Investing in a frenzied market

Fred Wilson at Union Square Ventures recently wrote about “storm clouds” in the venture capital market. In his words:

However, there are a few storm clouds out there that we need to be watching. In particular, I think the competition for “hot” deals is making people crazy and I am seeing many more unnatural acts from investors happening. If it were just valuations rising quickly, I’d be a bit less concerned. But we are also seeing large deals ($5mm to $15mm) getting done in a few days with little or no due diligence. Investors are showing up at the first meeting with term sheets. I have never seen phases like this end nicely.

I couldn’t agree more. Question is, are the storms pervasive and generalized or intense but highly localized? Sitting where I sit, which is largely away from Silicon Valley-based consumer web plays, the investment environment is far more rational and reasonable across every dimension. Valuation. Entrepreneur expectations. Development time-lines and achievement of key milestones.

Part of this is due to geography but I believe more of it is due to our domain focus, which is largely ex-consumer web. We have investments in Boulder, Boston, LA, SF, Tel Aviv – and NYC. No frenzied deals yet. We have found comfort in both our domain focus and approach to creating true partnership with our entrepreneurs, which necessarily means investing in fewer companies than some and working with great syndicate partners for the long haul.

Some might interpret a lack of investing in “hot” sectors as an indication that our investment focus and methodology is, well, not interesting. If fewer people care then shouldn’t it follow that our investments would be less attractive? Well… Mark Suster made this point in a great talk he gave up at Columbia Business School last night. By definition, what is “novel” is out-of-step with what is currently being done, and therefore not “hot.” A lack of heat can scare many away who find comfort in the warmth of the herd.

However, it is truly novel ideas that often represent the greatest opportunity for disruption and value creation. But it is scary to stand alone. Cold. Exposed. With the potential for looking like a singular idiot with nowhere to hide. Much better to be part of a group of idiots, right? Less social risk, less exposure to a crushing blow to esteem and confidence. However, this is exactly what I ask of my entrepreneurs: pursue the vision, take the risk, put yourself out there to be battered and bruised (in the process of learning) before ultimately emerging victorious. Why should my approach to investing be any different? I am not arguing for being contrarian to be contrarian, but to pursue novelty even in the face of ridicule and a lack of “social proof” (which I think is garbage as well).

So how should one think about investing in a frenzied market? Remain true to your investment theme and mission. Work on building sustainable and mutually beneficial long-term partnerships with entrepreneurs. And by all means, assign no stigma to investing in fields, technologies or applications where others have feared to tread. Consider it a badge of honor. True disruption might just be at hand and the spoils may well be yours.

Roger Ehrenberg is managing partner of IA Ventures, an early-stage venture firm focused on managing and extracting value from “big data.” Roger is also founder of Kinetic Trading Strategies, LLC, a quantitative trading firm that develops proprietary, alpha-generating language models for top proprietary trading firms and quantitative hedge funds. He blogs at www.informationarbitrage.com.