I’ve spent the last few weeks, in the occasional moments of downtime, reading through the NVCA’s four pillar plan for reopening the IPO markets with the goal of restoring liquidity to Venture Capitalism. Any executive or board member of a venture backed startup doing $20M in annual revenue or more should get really familiar with this content. The NVCA’s efforts along these lines will be important input to your financing strategy for the next 2-3 years.
Here’s my summary of the four pillars:n
1) Ecosystem Partners: Working with the global investment banking and accounting firms to help them develop programs that are more relevant to small cap companies. One method discussed is encouraging smaller boutique investment banking firms to provide ongoing coverage and research on small cap companies in exchange for fasttracking the boutique bankers as co-leads when the VC backed firms go public.
2) Enhanced Liquidity Paths: Improve efficiency in the crossover between private and public markets by connecting pre-IPO firms with committed investors which makes the IPO process easier on the company and reduces post-IPO volitility.
3) Tax Incentives: Extend capital gain holding period to 2 years (from one year now) and implement short term tax incentives to stimulate IPOs.
4) Regulatory Review: Review SOX and reduce regulation of pre-public and smaller public companies by fine tuning the abuse controls that were created to keep large companies honest.
To see the plan or to get some more context on the situation check out the following sources:
The National Venture Capital Association is reporting the results of a recent survey of Venture Capitalists in which 60% of VCs believe that a drop of venture capital investments of 10% or more will occur in 2009. Also, the President of NVCA feels that 2010 will be a better year for Venture Capital as investments in private companies are expected increase alongside expecations of reopening IPO markets then.
Many VCs I’ve talked to recently feel like their industry is in real trouble but on the flip side just as many feel like now is a great time to get a deal on a struggling company. I guess one of those opinions will prevail based on how flexible entrepreneurs are willing to be with their company valuations. When Sequoia got their CEOs together a few months back in order to scare them profitable with pictures of pig carcases and economic graphs that would have put Alan Greenspan to sleep they clearly were warning against the risk of a down round if the companies burned to the bottom of their cash piles.
In the same way that the challenging economic environment right now will drive companies out of business across a wide variety of industries who rely on institutional investors, the VCs are also in this boat. They of course are just focused investment vehicles primarily for large endowments in the private and public sector. As those endowments miss cash calls (because of their recent losses in other investment categories) from the VCs some firms will not be able to properly support even their existing portfolio companies. As their portfolio fails so will the firm over time.
I know of a few small VC firms in real trouble right now. Many are essentially non-operational although still technically in business. Some of the larger VC firms are shedding associates right now to cut costs considering the typical job of turning up leads for dealflow isn’t really needed right now… because the firms aren’t planning on putting any money to work anyway.
Additional Note (1/2/2009): Forbes.com has a great article with more details on what they call “Venture Capital’s Coming Collapse.” At the very end of the article (on page three) is a point I think is very valid and reflects a bit of what may ultimately happen in the auto industry (whether right or wrong)… a mention that a consolidation of VC firms (ie: the demise of the lower performing firms) would lead to generally higher returns across the industry.
From the numbers it does appear that mediocre VC funds are not worth a 2% management fee or any management fee at all. A long term 5% fund gain is just terrible considering the risk. The Forbes article mentions that “the median return for all venture funds was just under 5%, or worse than what Treasury bonds would have given you.”
The Forbes article is also a bit unfair since it mentions lots of fund IRR (Internal Rate of Return) percentages for incomplete funds. VC funds, because of their risk, can be extremely upside down through a significant portion of the life of the fund. More interesting numbers here would probably be some trending information on the average length in years of funds (for which general knowledge is telling us that it has been extending in recent years and certainly currently with no IPO market) and also the average percentage of a good fund’s life (maybe defining a good fund as one with an IRR of 10% or greater at its close) that it spends with a negative IRR. Also the average negative IRR for those good funds during their negative IRRs phase (or phases possible?) would also help us evaluate this further. Based on my recollection I would assume that even the good funds have a negative IRR through at least 30% of their lifetime. Anyone have any of this data?
A few more articles came out today highlighting the low point in VC liquidity since 2003 (five years). One of them calls it the complete death of IPOs and the other calls it the lowest point since the tech bust. As an interesting aside the VC market doesn’t look that bad in this article where Mark Heesen of the NVCA mentions that although Q4 2008 venture fund raising was slow ($3.4 billion down from $8.4 billion from the previous quarter and $11.7 billion from Q4 2007) that many funds raised earlier in 2008 and in 2007 and thus because of cyclical timing in addition to economical timing the Q4 raise number is expectedly low.
Mark Heesen is shedding some light on the VC market’s long term gains today in a report stating that the 10 and 20 year VC gains remain around 17%. Right now is a good time to be quoting long term gains in any industry 🙂