30th May 2012
As Pinterest, the online scrapbook site and current social media darling entered its third round of funding a few weeks ago, one group of investors was conspicuous by its absence – venture capitalists.
Missing out on the $100 million cash-fest that saw Pinterest valued at $1.5 billion, VCs have not had a great publicity run of late, with suggestions that their industry is broken not helping.
Much ventured, little gained
11 days before the round, the Kaufman Foundation, an investor in VC funds published a report on the performance of venture capitalists. It found that no fund exceeding $400 million had made more than the "venture rate of expected return" – between 3 and 5 per cent above the general stock market rate – in over 22-years.
The report's author Harold Bradley also said that VC funds lacked transparency in their investments and compensation awarded to partners; were not very liquid, making it difficult for investors to retrieve funds; and that VCs seemed to be rewarded for the size of their funds rather than the profits generated.
Bob Rice of the angel investor Tangent Capital Partners of was of the opinion that there was generally just "too much VC money chasing too few start-up ventures."
Such a poor track record chips away at any authority VCs wield over their investment targets. The report must have been a sobering read for the Pinterest C-suite or just vindication for what many were beginning to articulate about the U.S VC scene: so instead of going down that tried-and-tested route Pinterest went all the way to the Far East for this round's very different kind of lead investor. Rakuten, Japan's largest e-commerce operator, bought in at "upwards of $50 million," giving Pinterest a strategic partnership with a global player.
Pinterest had raised some $37.5 million in earlier rounds from VC and angel investors that include Andreeson Horowitz, Bessemer Venture Partners and FirstMark Capital.
For Round three though, Pinterest CEO Ben Silbermann was quoted as saying he wanted an investor that would move the company forward rather than just another VC, and was by all accounts impressed with Rakuten's own refusal to engage a single one.
What Pinterest is Buying
Rakuten CEO Hiroshi ‘Mickey' Mikitani told the Financial Times that in exchange for some equity, Pinterest gets and advisor for into breaking into the global marketplace and "a little ecommerce flavour to their business model," including mobile capability.
Pinterest not only gets a strong partner to guide it into the Japanese market, but access to the investor's 16 other markets around the world. Rakuten's recently acquired online properties include Buy.com, bought in a $250 million all-cash deal in 2010, Jersey-based Play.com, bought for £25 million and e-reader vendor Kobo (global number three behind Amazon's Kindle and Barnes & Noble's Nook) for $315 million – both bought last year.
Mikitani, insists ecommerce is a socially driven rather than a "vending machine-like experience." He's convinced Pinterest already drives traffic to Rakuten sites, and will only increase following their strategic agreement and some ‘Pin it' buttons on them.
That assertion is backed up by two sets of figures released either side of the funding round, that purport to show just how effective Pinterest is in pushing traffic to online merchants. According to ecommerce systems vendor Shopify, Pinterest is the joint second biggest referral source to its 25,000 online partners, behind Facebook and on par with Twitter.
AllThingsD picked up on a survey in March by price comparison site PriceGrabber: "21 percent of people who identified themselves as Pinterest users said in a recent survey that they had purchased a product after seeing it on Pinterest – most frequently, clothing, food or home decorating materials…of 4,851 U.S. online shoppers
who participated in the PriceGrabber survey, 10 percent said they had Pinterest accounts."
Imitation maybe the best form of flattery, but it's also the best way for a business to lose its lunch. Alongside the issue of ensuring Pinterest's global growth, help with fending off international clones – such as the inspired Pinspire, owned by Berlin-based clone operator Rocket Internet – was another concern.
It's debatable as to whether a U.S-based venture capitalist would have the tools or reach to tackle either of those issues.
Some of the current views on VCs gathered by the FT, would seem to concur with that – including this one from private equity firm Index Ventures:
"Start-ups are generally bad at strategically planning their capital requirements beyond a 6 to 12-month period, and often fail to consider the cash that will be needed in years two and three. Compounding this is the fact that venture capitalists tend to have short-term profits in mind, and will often expect start-ups to prove themselves by achieving difficult goals in a short space of time.
"Start-ups should therefore be alive to the reality that their interests are not aligned with those of venture capitalists, who have their own agenda and are not simply a benevolent source of cash. They should look for venture capitalists that offer strategic partnerships rather than those who offer the best hard numbers."
Pinterest's strategy illustrates the power that a start-up that catches the industry's imagination can exert when it comes to choice for next-level funding. While this is by no means universal, it does show the possibility that new companies yet to prove themselves financially can still retain some control over their decision-making and strategic direction.
Can we also expect more already successful commercial ventures (and their investors) to take up some of the slack of VCs – providing cash, but also strategic expert advice borne of ‘real world' experience – in exchange for start-up equity? This is an already familiar model in Europe where the VC tradition is less widespread. And since the banking crisis, more money from the angel investors, as well as the Middle East and Russia has been pumped into areas usually populated by VC funds.
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