From 2006-09, USV *led* Series A deals for Etsy, Tumblr, Twitter, Zynga, Disqus, Foursquare, Twilio // Leading at A is the art of venture.

— Semil (@semil) May 19, 2013

Ever buy and reserve a nice bottle of wine, only to open on a special occasion, years later? Well, in venture terms, get out your finest decanter, because we are about to taste the notes of a vintage rarely seen. Now, there are the Accels and Google-backers of the world who can still, to this day, enjoy a return from one company, the right bet placed at the right time — but on a pure batting average basis, what Union Square Ventures is pulling off is insanely amazing. Of course, everyone knows this, but I wanted to gently dig into how great this could be with some rough calculus.

A few serious disclaimers as I try to string this together. One, it’s not gentlemanly to keep score (especially about money), but in terms of venture, what USV is beginning to realize warrants attention and respect. Two, the information below isn’t 100% accurate because I don’t have all the data, nor do I seek to obtain it — I want to simply scribble on the back of an envelope and try to quickly approximate the scale of their success. Three, I’m making a lot of assumptions to back into a numbers at the bottom. I’ve probably made lots of mistakes, just using my intuition based on CrunchBase. Four, I’m bullish on all of these companies myself and trying to be conservative in approximations. Five, I’m not sure if these investments were made out of the same fund. Six, I don’t have details about follow-on funding, sales of secondary shares, or any blended averages. And seven, I’m only looking at a small handful of Series A investments made within a 3-year timeframe, so this excludes a lot of investments the firm made before and after the fact, leading up to today. I repeat, this is a small cross-section of their vintage, but a juicy cut at that:

• Tumblr: $750K in at $3M pre-money valuation, plus follow-on funding, sold for $1.1B to Yahoo, generating a return now of 293.3, or at least $220M
• Zynga: $2.5M in at $20M post-money valuation, conservatively assuming majority holdings liquidated at $5B valuation in 2011, marks ~250x return, or $625M
• Disqus: assuming $7.5M in at blended $30M post-money valuation, and I’m very bullish on this company and feel it’s underrated and will be a sleeper $500M+ exit, so will approximate a ~17x return, or $127.5M
• Foursquare: assuming blended $5M into a $50M post-money valuation, and although I’m bullish on this company (thought that’s controversial), I’ll conservatively say they can liquidate at $600M valuation, will mark ~12x return or $60M
• Twilio: assuming $3M into a $17M pre-money valuation, this is another billion dollar company in my opinion, so estimating a ~50x return or $150M
• Etsy: assuming blended $4M in at a $12M pre-money valuation, conservatively assuming exit will be $500M at least, so marking a ~31.25x return, or $125M
• Twitter: $5m in at $25 valuation post, will conservatively assume majority holdings liquidated in secondary offering around $200M/$4B valuation in 2011, marks a ~160x return, or $800M
• ***  Lots of assumptions here, again. *** Yes. But, if we add up these end numbers and assume it’s the same vintage, we’re looking at at least $2.1B+ in gross cash returns generated by seven (7) investments made within a 3-year period, this all with $150M fund-size gunpowder — not a mega fund. Huge.

Apple has a good deal of cash. And, in the Valley, the startup ecosystem — for many reasons — wants to see Apple spend that cash. As their cash pile continued to grow as their stock price and market cap soared, Apple’s inability to provide robust software services combined with opportunities to expand their reach through acquisitions has become a fancy parlor game which includes every stripe of public and private investor imaginable. On top of this, pumping even a small percentage of cash pile into acquisitions could provide another pool of much-needed liquidity for founders and investors alike. While it all makes sense on paper, part of what makes Apple “Apple” is that they operate how they want to — not how the market wants them to. Recently, in response to a variety of pressures to do something, to do anything, Appleannounced a two-part share buyback. There are many explanations for this financial strategy, and while the Valley may have their own armchair financial analysts with a Twitter account, I reached out to some friends who actually work in technology banking or at techonology-focused hedge funds and asked them to send me a paragraph on their perception of the move. Because of the world these folks work in, I’ve reproduced their answers below anonymously, as they are not permitted to publicly share their opinions on such matters:

