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. Fabrice is a serial entrepreneur who founded the free classifieds site OLX, now owned by Prosus, and has been building his venture firm FJ Labs .. Fabrice often compares the outfit to an angel investor “at size”, saying that unlike many angel investors, “We don’t lead, price, or take board seats.” After two one-hour meetings, we decide whether to invest .
The outfit, which Grinda founded with Jose Marin, is certainly busy. Though its debut fund was relatively small — it raised $50 million from a single limited partner in 2016 — Grinda says that FJ Labs is now backed by a wide array of investors and has invested in 900 companies around the world by writing them checks of between $250,000 and $500,000 for a stake of typically 1% to 3% in each.
In fact, PitchBook recently ranked FJ Labs as the most actively venture outfit worldwide, just ahead SOSV. (Pitchbook’s rankings are at the bottom of this page. )
Yesterday, Grinda suggested that the firm could become even more active in 2023, now that the market has cooled and founders are more interested in FJ Lab’s biggest promise to them — that it get them follow-on funding come hell or high water through the connections of Grinda and his partners. While that promise may have been less appealing in a capital-rich world, it is likely to be more compelling now that investors are pulling back and founders are faced with fewer options. Below are excerpts from our lengthy chat with Grinda, edited for length.
TC: You’re making so many bets in exchange for a very small stake. You’re betting on Flexport, which has raised a lot of money. These deals are not going to disappear as investors raise more money.
FC – It is true that sometimes you can go from 2% to 1.5% to 0.5%. But as long as a company exits at 100 times that value, say we put in $250,000 and it becomes $20 million, that’s totally fine. I don’t mind if the company gets diluted along the way.
When making as many bets as FJ Labs does, conflicts of interest seem inevitable. What is your policy regarding funding companies that could compete with each other?
We avoid investing in rivals. Sometimes, we may bet on the wrong horse. It’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 abstracted.
We will invest in the same idea in different geographies, but we will clear it by the founder first because, to your point, there are many companies that attract the same markets. If there are seven companies doing the exact same thing, we may not make a call if a company is in the preseed or seed stage. We are like, “You know what?” We don’t feel comfortable placing the bet right now because if we do, it’s our horse in this race forever
You mentioned not having or wanting board seats. Considering what we see at FTX, and other startups that don’t seem to have enough experienced VCs involved in their ventures, why is this your policy.
I think most people are good-intentioned, trustworthy, so I don’t worry about the negative. The downside is that a company goes to zero and the upside is that it goes to 100 or 1,000 and will pay for the 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 be able to identify it.
My personal history is also a part of my decision not to serve on boards. While I felt they were useful for reporting purposes, I didn’t think they were the most interesting conversations. 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, a lot of late-stage investment has dried up. How active would you estimate that these investors are in earlier-stage deals as well?
They’re writing checks, but not many checks. Either way, it’s not competitive with [FJ Labs] because these guys are writing a $7 million or a $10 million Series A check. The median seed [round] we see is $3 million at a pre-money valuation of $9 million and $12 million post [money valuation], and we’re writing $250,000 checks as part of that. You won’t be playing in a fund worth $1 billion or $2B if you don’t have enough capital. There are too many deals to make to deploy that capital.
Are you finally seeing an impact on seed-stage sizes and valuations owing to the broader downturn? It clearly hit later-stage companies more quickly.
We’re 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. Sometimes we give these companies a 10% or 15% or 20% bump to reflect the fact that they’ve grown. These startups have grown 3x-4x, 5x and 5x since their last round, but they are still raising flat.
What about fatality rates? Many companies raised money at excessively high valuations last year as well as the year before. What are you seeing in the portfolio of your company?
Historically, we’ve made money on about 50% of the deals we’ve invested in, which amounts to 300 exits and we’ve made money because we’ve been price sensitive. But fatality is on the rise. 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. I saw one this morning where we got like 88% back, another that delivered 68%, and another where we got between 1 and 1.5x of our money back. That wave is coming, but it will take six to nine months.
How do you feel about debt? I worry about founders thinking it’s comparatively safe.
Typically, startups don’t take out [secured] debt until they have completed their A and/or B rounds. This means that the problem is not venture debt. The issue is more about credit lines which, depending on your business, you should absolutely use. 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 issue is in a rising rate environment and an environment where maybe the underlying credit scores — models that you use — may not be as high or as successful as you think. Your business could be at risk if those lines are pulled. This means 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.
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 increasing. 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.
I’m a journalist who specializes in investigative reporting and writing. I have written for the New York Times and other publications.