Archive for the “The Equity Kicker” Category
Nic Brisbourne’s view from London on venture capital and exploiting change in technology and media.
According to the IAB, US digital advertising revenues grew 19% from H1 2015 to H1 2016. That’s very healthy growth for what is now a $32.7bn market. However, when you look at the numbers in more detail it’s clear that this strong headline performance masks a tonne of turmoil underneath.
Display continues to crater and the growth areas are mobile and video, but the surprising thing to me is how much Facebook and Google are now dominating. As you can see in the embedded tweet below Jason Kint analysed Google and Facebook revenues in the context of this market and found that revenues for all the other digital ad players went down over the last year.
.@iab it does seem relevant to note when you back out Facebook and Google, the digital ad industry actually shrunk in 1st half. #unhealthy pic.twitter.com/x0gRXWz6XT
— Jason Kint (@jason_kint) November 1, 2016
This bears out what we’re seeing in practice, which is that startup founders who want to pay to acquire customers on the internet do so on Facebook and Google. These are the channels that our partner companies have been using recently (in rough order of significance, results skewed towards the companies we know best):
- Facebook – all properties
- Google (paid)
- Google (SEO)
- Direct Mail
There are a couple of obvious implications of all this. Firstly, evaluating whether a company can get off to a fast start means analysing whether these channels will work (especially the top two), and secondly startups with advertising based business models will increasingly need some super-special secret sauce.
Then there is the non-obvious implication which Benedict Evans of A16Z has been tweeting about recently, which is that as advertising becomes less effective (at least outside Facebook and Google), innovative companies will find new discovery models that reduce reliance on media spend. Amazon has pulled this trick off in a huge way for their core products and there will be big rewards for those that crack it in other areas.
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The charts above are both from the new KPMP/CB Insights Venture Pulse Report.
There’s a lot more data contained within, but my read from these is that VC investment is down significantly since the highs we saw in 2015, but is now holding steady at it’s new level, both globally and in the UK. (The last bar in top chart on global investment might suggest a different interpretation, but Q3 is often quiet for venture investment.)
Moreover, overall investment is holding roughly flat despite a big drop in mega-rounds, buoyed up by activity at the earlier stages. Only one new unicorn has been created in Europe this year (11 in the US).
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McKinsey have just released a report which predicts:
that the global revenue pool from car data monetization could be as high as $750 billion by 2030
That caught my attention for two reasons. Firstly $750bn is a truly huge market to come out on nowhere. For context Gartner predicts the wearables market will be $29bn this year (including Fitbit and smart watches). Secondly, in my experience it’s hard to make money out of data that’s produced as a by-product of another service, at least directly. Lots of startups have ‘sale of data’ lines in their business plans and they very rarely come to much. Rather, the way most companies make money out of the data their service produces is to use it to build better products – the way Google uses our search data to sell better advertising (and build a better search product).
The excitement is coming because cars, particularly electric cars, are increasingly connected and will generate huge amounts of data. To their credit McKinsey developed 30 use cases for automotive data. Most of the aforementioned startups don’t go that far. They just assert that their data will be worth something to somebody.
However, the excitement doesn’t make it much beyond that. Some of the use cases McKinsey lists out are interesting (predictive maintenance, usage based insurance), some a bit so-so from a revenue perspective (emergency call service, over the air software add-ins) and some are merely enabled by internet in the car (car pooling, in-car hot spots).
There isn’t much in the report on how they get from these use cases to a $450-750bn market. There are around 1.2bn cars on the road now so that would be $375-625 per car – which is quite a lot. The most obvious way that will happen is if a chunk of the maintenance and insurance markets start to become counted as part of this total.
That’s already starting to happen, particularly on the insurance side. Overall, I haven’t found the new opportunities I hoped I might when I read the report’s $750bn headline figure.