Technology Investment Banker: With the amount of cash stock piled by Apple, and mainly overseas, it was only a matter of time until the water would break, especially with activist investor David Einhorn ruffling feathers. Apple did something very standard and not uncommon, but on a large scale the way Apple likes to do things. At the end of the day I feel Apple’s actions represent the following four points: (1) Increased Shareholder Value: There are many ways to value a profitable company but the most common measurement is Earnings Per Share (EPS). If earnings are flat but the number of outstanding shares decreases. . Voila! . . A magical increase in period-to-period EPS will result; (2) Higher Stock Prices: An increase in EPS will often alert investors that a stock is undervalued or has the potential for increasing in value. The most common result is an increase in demand and an upward movement in the price of a stock; (3) Increased Float – As the number of outstanding shares decreases, the shares remaining represent a larger percentage of the float. If demand increases and there is less supply, then fuel is added to a potential upward movement in the price of a stock; and (4) Excess Cash: Companies usually buy back their stock with excess cash. If a company has excess cash, then at a minimum you can bank that it doesn’t have a cash flow problem. More importantly, it signals that executives feel that cash re-invested in the corporation will get a better return than alternative investments. This is definitely a positive sign for the company going forward. Customers and investors should feel confident with these events transpiring that Apple will continue to deliver value to both parties respectively.

Technology Hedge Fund Principal: Since Apple has around $150B cash on the books (70% of which is foreign), it’s clear they need to do something with this cash because it’s just wasted sitting on the balance sheet earning low interest rates. People have assumed the market would respond well to Apple making acquisitions, especially in software and services, particularly in cloud and mobile software. While they have reaped the benefits of profits in mobile hardware, the value going forward is at the application and services layer. Other hardware manufacturers are catching up, if they haven’t caught up already. Unfortunately, Apple doesn’t seem to have an appetite for these types of acquisitions. Another option is to buy back shares, a proven way to deploy cash, though doing so sends a signal that they are a mature (read: not growth) company. Tactically, buybacks can decouple EPS growth from new product lines, and Apple could see 2x its buyback investment in earnings growth as a result. Ultimately, Apple has withstood significant pressure from the investment community to do something with the cash, especially as growth has slowed. (Venture arms, since you asked, are not an effective use of capital for a corporate player; I see the share repurchase as a much more responsible use of proceeds.

Hedge Fund Partner #2: Apple had four basic choices of what to do with their cash, remembering that apple has a duty to its shareholders: (1)  Do nothing (status quo), which makes zero sense. given that they have ~$145Bn in cash and are adding ~ $40Bn in cash annually assuming zero growth earnings earning; (2) Strategic acquisition or expansion, though Apple will be hard pushed to effectively put either their cash hoard or future cash flows to use to do this; (3) a one-time special dividend and increased annual dividend; or (4) a share buyback (or various form of it). Only options #3 or #4 made any sense to me and I assumed it was only a matter of time before they did something. #1 is out as they are would not be meeting their shareholder responsibility and #2 is out simply because of scale.

I see the share buyback as positive for three key reasons: (1) Apple stock is currently very cheap. My back of the envelope calculations conservatively value them at $500-$550/share, so they are effectively leveraging and creating additional shareholder value here until the multiple recovers to fair value. What’s more is that management knows a lot more than what we all do, so they should be able to calculate their own value in two to three years fairly well, and I assume they saw this as a positive. (2) Because Apple issued bonds to finance the deal rather than using cash, this way they will not need to repatriate taxable offshore cash to perform the buyback and they will likely get a bond rate the crazy low prices. Bottom line, they are saving shareholders cash, although at some point they will need to find a way to address the offshore cash, so perhaps they are waiting for another tax holiday. And (3), assuming the market reacts rationally, a buy back signals that managements believes in stock and the story and believes that this will generate returns that will outperform for long-term investors, something that a cash hoard did not address at any level and effectively generate returns far in excess of what could be achieved in any other safe manner.

More often than not I do not like share buybacks. often management does this to boost their own salary bonuses (EPS biased etc) or simply follow bad advice and follow the investment banking herd, but this time I liked Apple’s share buyback at this share price and multiple and applaud the debt financing way of doing it, I would have applauded it more if they had also issued a $40 special dividend.

