Since the summer of last year, I have been hearing news that something is not quiet right with Venture Capital – at least in the US context.
First you had Promod Haque at TiEcon 2005 saying that, “”Over the next five to ten years, I believe there are going to be half as many venture capital firms in this business, and there are going to be half as many companies being created”…his opinion on returns was even more pessimistic, “Over the next ten years, you’re going to get 30-year bond yields on venture capital investments”.
John Malloy of BlueRun Ventures, speaking at the same conference suggested that the main problem was not so much as oversupply of capital as concentration of it in Silicon Valley (or more broadly US)
But neither Promod nor John talked about getting out of Venture Capital.
However, Howard Anderson, Founder of Battery Ventures (and now the William Porter Distinguished Lecturer at MIT’s Sloan School of Management), actually penned an article in the Technology Review titled, “Good-Bye to Venture Capital”
Howard’s main contention (and the title of the piece he wrote) was: “Technology finance has turned rational — so I’m outta here”. In the article, he said: “…We venture capitalists like to think of ourselves as giants striding across the technology landscape, showering money on terrific young entrepreneurs, adding value, creating jobs, nurturing real companies. We are financial samurai.”
“But I am giving it up. Why?
First, technology supply is bloated. Innovation is not dead, but demand for new technologies is moribund and will continue to be weak for at least the next five years…
Second, there’s a good reason why technology spending is stagnant. The hype machine is broken…
Third, the financial markets for technology companies are no longer exuberantly irrational…We need a little irrationality to earn a living — but the total capitalization for the leading technology companies is now one-sixth of what it was five years ago.
Fourth, these changes in venture funding are structural, not cyclical. VCs actually like cyclical markets; we can buy in cheaply and wait for exuberance to bail us out. …But those days are, regrettably, over.”
And he fondly remembers the good old days of Venture Capital:
“Ever wonder what we did for a living in early-stage venture funding? I bet you think we spent the day searching for the next insanely great company. But we spent most of our lives in endless meetings with people who were lying to us: scientists who swore that their patents were solid and entrepreneurs who insisted that they had no competition. We lied right back at them: said our money was different.
That was the old way, and it was tons of fun, and we all made too much money. I’ll miss it. But now the markets are too rational, and the returns are too small and uncertain. So, time to leave.”
Last week’s big news was of course Sevin Rosen. Steve Dow, one of the Partners was quoted in the New York Times as saying, “The traditional venture model seems to us to be broken” Sevin Rosen is no ordinary firm…Over its 25-year-old history, it has backed some of the best tech start-ups in the US and was raising money for its 10th (!) fund.
Sevin Rosen offered three main reasons behind this radical step:
• Too much capital
• Too many companies being financed and
• A weak exit environment
It also said that “The venture environment has changed so that overall returns for the entire industry are way too low and even the upper-quartile returns have dropped to insufficient levels.”
Had these words been uttered by anyone else, they would have been dismissed off as “excuses” for a difficult fund-raising or poor performance. In case of Sevin Rosen, neiither of this is true.
Although there have been instances of firms returning money to investors – most notably after the 2001 dotcom burst, I had not yet heard of an entire fund being being called off – especially when there is no trouble raising it…
What is going on? Is this the beginning of the end? Depends on who you ask and where you are talking.
At the EVCA last week, I sensed an unmistakeable mood of optimism…it even looks as if it might be the end of the nuclear winter for European VCs
Are things different in the US? Kliener Perkins, Hummer Winblad and others don’t think so..In fact, Mitchell Kertzman at Hummer Winblad thinks this is “one of the best times to be an early-stage investor”.
My feeling is that more than returning the fund, what Sevin Rosen really did was to buy time to think…think whether there is a new model that may work better, think whether there are new geographies that could be explored (Sevin Rosen is conspicuous by its absence in China or India), whether they need to move at the earlier stages of the venture cycle, work with affiliates, invest less in a larger number of companies or something entirely different.
I think most of us in this business (whether in the US/ Europe) would agree with Fred Wilson that the model that worked for the last 30 years will not work for the next 30..
So what needs to be done differently?