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The European Investment Fund (EIF) is an EU institution that exists to stimulate the startup ecosystem by investing in venture capital funds. They have made a huge contribution to the UK scene, backing 37% of UK based venture funds between 2011 and 2015. Moreover, they are often the first investor to commit to these funds making their role even more important than the headline figure suggests. Back in July Bloomberg wrote:
It is an open secret among British venture capitalists that many of their funds would have never gotten off the ground without a hefty check from the European Investment Fund
To state the obvious, if the venture funds hadn’t gotten off the ground, the startups they back would also still be on the drawing board. So the EIF has had a huge positive impact on the UK. It’s a big deal.
And post Brexit there’s a chance we will no longer have their support. That would be very bad news, and might happen as soon as Article 50 is invoked. The EIF hasn’t invested in our fund to date, but they might in the future, so there’s an element of self interest at play here, but this is bigger than Forward Partners and I would still be writing this post if that wasn’t the case.
It’s therefore imperative that maintaining the role of the EIF in the UK is part of our Brexit negotiations. In the medium to long term we could well manage our our own programme for supporting UK venture funds, and the programmes of the British Business Bank augur well in this regard, but replacing the EIF’s programmes would take time and a short term hit to venture funds raised of around 40% would inflict damage on our ecosystem that would take years to repair.
I often get asked about whether the EIF has pulled back from investing in the UK already. There are all sorts of rumours swirling around but the best intelligence I’ve heard, including comments directly from the EIF, tell me that they are carrying on with business as usual. Additionally, I know for sure that one UK fund which closed after the June 23rd referendum has the EIF as an LP.
Earlier this week, David Kelnar of MMC Ventures wrote an interesting blog post setting out the implications of Brexit for UK startups. He included the following passage which describes in detail what we will have to do to keep the EIF investing in the UK. As he mentions, we will need the consent of 33% of EU governments, so this is not something we can take for granted.
The UK’s formal influence over the EIF is limited. The EIF is 60% owned by the European Investment Bank (EIB), 28% by the EU and 12% by 30 individual financial institutions in member countries, with votes cast proportionally. Decisions by the EIB’s Board of Directors require the agreement of one third of EU members. Post-Brexit, therefore, extending the EIF’s core activity to the UK will require at least one third or more of EU members to be supportive. Given the extent to which UK VCs invest across Europe, the attractive returns available from UK funds and the UK’s informal influence, they may well be. Alternatively, other countries may assert their interests to the detriment of the UK.
Other important points are that if the EIF is to keep investing in the UK, the UK will have to keep paying into the EIB, for which a mechanism will need to be established. The good news is that there are precedents, as David notes Israel has a deal which allows the EIF to invest in their country and Norway has something similar.
As with all things Brexit, there is much to do if we are to make the best of our situation. Our task in the startup community is to make sure our agenda doesn’t get forgotten.
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Every company has to strike a balance between focusing on being great at what they do and telling the world about it. Some very successful companies lead with hype and have their people permanently scrabbling to keep up. You might call that the Elon Musk school of entrepreneurship. Other successful companies focus on delivering value rather than making promises – Google and Facebook spring to mind as examples here.
There are pros and cons to both approaches. Leading with lots of ‘noise’ and hype can maximise interest in a business, helping to gain attention from investors (thus paving the way for fundraising) and can also ultimately drive growth. However, chaos behind the scenes kills many companies that take this path. Focusing on delivering value first is a safer approach to building companies of substance, but unfortunately this often results in slower growth and can mean that a business is left trailing behind hype-charged competitors.
Here at Forward Partners we’ve focused on delivery first and have prioritised telling our story second. That’s our natural predisposition anyway, but it always seemed that the most important component in our mission was to deliver value to the founders we back and to our investors, rather than telling the world about our work.
Since I founded the business three years ago, we’ve concentrated on building a well-oiled machine which can supercharge our partner companies, providing not only the funding but also the operational help needed to achieve rapid growth. However, as we now enter the next phase of our own growth, we are beginning to focus on telling our story a little more. This is largely in the hope that we can speak to more of the next generation of entrepreneurs and more founders at the earliest stages will understand our unique approach to VC.
A big effort for us recently has been redesigning our website. It has become clear to us over the last year or so that the primary benefits founders get from working with us are speed and certainty of execution, and that comes because when we invest founders gain immense leverage from using our team. We wanted to communicate that message front and centre and also to have a more approachable look and feel. The homepage image you see above provides a flavour but please check the site out for yourself!
