After a few weeks of email discussions and meetings lead by CED a local group of entrepreneurs and investors have thrown their support behind LaunchBox Digital and Triangle Startup Factory, two RTP based startup company incubators who will join forces under the LaunchBox Digital brand. I’m really excited to see the incubator model coming to the Triangle and starting with an established brand name with LaunchBox means that some of the early ground work has already been done. For instance, upon the graduation of recent LaunchBox Digital classes TechCrunch has provided good coverage and exposure for the graduating companies and their products/services. The announcement of LaunchBox starting up in RTP is no exception. I look forward to being involved either as a spectator, adviser, or mentor to the startups and the incubators as they work together to create the next great companies in this part of the country.
Through a series of comments this week the Venture Capital industry has proven once again to be a highly fragmented group of independent thinkers who will likely never play nicely with each other. A great article in the NY Times on the state of the Venture Capital market shows contending visions for the path back to glory… from removing firms from the market to adding firms to increasing investment and fund size to lowering it. And as you might imagine, they all think they’re right. Don’t we all?
What ever happened to raising money and investing the right amount in the right companies? It seems like all of the current debate is regarding the sweet spot of investment size and the sweet spot of fund sizes . In an industry that thrives on the ability to find a unique diamond in the rough and the savvy to understand and catalyze the creative class I’m surprised that they think it should be so simple. Really though, since the industry is broken, and they broke it, should they really be listening to their own advice as they try to piece together a solution? This all quite circular if you ask me.
Venture Capitalists are used to giving lots of advice. I think maybe it’s time that they sat down and asked some entrepreneurs (one of their customer bases) what they need. Oh… I think I’ve heard that exact advice in the VC boardroom before 🙂
- Financial partners who think operationally
- The right amount of capital at the right time
- Patient, level-headed board members
- VC firms made up of former company operators (up to a maximum of one Wall Street financial numbers guy among the partners)
- A clear understanding of the mutual expectations of the relationship
- What is currently the biggest opportunity in our market?
- How often will we talk about the business (daily, weekly, quarterly, annually)?
- How often will we receive advice from you?
- Are you providing money or leadership or both?
- Who exactly will you be introducing and promoting us to?
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:
- Q&A with Dixon Doll, partner at Venture Capital firm DCM, outgoing Chairman of the NVCA, and major contributor to the NVCA’s Four Pillar Plan.
- Press release announcing the NVCA Four Pillar Plan to restore liquidity to the US Venture Capital Industry. The release includes a nice outline of the four pillars that can be read in less than five minutes.
- Online version of the NVCA Presentation of the Four Pillar Plan to restore liquidity to the US Venture Capital Industry.
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 🙂
Since 2003 I have been following the local and national venture capital market from a distance. In the early years because of the possibility of using venture capital funding to further our growth at iContact and more recently as a source of growing capital and helping other North Carolina businesses along their paths to success. Since 2006 I have felt like venture capitalists in the Triangle area of North Carolina have been slowing down. A number of the funds that were actively pursuing technology investments 2-3 years ago seem to have gone silent.
Although my impression could just as likely be from a shift in their focus from information technology to bio-technology startups as I live entirely within the web tech startup world these days. I do know that most of these funds in North Carolina claim to have expertise in assisting both info-tech and bio-tech companies and most employ some sort of credentialed academic with a background in chemistry or biology to assist them in evaluating deals.
I read an article this evening in USA Today covering the new challenges of the venture capital industry. They mentioned the new landscape of startups that are now located all around the globe and highlighted DFJ’s strategy of putting small offices everywhere to increase their local-touch coverage. They also mentioned that the lack of venture backed IPOs in the second quarter of 2008 is further discouraging VCs and their limited partners, the people who give them money to invest.
As a few experts mention, venture capital funds are toiling with a strategy of long term growth that requires them to put more money over more time into their portfolio companies which means a few things. First, they won’t be expecting to get cash back from the proceeds of the sale of their companies quite as fast as they’ve expected in the past and second, with more money going into their companies assuming a stagnant or falling average fund size they will be forced to invest in fewer companies overall. This will of course result in them being even more stingy in their review of potential investment deals than before because they’ll expect to live with them longer and to have fewer alternatives in their overall portfolio in case things turn south.
