Global Themes

Beginning of The End for Venture Capital?

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

This is why VCs are sexy…

Paul Kedrosky had this statistic on his post on YouTube (the deal made the headlines just hours ago):

Total invested: $11.5m (over two rounds: 11/2005, and 4/2006)
Percentage ownership: 30%
Value of Google shares, post-acquisition: $495m
Multiple: 35.2

No wonder, Venture Capital is so sexy…and this is why the rest of us (minus Sevin Rosen) get a bad name (in other words, “What? you didnt deliver a 100% IRR? Why are you still in business?”).

Cheers to all the bright sparks at Sequoia…as for the rest of us, time for introspection…and just in case you thought this is easy, read this

October 9th, 2006 Posted by Shantanu | Venture Capital, What VCs really do | no comments

The Hard & Sexy bit of Venture Capital

Over the last few months, I have been thinking a lot about venture-backed exits and M&A … Exits themselves are not rocket science…but executing one is, I think, a fine art…Not many are good at it and I am trying to figure out what makes a company (or an investor) better than others in engineering a valuable exit for itself (themselves). 

As I mulled on this, I came across several interesting posts in a random trawl of what fellow VC bloggers had to say on this topic. 

First, Ray Wu. Ray leads HP’s venture management organization and blogs on interesting venture and technology trends and start-ups. I came across this post on his blog – “Exit strategy for technology companies”. 

Ray mentions that: “Overall, the general ratio is 20:1, highly tilted towards M&A”. He reckons that SOX (and related costs) make it even harder these days for most start-ups to consider listing for an IPO – of course you could always list it on a foreign exchange such as AIM (see “NASDAQ, AIM and IPO…”). 

He says, “…If a company is structured for M&A exit, then it should be positioned correctly up front, be really careful with venture funding intake, stay narrowly on product/service focus and excel, and try to establish a defensible position through patents and customer base.” 

This is fine advice. Too often companies look at M&A as just another “exit” option – and sometimes as the “only” exit option. 

In the first case, they are rarely strategically positioned to precipitate an offer from a potential acquirer. Not only should start-ups be correctly positioned upfront (as Ray mentions above) they also need to be very active in seeking partnerships, OEM agreements, joint marketing programs and joint development opportunities with strategic partners and acquirers well before there is an “exit situation” – this rarely happens…and unsurprisingly, start-ups find it extremely “hard” to get noticed amidst the noise of a large corporate machine… 

This is so blindingly obvious once you say it that I wonder why investors don’t make this a matter of discussion at every Board meeting. 

In situations where start-ups are faced with an M&A as the only “exit-option”…it is usually too late and there is almost zero likelihood of salvaging any value from the investment. 

Next I came across Tali Aben’s blog. Tali recently wrote about a keynote interview that Russ Garland, editor of Editor, Venture Capital Analyst had with Sandeep Johari, HP’s Vice President of Strategy & Planning at the Enterprise Ventures Conference. 

In the interview, Sandeep had this to say in response to the question (from Tali’s blog): 

“How does a company go about getting HP’s attention?”  

OEM is an excellent way to work. Businesses that OEM with multiple vendors create a co-dependency, which creates a reason for one of them to own the IP. What companies need to think about (is) – how can they form a partnership? How do you work with these larger vendors in a synergistic way? Engagement out in the field, where you partner with the sales force with no commercial agreement is very effective. Riding that larger elephant is a great business model.  Most companies don’t do that.  Most just want HP to take product and ship into their channel – that’s not a sustainable business model for HP. 
 
Larger companies are getting much smarter about it.  HP doesn’t like to OEM unless it really benefits them in some way.  In every deal, they extract additional value (equity position), having some rights of first refusal, first offer, etc. something that protects their interests as well. 

Then I stumbled across Seth Levin’s blog with this series of posts. Seth writes in an engaging style and there is a lot of good stuff on his blog….but my personal favourite on M&A was this post: “Getting Bought vs. Selling”. 

Some points that I felt were critical:

• it’s much easier to have a company get bought than it is to sell… 
  
• Getting bought means that someone comes to you.  Selling means you go to them.  The former results in a more motivated buyer, an easier (and faster) process for rounding up competitive bids and a higher price.  The latter is a pain in the ass…
  
• …companies think too late in the game about their exit and as a result end up as sellers.  An ongoing conversation at companies should be the list of possible buyers and the right ways to get close to them. 
  