Hedge Fund Partner #3: The view is Apple has stopped being an innovator. While they were at the forefront of technology, people bugged them to use their cash for a dividend or buyback and they could say “no” because the stock price was going up on leading edge innovation. Once Jobs passed away, Tim Cook hasn’t been able to keep that going, and if anything they are now playing catch-up to Samsung or even Google. When you aren’t innovating and you have $150B in cash, a board has to find ways to keep investors happy and one tactic is to conduct a massive buyback. Showing they are returning money to shareholders, creating a new base if “capital return” investors rather than growth investors. It’s all a game to prop up the stock price, money is cheap because of Bernanke, so it’s an easy way for them to please shareholders without much cost to the business. In general, I think that Apple is falling behind and trying to figure out how to regain their lead, and I’m not sure if its possible any time soon.

Technology Stock Investor: They’re doing the buyback because: 1) they have an unprecedented amount of cash ($140+ billion) that’s earning nearly nothing; 2) the stock is down nearly 40% from its high and shareholders are angry; 3) the stock is cheap on every financial metric, signaling that buying shares is a good use of cash if you believe in the long-term growth of the company.  The company does not appear to want to do a large acquisition or massively increase its capital expenditures.  They don’t “need” to hold that much cash. So the company had a very inefficient capital structure ($140+ billion of cash and no debt). Equity investors (who, in the end, own the company) sooner or later demand to get returns on their companies’ cash. Capital markets are competitive, and if management doesn’t give investors great reasons to own their stock, investors will go somewhere else. AAPL is facing slowing revenue growth, margin pressure, and uncertainty about their next major product line. A management team that is perceived as unfriendly to shareholders is another reason for investors to sell the stock. The buyback is a big gesture by management that they understand their shareholders’ concerns, in addition to likely being a good investment.

@chudson well, two diff q’s – overall feels undervalued at 1.1b, but “to yahoo” I don’t know – though it feels like a good deal for yahoo

— Semil (@semil) May 18, 2013

@semil naive question. How does Yahoo accelerate Tumblr or increase its value relative to what it is today? Cc @ifindkarma

— Charles Hudson (@chudson) May 18, 2013

So, we have two questions:

1. From Tumblr’s POV, is $1.1B too low, a great deal, or just right? and
2. Is Tumblr worth $1.1B to Yahoo! and, if so, why and how?

Question 1 - If I were an early shareholder or founder in Tumblr, I would think $1.1B undervalues Tumblr right now as an acquisition target. The instinct among many observers is to approximate revenue projections and model a revenue stream, which produces some multiple. The statistic batted around here involved the $13m revenues booked by Tumblr in 2012, and then suggests the company is aiming for $100m in 2013. There’s no way to verify this, let alone it’s just a distraction anyway and probably leaked to the press for future positioning — case in point, this week. So, back to the early shareholders in Tumblr…if I were in that position, I would perceive the acquisition market for Tumblr to assign a value greater than $1.1B given the basic stats of the product today: Tumblr is ranked in The Top 20 highest traffic web sites in the U.S. (Alexa), is ranked in The Top 100 of iOS apps and near the Top 10 for Social Networking (AppData) and probably has tens of millions of mobile downloads (and growing) across iOS and Android, of which I’d assume a good percentage of those are at least reliable weekly active users. For a “blogging” platform, Tumblr’s mobile product and footprint seem unrivaled with the competition no where in sight. Then, there are the intangibles, such as young people using Tumblr as a place to be themselves or assume pseudonyms and avoid the watching eyes of elders, parents, teachers, etc. Yahoo! or not, and despite revenues that would not (yet) impress an Excel junkie, I’d have to believe a company like Facebook, or Microsoft, would want our New York-based team of engineers and designers, our brand, our mobile footprint, the reliable web traffic (which includes data tentacles into Twitter and Facebook).

