Every year, Sand Hill Angels invests in number of start-ups. We know how much money we’ve invested (several million dollars a year) and what we’ve received in return (securities of various types). But, we have not, until now, tried to determine what those shares are worth.
One approach is to declare the problem vacuous. Our portfolio consists mostly of companies whose shares will be illiquid for a long time to come. So, whether the shares are (in some theoretical sense) worth one dollar or one million dollars, there is no way to exchange the shares for dollars. And companies that look great often fall apart, companies triumph after appearing all-but-dead, and markets shift quickly.
But, I believe it is important to value these companies precisely because they are so illiquid. Valuation, even if far-from-perfect, provides useful feedback to investors about their portfolios.
So, how can we value a portfolio of illiquid start-ups?
In the early stages of a Monopoly game, you generally accumulate a somewhat random collection of properties. After moving your token (I prefer the top hat, naturally) around Parker Brothers’ version of Atlantic City once or twice, you might own Vermont Avenue, the Electric Company, St. James Place, the B&O Railroad, and Park Place. In real life, that might be a well-diversified portfolio, including transportation, utilities, and real estate — but in Monopoly, where the goal is to have all the properties in a sector, that’s not what you want.
As I’ve mentioned in previous posts, I joined Sand Hill Angels earlier this year. In that context, the equivalent to a trip around the Monopoly board is a series of meetings by which thirty or so companies are whittled down to two or three in which members may choose to invest. Assuming due diligence doesn’t turn up any surprises, documents are signed, funds are transferred — and then the members sit back and wait, often for years, to find out whether or not their investment is worth anything. (Start-up investing takes even longer than Monopoly!)
So, after a few months, what do I own?
What do Bitcoin, angel investors, and high-school algebra have in common? Before I answer that question, I need to tell a story.
In 1995, I lived in Washington, D.C. At the time, Citibank was in the process of replacing its monochrome ASCII-only ATMs with spiffy new color bit-map machines. We users had to adjust to the new interface, including the conversational tone of the new software. For example, instead of offering buttons labeled “Checking” and “Savings”, the machine would politely ask “From what account do you wish do withdraw money?” And, while checking to see whether you had enough money in your account, the ATM would let you know it hadn’t forgotten you by saying “I’m working on it.”
Hilarity ensued one day while I was in line for the ATM. The man in front of me was clearly in a hurry. He requested his cash and shouted “Hurry up!” at the ATM. The machine responded “I’m working on it.” He interpreted the message not as a sincere expression of its desire to perform the requested task, but rather as a defensive response to his “Hurry up!”, and proceeded to harangue the machine as to how it should address valued customers.
The user interface mistake made by Citibank was that there was no progress bar. In other words, there was no proof the machine really was working.
Which brings us to Bitcoin.