As well as working on our marketing materials, we’ve also been building out our press and storytelling function, for both Forward Partners and for some of our partner companies. Last week, we were pleased to be profiled in The Times alongside our partner company Live Better With – a really exciting step forward for our brand and incredible to share it with Tamara Rajah, one of our inspirational entrepreneurs.
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Regular readers will know that for me the rising pace of change is one of the defining features of the early 21st century. Things are now changing so quickly that traditional structures are breaking down. Within a decade or so we will have adjusted to rapid change as the new normal, but in the short to medium term expect more disruption rather than less.
One example of traditional structures breaking down is that large companies are increasingly unable to keep up via internal innovation. Instead they are looking to partner with the startup ecosystem. Corporate sponsored accelerator programmes are one of the most visible aspects of that partnership, but whilst they command a lot of column inches they are small beer in terms of dollars committed.
The chart above (courtesy of Pitchbook) shows another aspect – direct investment by corporates into startups. Most striking is the rapid growth since 2009, but the dollars involved are also significant. The $26bn so far this year is the total deal value including the contribution from corporates, rather than the contribution itself, but I would guess that the actual corporate contribution will easily top $10bn this year.
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I was talking with an old friend on Friday about the fundraising pitch for his startup and how his conversations with VCs were progressing. He’s got a great business and I think he will get his round away, but he felt that he was losing some potential investors because they weren’t buying into the upside of his story.
We discussed how he could add a slide making a better link from his impressive recent results to his vision of the endgame and I hope that will make a difference. We also talked about his personal style. He’s low-key and likes to present plans he feels sure he can deliver, and he has a tendency to caveat the upside. The danger with this approach is that investors are used to a punchier presentation style and assume that if the entrepreneur isn’t punchy, the upside is less likely to be realised. As an investor I feel the same way. I know that there are some founders who successfully under-promise and over-deliver, but the majority of successful founders are the other way around – they have a tendency to over-promise.
Since then I’ve been thinking about how aggressive founders should make their business plans. Here are some guidelines:
- VCs want to back aggressive plans. That means your growth should be as rapid as possible.
- The plan must be believable – you must believe it is deliverable.
- Investors expect most of their investments to fail, and that nearly all under-achieve initial plans. If when you look at it objectively you have a 30-50% chance of hitting yours that’s more than enough – although you should believe in your gut that it’s much more certain than that.
- You should believe more strongly in the first couple of years than in the out years. If you deliver over 24 months opportunities will almost certainly open up.
- It’s important to show the path from today to the big upside. A series of big steps with no risky big leaps works best.
- Increasing your financial projections in the expectation that investors will discount them falls foul of the earlier points, and undermines trust.
It’s common for entrepreneurs to start with a big endgame that they think will work for VCs and then work backwards to build a plan that gets there. If you’re going to take that approach then make sure the plan is credible, as per the advice above. If not think about a smaller goal and perhaps different types of investors.
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I’ve been asked how to analyse cohorts by a couple of companies recently, so I thought I’d distill my thinking here into a blog post.
Most companies show their cohort analysis in the form of a table like the one below. This is the format that comes from most popular analytics packages.
Whilst these tables are helpful (and believe me, I’ve read a lot of them) they are a lot more useful if combined with margin data and shown in a chart like the one below:
CM1 in the chart title stands for Contribution Margin 1 – i.e. the contribution from the average customer in the cohort to covering the cost of marketing and the central overheads of the business. For marketplaces and ecommerce companies that means revenues (net of VAT) less any discounts or rebates, the cost of the physical item, delivery costs and the cost of returns.
This view is useful for a few reasons:
- It’s easy to see that even the oldest cohorts are still improving over time and that the new ones are more valuable than the old ones (you can see this from the table too, but it’s harder).
- You can see the lifetime value (LTV) of each cohort – the more mature cohorts are nearing £80, whilst the newest is nearer £70. Young companies can extrapolate these lines to estimate the ultimate LTV.