• The right time to do this is when you don’t need an exit.  The wrong time is when you’re got 6 months of cash left and need an out.

As Seth said, it’s stating the obvious but certainly bears repetition. Seth also has a post on his blog by Daniel Benel (earlier with Lehman Brothers and currently a corporate development exec at Verint Systems) Daniel had this to say about acquisitions and M&A from an acquirer’s perspective (excerpts/ main points): “Below are three topics on my mind related to acquisitions from a corporate development perspective

• The Hockey Stick Projections – Hockey Stick Financial Projections did not die with the bubble’s burst…It is more likely than not nowadays, when I receive a book from a banker selling a technology company, that the financial projections show jaw-dropping out-year growth. The most noted reason for the turbocharged numbers: The Market. The Market is hitting a “sweet spot,” or the company is in a sweet spot and the market is about to develop a sweet tooth. These saccharine solution sellers expect, of course, to be valued off of forward numbers. My common response to wild growth projections is to advise the company not to sell. If management of a selling company believes that they can accelerate growth dramatically over the next 12 months, why don’t they prove the business plan and come back to the merger market with a significantly higher value? At this point in a discussion some sellers choose to revise their outlook. Other sellers claim that the projections are based on “what the company can do on a pro forma basis,” that is, when combined with “your more significant resources.” (I’ll discuss that in the “We Don’t Pay for Synergies” section.)
  
• We Don’t Pay For Synergies – Often stated as an acquisition truism, but not always true. In general, it is synergy that motivates an acquirer’s interest in a given target to begin with and not something for which a buyer is willing to pay extra…
  
• Overboard Competitive Concerns – Acquisitions often occur between competitors. This is natural, particularly in early stage markets that are in a consolidation phase…Sellers must recognize early on that they will have to accept the risk of sharing sensitive competitive information with potential acquirers in order to get a deal done. Some data, though, may be deemed so sensitive that particular workarounds need be put in place in order to make diligence acceptable for both sides. Sometimes a two-stage approach to diligence (deferring highly sensitive material to when the deal feels more certain) can resolve concerns. Sometimes competitive concerns kill a transaction, or at least slow it down to a degree that momentum is lost, which is a topic to be discussed in a subsequent post entitled: “Don’t Lose Momentum.”

Finally, another one from Seth: “When should you sell your business” 

I would be very interested to hear from readers on their experiences and take-aways…particularly from those who have been through a successful (or a not so successful) exit. 

I will also try and upload some interesting M&A statistics that I came across recently on what’s been happening in the tech acquirers’ universe..

October 6th, 2006 Posted by Shantanu | Entrepreneurship, Venture Capital, What VCs really do | no comments

“VCs Are Marketing Geniuses”

David Hornik wrote a great post on Marketing last week: “VCs Are Marketing Geniuses” (!)

Of course, they are not…but as Dave McClure says, “truly genius to write a blog post admitting you’re not a genius.”

I loved Lance Weatherby’s comment on the post: “Marketing is like sex. Everybody thinks they are good at it and wants to do it.” So true.

Keep Reading…

September 24th, 2006 Posted by Shantanu | Miscellaneous, Venture Capital, What VCs really do | no comments

“Life as a VC” c. early ’00s

My take on “Life as a VC” circa early ’00s: Life as a VC.

Originally prepared for a class at London Business School in 2002.

Have a look to get a sense of what it was like “back then, in the good ol’ days” – some of the points still resonate…and while at it, you may find this list of 10 pointers to an investment bubble entertaining.

September 6th, 2006 Posted by Shantanu | Conferences and Panels, My Presentations, Venture Capital, What VCs really do | no comments

Globalization – What’s it got to do with me?

A few days ago, Iggy Bassi (a friend from Monitor Co.) very kindly sent me some excerpts from a book that he has edited with Jeremy Grant titled, Structuring European Private Equity.
 
In an insightful chapter on “European Venture Capital”, Iggy and co-author Vesa Jormakka (Argo Global Capital) make several interesting points.
 
In their introductory paragraphs, they talk about Globalization as being one of the key strategic challenges facing European VCs