One thing is clear – firms, investee companies and investors themselves (VCs as well as LPS) need to think about their strategy for other parts of the world, Europe in case of US LPs and firms, Asia in case of everyone in Europe and US. Fred refers to it in his list of trends: “- the globalization of technology development and consumption”
Josh Jaffe also talked about Sevin Rosen’s decision in his post, “Sevin Rosen’s capitulation is not indicative of VC industry problems”
He summarises the situation neatly in his last paragraph: “Despite Sevin Rosen’s claims, there are few lessons from this fundraising failure that should be applied to the entire venture capital industry. This is about one firm’s inability to succeed without its founders. It’s about a firm’s unwillingness to believe in new technology movements such as the Internet. What it’s not about is the venture capital model being broken….”
I believe him…but I also think that the bar has just been raised a few notches higher.
October 16th, 2006
Posted by
Shantanu |
Venture Capital, Venture Capital in Europe, Venture Capital in US, What VCs really do |
2 comments
I am pretty sure that this is not a complete list but it is interesting nevertheless. Below are names of some very well-known VCs who formally declared their intent to invest in Asia in the last twelve months.
This move towards investing beyond the “2-hour drive” periphery signals a profound change – whose ramifications will continue to be felt for years. Yet, I find it odd that there are not more people commenting on it.
More remarkable than the impressive list of names is the conspicuous absence of European VCs from the list.
In April ’06, the EVCA did a survey of European VC firms that showed almost half (47%) had no activity at all in Asia (either via portfolio companies or through direct investments).
Why are European VCs so cool/cautious on Asia?
Partly it could be that Asia is still viewed as a “supplier of good or services or (an) outsourcing region” and European investors see neither market opportunity nor any signs of innovation happening there (they are wrong on both counts, of course).
As I was searching for some answers, I came across this gem (buried deep under news archive on Walden International’s website)
It was written in Feb ’01, I guess weeks before the markets began to wobble. It mentioned a few reasons why US VCs were not keen on Asia (this was then). Some of those points resonate in Europe today (excerpts).
1. Distance
“Distance is one key factor keeping the creme de la creme of Silicon Valley VCs from setting up offices overseas. …Sequoia Capital founder Don Valentine said: “In 30 years we haven’t convinced ourselves to set up a presence in Boston. It’s a very difficult business to be good at consistently over a long period of time, and it requires a lot of thoughtful and integrated decision-making….”We make enough mistakes on investments we make here (in Silicon Valley), that we’re not comfortable we can (be successful) 3,000 miles away, never mind 8,000 miles away.”
Keep Reading…
August 17th, 2006
Posted by
Shantanu |
Europe and Asia, Venture Capital in Asia, Venture Capital in Europe, Venture Capital in US |
one comment
A slightly dated (in internet terms) – but still a hugely insightful article on the economics of a VC firm and why VCs behave the way they do. As good friend Sumanth Raghavendra (CEO of Instacoll) put it: “definitely guffaw-worthy!”
David Gammon, a Cambridge, UK based angel investor, posted an addendum to the article which is also very readable:
a) The client of a VC is not the investee company but the LPs whose money the VC manages. This is the first fundamental flaw made by all companies seeking money from a VC. Viewed from this angle VC behaviors are very understandable. Entrepreneurs should take the trouble to try and understand the VC model before seeking funds from them and VCs might help this by explaining their model more clearly.
b) VCs do not undertake a shoot gun approach to investment – typified by public market investors who typically get a spread, invest in 50 or more companies and maintain a watching brief. VCs have to adopt the rifle shot approach to investment – i.e. concentrate the fund in a few well selected thoroughly researched opportunities. The prime reason, in my view, this happens is because information and data about private companies is so difficult of obtain. I think this is going to change in the not too distant future as providers of granular information, updated on a regular cycle, on private companies becomes more available.
c) Public markets operate through intermediaries – stockbrokers – who do a large part of the work which VCs have to do themselves. Private equity in the venture field is not intermediated. Stockbrokers make the information available to public market fund managers, disseminate it, arrange the deal, decide the terms, do the research, conduct the references, do the due diligence. All the public market fund manager has to do is make a decision – buy or sell. VCs have the entire onus placed on themselves. Personally I view this as an inefficiency (and opportunity) in the industry.