- You can work out how long it will take to pay back varying customer acquisition costs (CAC). The dotted red line shows that all cohorts would have paid back a £60 CAC after three months, but that the most recent cohort would have paid back a £72 CAC in the same period. CAC and payback period are key inputs into the financial model which works out how much cash a company will burn each month at a given growth rate, and therefore whether a company can get past key revenue milestones before they need to raise their next round.
This chart is most useful for companies like ecommerce businesses and marketplaces where customers make repeat purchases on irregular schedules. You can also use it for with subscription businesses (including SaaS) but in these situations calculations based on churn rate might be simpler and more effective.
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I love it when complicated things are made simple and this Guardian animation does exactly that for Stephen Hawking’s theory of black holes. In 163 seconds we learn that the force of gravity in black holes sucks in everything, including light, that there is infinite gravity at the centre of black holes, that black-holes reduce in mass over time, eventually exploding with immense power, and that our universe was created in such an explosion.
Simplicity is hard to find, hence the old adage ‘if I had more time I would write you a shorter letter’, but, as this video shows, simplicity is also immensely powerful. There’s a lesson here for companies as well as scientists.
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I just read a review of a new Wiley book Design a better business which argues that:
better businesses are ones that approach problems in a new, systematic way, focusing more on doing rather than on planning and prediction
For them, of course, the point is that design thinking is that ‘new, systematic way’, but this sentence made me think of startups, where the emphasis is very much on doing rather than planning. Since Eric Ries wrote The Lean Startup in 2011 smart founders have understood that the best way to progress is to get onto the ‘build-measure-learn’ loop and iterate to success. That’s doing rather than planning.
Whilst doing rather than planning has been a hugely successful tactic for entrepreneurs and their investors, before I go any further I want to note that as with everything you can take it too far. To get the best chance of achieving huge success, and avoid getting stuck at a local maxima, a certain amount of thinking should be done before building starts. There’s a balance to be struck and whilst best practice is definitely to maintain a bias towards action in our experience an increasing number of f0unders are starting to build product before they’ve done enough thinking, sometimes encouraged by investors who want to play with product before they invest. Many of these founders end up failing when with a little more customer research they might have built a slightly different product which would have resonated much better and allowed them to iterate to success.
The reason that Design a better business advocates doing rather than planning is that the world is becoming increasingly uncertain. Consumer habits, technologies, and other trends are uprooting once-thriving businesses and disrupting entire markets with an ever increasing cadence. In this environment every year gets more difficult for those who like to plan, whilst it gets easier for those with a bias to action.
The increasing engagement of big business engagement with the startup ecosystem through accelerator programmes, incubators and acqui-hires is a reaction to this trend. However, these small-scale programmes don’t solve the fundamental challenge of every business leader, which is deciding which actions to endorse. At good startups it’s easy (or easier..), all action is directed towards achieving their vision. Larger companies have a much more difficult challenge. They need to launch new products, attack new markets, or take radical steps to defend existing revenues, they can only put significant resources behind a small number of projects, and anything that won’t reach the scale to impact their financial statements isn’t worth doing. Historically planning has been the tool they used to figure out which projects have the best chance of moving the needle for them, but as planning is becoming less effective they have increasingly less confidence that putting resources to work will generate the scale of returns required.
That’s a problem startups don’t have. At least not to the same degree. Most founders want their companies to be huge successes, but if it turns out to be a medium sized success that’s still a worthwhile endeavour. A business that grows to £10m in revenues over five years and sells for 1-3x that amount can still be a life changing event. For large companies that’s not the case. If a £200m turnover business goes after a new market and it only adds £10m to the top-line after five years the project will not have been worth the effort.
This is one of the reasons why companies are increasingly buying back shares instead of re-investing profits.
In summary, increasing uncertainty is an unfair advantage for startups. And it’s an advantage that gets stronger every year.
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When I read in David Kelnar’s ‘Respect your elders’ and five other powerful trends shaping consumer retail that in the US retailers suffered a 48% decline in shop visits between 2010 and 2013 I did a massive double take.
