Miners vs. picks and shovels: a contrarian venture capital investing approach?

Earlier this week, The New York Times published an article about the “fuzzy math” driving the funding of companies in Silicon Valley. In talking to my peers in the investment community, there seems to be consensus that valuations are regularly disconnected from the reality of many companies. That said, the exuberance seems to be continuing and is at its peak amongst consumer-facing media companies.


At Battery, our digital media investing is focused on two categories of companies, of which the first is consumer-facing media properties that build, aggregate and monetize audiences in differentiated ways. The second category is companies that provide the tools and technologies to support the first category, including everything from ad networks to targeting and optimization software to video delivery infrastructure. Increasingly, we find ourselves spending more time on the second category while largely avoiding the first. Broadly speaking, this seems to be a fairly contrarian investing approach.


There is no shortage of speculative, high-priced investments being made in hopes of finding the next YouTube or MySpace or Photobucket. My perspective is that the risk/reward tradeoff associated with investing in many of these companies does not compute. I’d much rather invest in the companies that are arming all of the competitors in the consumer media market (the picks and shovels approach) than bet on identifying the one that is going to be the next big hit (trying to find the goldmine). There is no doubt that incredible amounts of equity value can be created by leading consumer media companies, as evidenced by the aforementioned companies. However, neither I nor any investors I have spoken to have found a crystal ball that tells us which consumer web properties are going to be the next ones to resonate with consumers and spread virally. In addition, there is intense competition for consumer attention on the web, making it an expensive battle to fight. Lastly, it seems that the equity value that has been created by consumer web properties in recent memory has been independent of demonstrated economic success.


As we learned in earlier this decade, valuing companies primarily on audience-based metrics is not a sustainable approach. At the same time, we have also seen that companies that build fundamentally sound businesses by providing value to and extracting value from paying customers can also create tremendous amounts of equity value. As an investor and an entrepreneur, do you have a better shot at creating the single winner in the online video destination market (i.e., Youtube) or building one of several successful companies in the online ad serving market (i.e., DoubleClick, Aquantive, 24/7 Real Media, Right Media)? Which businesses are easier to predict and monetize?


I think that chasing the next Youtube also puts investors at odds with their entrepreneurs. Searching for a single big win forces investors to take an aggressive approach to managing their portfolio of “bets”. Approaches to financing and exits can diverge dramatically when an investor is swinging for the fences at the potential expense of the entrepreneur. While the economic rewards of investing in picks and shovels may not be as great (although this can be argued), the satisfaction of building a sustainable business in partnership with entrepreneurs is well worth the cost associated with watching this current “gold rush” from the sidelines.