d) There are many more arsehole companies seeking money from VCs than arsehole VCs. When I established the private equity advisory business at Credit
Lyonnais it staggered me how many rotten, sometimes fraudulent and hopeless propositions came past my desk. VCs have to be cautious because many have learnt the lesson the hard way.
e) When it comes to exit you have the financial asset cycle. Equities as an asset class experience PE value ranges from 5x to 30x for the same asset at different points in the financial cycle. In my experience neither VCs nor entrepreneurs have any understanding of this cycle, how it works, where it comes from. A VC can make just as much money playing this cycle as public fund investors but none of them seem to strategically do so. In about 2000 Durlacher almost came in the FTSE100 entrant with a market cap in excess if £1bn. Thus a company without a jot of substance can be worth £1bn or £10m depending on the timing of that asset’s valuation in the financial cycle. As a broker who had the responsibility of determining which issues we IPOed or not it was a constant struggle to explain and justify valuations. At the end of the day it is the market and nothing else that makes the valuation. So far no one has come up with a model that can predict this. You can spot and play the trend though. VCs try to understand value by reference to their own set of criteria – the company fundamentals – which sadly have very little bearing on market value in general. Entrepreneurs in this case are just as poor judges of their value as the VC.
July 10th, 2006
Posted by
Shantanu |
Entrepreneurship, Venture Capital, Venture Capital in US |
no comments
A slightly dated (in internet terms) – but still a hugely insightful article on the economics of a VC firm and why VCs behave the way they do. As good friend Sumanth Raghavendra (CEO of Instacoll) put it: “definitely guffaw-worthy!”
David Gammon, a Cambridge, UK based angel investor, posted an addendum to the article which is also very readable:
a) The client of a VC is not the investee company but the LPs whose money the VC manages. This is the first fundamental flaw made by all companies seeking money from a VC. Viewed from this angle VC behaviors are very understandable. Entrepreneurs should take the trouble to try and understand the VC model before seeking funds from them and VCs might help this by explaining their model more clearly.
b) VCs do not undertake a shoot gun approach to investment – typified by public market investors who typically get a spread, invest in 50 or more companies and maintain a watching brief. VCs have to adopt the rifle shot approach to investment – i.e. concentrate the fund in a few well selected thoroughly researched opportunities. The prime reason, in my view, this happens is because information and data about private companies is so difficult of obtain. I think this is going to change in the not too distant future as providers of granular information, updated on a regular cycle, on private companies becomes more available.
c) Public markets operate through intermediaries – stockbrokers – who do a large part of the work which VCs have to do themselves. Private equity in the venture field is not intermediated. Stockbrokers make the information available to public market fund managers, disseminate it, arrange the deal, decide the terms, do the research, conduct the references, do the due diligence. All the public market fund manager has to do is make a decision – buy or sell. VCs have the entire onus placed on themselves. Personally I view this as an inefficiency (and opportunity) in the industry.
d) There are many more arsehole companies seeking money from VCs than arsehole VCs. When I established the private equity advisory business at Credit
Lyonnais it staggered me how many rotten, sometimes fraudulent and hopeless propositions came past my desk. VCs have to be cautious because many have learnt the lesson the hard way.
e) When it comes to exit you have the financial asset cycle. Equities as an asset class experience PE value ranges from 5x to 30x for the same asset at different points in the financial cycle. In my experience neither VCs nor entrepreneurs have any understanding of this cycle, how it works, where it comes from. A VC can make just as much money playing this cycle as public fund investors but none of them seem to strategically do so. In about 2000 Durlacher almost came in the FTSE100 entrant with a market cap in excess if £1bn. Thus a company without a jot of substance can be worth £1bn or £10m depending on the timing of that asset’s valuation in the financial cycle. As a broker who had the responsibility of determining which issues we IPOed or not it was a constant struggle to explain and justify valuations. At the end of the day it is the market and nothing else that makes the valuation. So far no one has come up with a model that can predict this. You can spot and play the trend though. VCs try to understand value by reference to their own set of criteria – the company fundamentals – which sadly have very little bearing on market value in general. Entrepreneurs in this case are just as poor judges of their value as the VC.
July 10th, 2006
Posted by
Shantanu |
Entrepreneurship, Venture Capital, Venture Capital in US |
no comments