If that rate of decline has been continuing visits this year will be roughly 75% down on 2010. Physical retail is a high fixed cost business and given that it’s fair to say sales correlate with footfall these levels of decline will put many retailers out of business.
So I double checked the statistic, and the original source was a solid PWC report, and this report has found a similar trend in grocery retail.
The upshot can only be that the growth of online sales will accelerate. As per the PWC report the main reason that people shop online is for better prices and the more sales that go online the more they online retailers will be able to discount, whilst physical retail is suffering the reverse logic and can only get more expensive. The main reason people shop offline is to be able to see and touch product and to try it on, and those factors aren’t going away. So we’re not looking at the end of physical retail, but we are looking at some pretty dramatic changes.
In most scenarios I’m a fan of creative destruction, but this decline in retail traffic is exceptionally fast and I worry that the adjustment period will be rough, especially for some of the more vulnerable portions of society.
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I’ve finally got round to reading Andy Grove
‘s High Output Management
, widely regarded as a classic on management that was originally published in 1983. The Foreword to the latest edition is written by Ben Horowitz of A16Z fame and includes the following paragraph:
As he describes the planning process Andy sums up his essential point with this eloquent nugget of wisdom: “I have seen far too many people who upon recognising today’s gap try very hard to determine what action has to be taken to close it. But today’s gap represents a failure of planning sometime in the past.” Hopefully, the value of this insight is not lost on the young reader. If you only understand one thing about building products, you must understand that energy put in at the beginning of the process pays off tenfold and energy put in at the end of the program pays off negative tenfold.
Ben’s point is that investing time in proper planning pays huge dividends when building products. In practice that means not simply growing as fast as possible, but taking time out from focusing on growth to find and iron out issues that might slow growth in the future. In startups that entails diverting resources to learn from customers, learn from data (including building the tooling to extract data), and to think deeply about product.
Finding the right trade off between growth and learning isn’t easy and is a debate we come back to time and time again at Forward Partners in the context of individual partner companies we are working with. There’s no universally applicable answer, but here are some guidelines from our experience:
- Growth is the biggest driver of value. Once revenues are established, then maintaining some level of growth is hugely important. If you’re not growing investors will assume that’s because you can’t grow.
- If you have venture scale ambitions in your first year but have less than 20% month on month growth, picking up the pace should be the priority.
- Once there’s enough growth to hit the milestones needed for the next round then you have the luxury of diverting resources to learning.
- In a high growth scenario, tell-tale signs like falling conversion, worsening engagement and increasing churn are signs that the trade off between growth and learning is too skewed towards growth.
It’s more common to see founders insufficiently focused on growth than it is to see them insufficiently focused on learning, but we definitely see both.
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‘Flow’ is the almost magical state of extreme creativity and productivity. Most often associated with artists and developers, but I believe applies to a lesser extent to all of us.
What follows is an extract from How anyone can enter flow state for maximum focus. I wanted to get these tips for enabling ‘flow’ down in one place that I can refer back to.
If you want more detail on what ‘flow’ is from a neurological perspective or much more detail and colour on the subject generally then please read the article above. It’s good. The most important point for me is that the more people work in a flow state, the more productive and happy they are.
These tips work for individuals and managers.
- Find work that is in the ‘flow channel’ – flow only comes after a struggle with a difficult task, so the work should be stretching enough that it’s genuinely challenging, but not so difficult that it creates fear that ultimately blocks creativity. This is a matter of balance – some boring work is inevitable in all day to day roles, but too much creates disengagement.
- Create the right environment – all necessary tools and information should be at hand, to minimise distractions and excuses for not focusing on the task in question.
- Remove distractions – Slack, emails, team meetings, colleagues wanting a quick chat and a cluttered desk all detract from focus, making it harder to enter flow state. Again, this is a matter of balance, but eliminating necessary distractions and giving people long periods of uninterrupted time will help. Permitting people to say ‘don’t interrupt me now’ is a good trick, maybe just by wearing headphones.