The number of VC firms was also mentioned, with the total since the dot-com era being nearly 1,000. It’s incredible to consider the challenge that most entrepreneurs have in raising VC money considering the sheer number of opportunities available to them. Although, if you were to narrow this total number down by region and by specialty (information technology, bio-technology, clean energy technology, etc) and by the stage of company typically invested in (concept, pre-revenue, early revenue, expansion, long-term growth) I bet you would get a much more realistic picture of what we’re all up against as entrepreneurs and that is a small handful of VC funds within a two hour flight that have a clue what you’re talking about when you make your pitch. I’ll hold judgment on who’s fault that is 🙂
The also article took note of the emotional result of the challenges that VCs now face stating that “[n]ot surprisingly, venture capitalists are gloomy about the near future. ” It mentioned a survey done by University of San Francisco entrepreneurship professor Mark Cannice among VCs in the high tech corridor in California and that “[t]heir confidence last month fell to record low of 3.0 on the 5-point scale of the Silicon Venture Capitalist Confidence Index.”
With the economic uncertainly of the moment right now is a great time to get down to work building a great business behind the scenes. Looking for investment capital right now is going to be a challenge because VCs have to be very very careful where they place their bets. Build for the long term and build for the type of profitability that will allow you to fund your own growth. On the flip side, if you’re a growing company that is profitable or that has profitability in sight now may be the perfect time to raise venture capital under great terms. Firms that are traditionally more early stage investors are looking now to make investments in slightly more established companies that offer them a higher chance of survival at the cost of missing out on some tiny diamonds in the rough that might have provided them a 10X or greater return over the mid-term. As a growing, cash-flowing company focus on proving the predictability of your revenue streams and don’t lose sight of the fact that VCs need your growth in their portfolio. But also keep a version of your plan hidden in your top desk drawer that gets you through to IPO without any additional outside equity investments. If the VC market crams down any further in the next few years hunker down may be the name of the game for a while.
Widget maker RockYou who claims a reach of nearly 90 million users per month has raised another round of funding at a handsome valuation estimated at around $400 million. With a similar widget solution used primarily as way to creatively display and share images, audio, and video within a social network, Slide, a company founded by startup second-timer and Pay-Pal co-founder Max Levchin recently raised a round at $500 million. It makes sense that platforms with this type of reach should be worth a lot of money but from a traditional financial standpoint these valuations are way out there. RockYou is rumored to be on track for about $10 million dollars in 2008 revenue which sets the revenue-to-value multiple at 40x in comparison to other Software as a Service (Saas) companies being valued at closer to 10x fiscal 2008 revenue.
In search of companies with compelling technological solutions and a wide social network footprint it appears that investors are driving the price of social widget companies through the roof. In this case, unless there’s a potential acquisition negotiation in process that I don’t know about, it seems that a 30x additional revenue multiple premium is being created from future expectations on the potential of 90 million monthly uses. Although I don’t know the current estimations, I would assume that 90 million monthly users is still pretty insignificant in comparison to the total number of monthly worldwide social network users. If by chance it’s less than 1% of the market then I guess there is some pretty significant opportunity for growth here from top market contenders.
Going back to dot-com-era valuations which were in many cases based on exposure and activity, not revenue or profit, RockYou is currently supporting an enterprise value of $4.60/monthly-user (and Slide an EV of $7.80/monthly-user). Who would have thought that each time I load a MySpace profile and interact with a RockYou supported widget (by hitting play or clicking to answer a question) that I’m putting five bucks into the pockets of the RockYou team. Pretty sweet deal. Keep it up guys, other SaaS companies I know of need more of these great funding model comparables. I wonder what a company doing twice the annual revenue with 600 million monthly users is worth under this model? By revenue alone $800 million, or by exposure $3.7 billion.