful Programming Languages (e.g. Ruby, etc.) make development teams can be smaller and development time shorter

  4. (Inbound) Marketing and Distribution is free through the internet.

  5. Cloud Infrastructure (e.g. heroku, AWS) is a cheaper, more scaleable way to host

The cloud might sound like a buzzword but is in fact a vastly superior architecture, not because it makes installation and updates easier (although that’s good too), but because it starts to remove IT from the purchasing process, meaning the user and the buyer are, increasingly, the same person. -Chris Dixon

Running a startup includes always being mindful of how much “runway” they have in the bank [i.e. how long until the money in the bank runs out and they either have to be (a) profitable (b) raise more money or (c) go out of business].

How does this affect us? It means we can test more ideas, test them quicker and use a smaller fund which is a key driver of our volume investing approach to de-risk for investors.

5. Shifting venture capital landscape

We believe the venture capital landscape is changing.

There is less demand for venture capital

There are a few reasons for this. First, companies are becoming cheaper than ever to start (see above), so companies don’t need as much capital to get to started or to get to ramen profitability.  Angel investing has been commoditized through things like Angel List, angel networks, etc.  There are new and more prevalent alternatives to venture capital: Incubators, Crowdfunding (e.g. KickStarter, IndieGoGo, etc.), Private Placements (e.g. Funders Club, Local Stake, etc.), Peer 2 Peer lending (e.g. Lending Club, Prosper, etc.)

Conclusion: Venture capital isn’t as demanded by entrepreneurs to build startups.

Funds are too Large

Venture Funds are too large now a days and require an ungodly amount in exits to return venture type returns (~3x in 10 years).  We’ve used this quote before to illustrate that growing problems with Funds being too large.

VC firms are…responsible for the full life cycle of a company: they find it, help it grow, open up a Rolodex and sell it. What you’ve had is the firms go out and raise a fund and take a management fee, so you get paid millions of dollars for doing no work, and it takes years to get results. You have an incentive to raise larger and larger funds to get a bigger fee. With larger funds, you have to find ways to invest all that money or give up the fee. The VCs have investors who want a return in three years, so they will lower the bar and make a worse investment. -Bill MarisGoogle Ventures

However, there are only a few companies each year who grow large enough (and exit for a high enough amount) to move the needle on the mega funds.  This means that only the top, top tier of venture capital funds generate expected returns.

Cambridge Associates, an advisor to institutions that invest in venture capital, says that only about 20 firms – or about 3 percent of the universe of venture capital firms – generate 95 percent of the industry’s returns, and the composition of the top 3 percent doesn’t change very much over time.

Conclusion: Venture capital isn’t as demanded by entrepreneurs to build startups, yet Funds are too large to efficiently put capital to work.

Lack of differentiation in VC’s

“For many early-stage companies still working on their product or developing customers, most of their challenges do not require large amounts of capital nearly as much as they require expertise — particularly in engineering, design, and marketing.” – Dave McClure

We believe that the growing trend will require investors will need to be more operational and hands on with their portfolio companies – this will both attract the best companies, differentiate their firm and help the investments achieve superior returns.

There are too many firms that are indistinguishable from each other and too many firms operating without an investment thesis.

Conclusion: Venture capital isn’t as demanded by entrepreneurs to build startups, yet Funds are too large to efficiently put capital to work and too many funds are too similar and have un-differentiable value propositions.

There aren’t enough good companies to fund

With too much capital in the marketplace that VC’s are trying to put to work, things are getting funded that shouldn’t be getting funded.  There are a lot of FNAC‘s, feature not a company, that are getting funded.  The talent pool is getting spread out since everyone wants to be CEO of a startup.  This means a lot these companies aren’t going to pan out and has made hiring a lot more difficult.

This has also led to a spike in valuations of the hot companies since they are needed to skew the portfolio to offset the losers.

Conclusion: Venture capital isn’t as demanded by entrepreneurs to build startups, yet Funds are too large to efficiently put capital to work and too many funds are too similar and have un-differentiable value propositions.  There are too many companies in the market, and companies that shouldn’t be getting funded are getting funded because of this excess capital in the marketplace.

Acqui-hiring kills chances of generating returns

With hiring becoming more and more difficult, acqui-hiring (an acquisition of a company just for its team members and not any of the IP) has become popular.  These are usually exits representing cents on the dollar returns for investors and forces the rest of portfolio has to make up for this.  This drives the portfolio to be even more home run driven and no longer able to hit singles.

Conclusion: Venture capital isn’t as demanded by entrepreneurs to build startups, yet Funds are too large to efficiently put capital to work and too many funds are too similar and have un-differentiable value propositions.  There are too many companies in the market, and companies that shouldn’t be getting funded are getting funded because of this excess capital in the marketplace.  Acqui-Hires don’t move the needle, so VC’s are forced to push companies that could be solid singles or doubles to be home runs to try and offset the acqui-hires and the FNAC’s.

We believe there is a more efficient capital allocation

We believe that the majority of venture capital funds (outside the top 20 or 3%) represent an inefficient capital allocation. Traditionally, VC firms have focused on making a few investments that each have the potential of achieving billion dollar outcomes (which there aren’t many of). However, as Dave McClure of 500 Startups puts it that’s “really f**cking hard!”

We believe we have a more efficient capital allocation as an ‘institutional founder.’  We place lots of small bets to test what will work (significantly less than a bet to see if a portfolio company in a seed or angel fund would work).  We utilize shared / common resources where improvements benefit every company in the Fund, and have re-risked through having lower hurdles to return cash to investors.

What do all of these five macro-economic conditions mean?

Let’s summarize – more people are carrying smart phones and tablets, the cost of smartphones is plummeting, and mobile usage is continuing to grow – all of this is leading us to a unique place in time where the rise of mobile devices is creating a huge disruptive windows for startups to stick their foot into.  Less money is needed to start a company (or test an idea), and we believe we have a more efficient way to put capital to work than traditional venture capital.

Mobile is already transforming industries – taxis (Uber), payments (Square) because of the above three factors. Businesses that couldn’t exist a couple years ago due to hardware constraints, smartphones not reaching a critical adoption yet, carrier networks not being robust enough, etc. are now becoming possible.

We see a huge opportunity to build mobile software companies and next generation businesses based on technology in unsexy industries that have been neglected since they aren’t typically associated with technology.  What little software has been built for these industries is PC based yet the jobs in these industries aren’t done at a computer or desk: they’re done mobile-y.

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