- Break difficult tasks into smaller chunks; my dad used to love the following joke: Q. “How do you eat an elephant?” A. “One steak at a time”. Now that’s chunking! It’s an old productivity hack, but very relevant here because it helps break through the struggle.
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I just read an old post by Nir Eyal about The psychology of sports: How sports affect your brain. Nir makes the point that our obsession with sports is weird. Writing at the time of the 2012 London Olympics he said:
“This week, fans packed stadiums in London wearing their nation’s colors like rebels ready for battle in Mel Gibson’s army. They screamed with excitement and anguished in defeat. Many paid thousands of dollars to travel around the globe to be there.
Among those who did not attend, 90% of people with access to a television tuned-in during past Olympics. In 2008, that was 2 out of every 3 people on the planet.
What the hell is going on here? How do sports engage, delight, and motivate people to put their lives on hold and become totally engrossed in watching other people play games?”
I’m sure you can think of plenty of other examples of sports fandom producing highly unusual behaviour too. The one that leaps immediately to mind for me is the tens of thousands of Chelsea FC fans who descend on London’s Fulham Road for every home game, wearing team colours and singing songs that we wouldn’t dream of singing anywhere else (I have a Chelsea season ticket).
Why do people do this?
Nir says it’s because the combination of hope and variable rewards is a dizzyingly powerful cocktail for the brain. We all know that hope sells and is a powerful motivator, and as Nir has been saying for some years variable rewards are addictive because they kick the brain’s dopamine system into high gear. That’s why people play slot and fruit machines for so long.
Entrepreneurship is the same.
The hope is much greater. The promise of changing the world and making millions of dollars is way more exciting than winning a football game. And the variation in rewards is much greater too. I’ve felt the highs and lows of football fandom, waking up the morning after a game instantly excited or groaning depending on what happened the day before, but that’s nothing compared to the euphoria that comes when a startup is doing well or the gut wrenching stress when it isn’t.
This psychology also explains why it’s so important for entrepreneurs to remain positive. If the hope goes, the motivation goes too, and then it’s a downward spiral. When things don’t go according to plan, balancing the need for positivity with the need for realism is one of the most difficult tasks founders face.
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I read two great posts advising founders on fundraising this morning. The first was a deck with pointers on fundraising from Jason Friedman of LionBird, which made two points I want to pick out and expand on (the rest of the deck is great too, and well worth a full read):
- 60% of fundraisings take three months or more (slide 2). “How long should I leave to raise my round?” is a question founders ask us all the time and we always answer 3-6 months. Sometimes we get pushback from people who have had success raising in shorter times than that in the past, and the data shows that 40% of companies don’t need three months. However, it’s advisable to hope for the best but plan for the worst and give yourself three months or more. A couple of quick additional points: people with strong investor relationships need less time to raise; the data in the slide is for the US where fundraising times are shorter than in the UK.
- Few companies have the luxury of holding off on meaningful monetisation (slide 40). This is another one that comes up a lot. Investors like to see evidence that the revenue strategy works because it removes a major risk in the business (that nobody will pay) and because it improves capital efficiency and hence investor returns. There are, of course, a number of highly successful startups which put off monetisation for years, but they are a tiny minority of venture backed companies characterised by extremely rapid growth in huge potential markets. We all believe passionately in our companies, but unless they can genuinely be the next Facebook, Twitter or Google, early monetisation is advisable.
The second post was on evolving fundraising milestones for SaaS companies from Ash Fontana and Mark Gorenberg of Zetta Ventures. Again, lots of solid advice and well worth a full read. I’m going to pull out the point they made about partnerships:
Partnerships are a distraction before the seed stage [defined as a $2-5m raise]. However, companies can leverage a few key marketing partnerships with complementary product companies to get enough traction to raise a Series A.
It’s super common for founders to spend time pursuing partnerships very early in the life of their companies and super rare for them to make any difference to revenues. Ash and Mark are spot on to advise ignoring partnerships before Seed and to then only focus on targeted partnerships until after Series A. This point hasn’t been spoken about enough and I’d advise all founders to consider it carefully to avoid misallocating their time.
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