Question 2 - This is a harder question for me personally to answer. All I can do is infer from Yahoo!’s moves over the last year during the Mayer regime. Buying Tumblr gives Yahoo! a team of great mobile and web designers and engineers based in New York City, where so much of media is bought and traded. It continues with Mayer’s acquisition strategy to help re-infuse the company with fresh talent and slowly siphon out the old guard. It gives them a reliable property with reliable traffic on the web (and trending up on mobile) to serve its ads to, as Yahoo! is an ad-content business without any social or pseudo-social graph. Buying Tumblr immediately puts a Yahoo! mobile property on tens of millions of mobile devices, where its user base is already trained to share their Tumblr content into other social channels where even more millions of people will see it. Charles’ question is a good one from the Yahoo-POV, and I don’t know exactly how they take their core ad business and extend it to Tumblr, but that has to be the crux of the strategy.

Therefore, given all this, I stay away from the numbers and look at the narrative. For Yahoo, $1.1B is a lot relative to their annual profits (especially in an all-cash deal), but I respect this bold move. For Tumblr, it’s a great outcome because they haven’t really turned from a product into a business, and unless one of the other big players wants to play, this may be the best — and only good — chance to exit. I don’t believe Tumblr has the leadership or mettle to really turn their traffic into stable revenue, and this may be outside of their core interests as they seem to be focused on design and engineering. There’s nothing wrong with that, which means this is the time to make the move. Ultimately, the value in a property, whether physical real estate or a web site or mobile app, isn’t what projections say it is, but what a willing buyer is willing to pay for it.

One of the early writers I grew to worship is, of course, Paul Graham. His essays are legendary. Someone recently referenced one of his essays from 2005, The Submarine, which still rings true today, over eight years later. His insights on how startups are formed, how they compete, and how they win is pretty much incomparable. Many of these essays, of course, touch on the tense relationship between investors and founders. There’s no doubt that, in the past, the relationship was rife with tension. Fast-forward to today, and things do feel different — the founder is quite empowered. And, while investors now market themselves and either are or behave in a “founder friendly” manner, the sheer competitiveness doesn’t bring out the best in people. Everyone reading this will have encountered more than one investor who rubbed them the wrong way. There’s no doubt we could use a few more saints.

A few months ago, Graham shared a post mocking investor language, which struck me as too heavy-handed because I had actually seen the opposite behaviors from investors. You can read my response here. I realize it’s not kosher to write about Y Combinator in this manner, but at the same time, I have helped many YC founders through the fundraising process (without ever asking for anything), and I’ve observed how they and others who are pitching behave. The investing game is business, and I would agree it’s unnecessarily tedious. And, the entire process can boil anyone’s frustrations. Believe me, there are some interactions I’ve had myself that still bother me. Everyone knows part of the YC mantra is to help founders navigate once-treacherous waters and not get screwed, but in that training, new behaviors emerge on the part of founders that aren’t always in their best interest. I’ve seen investors back away from a deal they like because of the overt game mechanics. Yes, this is a taste of their own medicine, but I’d argue that in the end, it’s the founder who learns a bad habit and that it’s the investor who is rendered irrelevant.

Last night, this tweet from Graham was retweeted into my Twitter feed. It made me sad. I totally understand that Graham has his own view of the relationship between founders and capital. And, I don’t have enough context or history to draw from. But, I also think he’s made his point clearly. He has ground-rules for his Demo Days. Some people are invited, and others are not.

So, when I read this tweet below, it makes me sad for Graham, that despite all of his successes, and all the great founders he’s helped and will help, and all the investors that have helped YC founders (even when they didn’t invest) that he would use his great platform to throw another cheap dig at a group that’s actually quite diverse. Maybe the founder below isn’t talking to the right people. Maybe the pomp and circumstance of a staged, gated Demo Day attracts those prone to cynical behavior. Maybe he needs to, yet again, remind everyone of his disdain for and disappointment in “investors.”

I don’t know, because I’m not an insider in this specific world nor do I seek to be. I’m just lucky to work with a few YC companies and have seen many, many pitches by them, as well as many of their funding negotiations. So, given all that, when I read a tweet like this, it makes me sad because not only is it petty, and not only is it directionally wrong (based on my experience), and not only does it potentially influence a founder to learn bad behaviors themselves, but ultimately I think one could switch around the words “founder” and “investor” in his tweet below and, perhaps more often then anyone would like to admit, have the quote read quite similarly.

“I tried to be as cynical as I could but it still wasn’t cynical enough.” — a w2013 founder on investors

— Paul Graham (@paulg) May 15, 2013