From Dan Primack this morning, these factoids:
"More than half of venture capitalists (52.9%) believe that their industry is “broken,” according to a survey conducted by executive search firm Polachi Inc. Moreover, nearly 60% said that they are less confident in the VC industry today than they were six months ago."
You can read the full report here.
Having spent plenty of time bashing lawyers and the accounting profession, it’s only fair that I call out my own industry today. Y’all are really confused.
The Industry Isn’t Broken
VC isn’t broken. In fact, I would argue that there’s never been a more exciting time to be involved in venture capital. I’m highly optimistic. (Mind you that I’m a software / IT guy, so I’ll leave the cleantech and biotech opinions to others).
What’s not to like these days?
1. It’s never been cheaper to start a business with the advent of cloud computing resources, open source development environments and specifically today, low rents and the ease of hiring quality people;
2. Because of past successes, this country (as well as the rest of the world) is producing a lot of entrepreneurs. Today, more than ever, our college graduates are creating their own opportunities, not just working for the incumbents. These folks are scratching their own itches and creating companies of value (see everything from Facebook to Techstars);
3. We have more experienced entrepreneurs ever to fund. Given the maturity of the industry, it’s much easier to find folks who’ve "been there, done that." And with point 2, above, there has never been better deal flow and cool stuff to invest in;
4. VC is not a slave to credit markets or other systemic risks like other areas of finance. While the popular press has dramatized that investors are defaulting on the VC commitments, I’ve spoken to many folks who think this reporting greatly overstates the issue;
5. While the report says that nearly 70% of VCs are worried about their investor syndicate, this is something that should be in control of the individual VCs. I understand that some VCs syndicate for extra brainpower around the board table (a good thing), but many VCs syndicate simply to validate their investment thinking. This lemming approach isn’t good in its own right, therefore I don’t have a lot of sympathy for folks worried about it now;
6. We learned (or should have learned) a tremendous amount during the Internet bust period (2001-2004). The VC industry essentially got a "free pass" and instead of just being thankful, we should have learned a lot of valuable lessons about building Internet and software businesses. In short, we know how the next generation of companies should create value; and
7. Broadband, mobile connectivity and attention from advertisers exists today in ways that we envisioned 10 years ago, but finally is reality.
The Industry Shouldn’t Analyze Itself in the Short Run
The report says that the past 6 months has deteriorated VC confidence. What? With all due respect to John Maynard Keynes (who said "in the long run we are all dead"), who gives a shit about 6months? We are talking about an asset class in which each fund has a 10-12 year life span. We are also talking about an industry that has proved its best returns are usually made on companies invested into during a down economic cycle. Why shouldn’t we be excited about today? If history does repeat itself, we could look back one day as this time period being one of the best for investment.
In short, if you are making decisions in VC based on trends and noise in a 6 month time period, you are in the wrong industry. We need to be patient. You can’t rush success and you can’t bet on "what might be" 6 months from now.
Exit Markets
Alright, all you haters out there are probably saying "none of this matters Mendelson unless we have an exit market." And yes, clearly, we need to have a vibrant exit market for us to achieve our financial return goals.
That being said, I speak to bankers on regular basis who think we are on the cusp of a wave of M&A. They are on the front lines and one of them (who is normally the most pessimistic dude that I know) is practically giddy.
On the IPO front, it’s bleak, but we’ve seen a few companies get out and folks like the NVCA are putting their weight behind plans to restore liquidity in the industry.
Unless you believe the entire U.S. economy is game over permanently, these markets will come back and they will allow us to meet our financial objectives.
So, there you have it – why more than half of VCs (surveyed) are confused/deluded/misinformed, if indeed, this presentation accurately represents their views that the industry is broken. It’s not. Invest in good companies with great entrepreneurs, stay patient, make our your investment decisions and the rest will take care of itself. And if they still don’t like it, I’m happy to have less of them around – it certainly won’t hurt my business.
*** I’ve had several comments about the VC industry being broken given that it got too big and raised too much money. I don’t think this is a fact of a broken industry, rather this is a situation that will be corrected. The industry will settle into a steady state. This is a bad fact, but doesn’t mean the industry is broken. ***
Jason, you are right on the money. It's not the venture capital model that is broken. It is the distorted evolution of using "venture capital" to refer to strategies of $50-100M+ investments in late stage growth companies, requiring exits of >$1B just to beat the S&P500. Of course that only works in a bull market! Meanwhile, the world's need for innovation is growing, not declining. As Graham said, "In the short run, the market is a voting machine. In the long run, it is a weighing machine." Those who say the model is broken are just disappointed with the results of the most recent voting.
Comment by Trevor Loy — June 29, 2009 @ 7:13 pm
Great points Trevor.
Comment by Jason Mendelson — June 29, 2009 @ 7:18 pm
I think you are overlooking the most basic fundamental and serious point – there is way too much capital in venture capital. If $30 billion continues to be invested in/by VC every year (as it is now) there will not be anywhere near enough returns to justify the asset classes existance, and huge huge fees (management fees, not carried interest.)
To wit, if a VC contract is 10 years, then the VC fund has to generate 3X on the fund to justify its illiuidty and long time frame (otherwise the LPs should invest their dollars in bonds or some asset class far more liquid etc).
That means $90 billion has to be generated in exits every year
IMHO, NFW
Comment by Steve Kane — June 29, 2009 @ 7:33 pm
That doesn’t mean the industry is broken. That means this will be corrected and many folks will no longer to be VCs.
Comment by Jason Mendelson — June 29, 2009 @ 7:36 pm
Jason, I believe you are right for the most part. Many VCs (read the 52.9%) made foolish bets that haven't panned out and then doubled down and got burned again. The expanision of broadband and the explosion in social media have given the IT investors all sorts of new things to play with. As a biotech voice, however, things are tighter than in the IT world. You still see the big names investing with the entrepreneurs who have "been there, done that", but more importantly have made money for past funds. A good example is Clovis Oncology, right here in Boulder, that raised $145M on the come, essentially. That's what an exit of $2.9B will do for you. Like IT, the biotech ideas are spewing forth and technology is moving faster and faster. However, the capital commitment required to get there is huge and as a result some really great science is going unfunded. VCs don't have the patience for a 8-10 year development plan anymore and the feds haven't figured a way to help beyond the initial grant stage. Nevertheless, it is deal flow in the end and that counts and whether it is IT, biotech or cleantech, a win is a win for the industry.
Comment by mikehartcxo — June 29, 2009 @ 7:51 pm
Maybe you should re-title the post 47.1 percent glass half full.
Good post
Although I agree with your points above (about best time to start a company), it is absolutely the hardest time to get funded in all of my years on the startup streets since in 1997. It's an absolute mess out there and many entrepreneurs are losing confidence in VC.
I like your long run" angle. On the investing momentum I'm just not seeing it. It is a perplexing time.
To me I agree with your view about opportunities are great now so a good filter is to look around and see who is actively venturing…that speaks volumes of who is in touch and who is milking mgt fees..
Comment by John Furrier — June 29, 2009 @ 7:54 pm
I agree that funding is difficult. Probably b/c more than half of the VCs are freaked out according to the report.
Comment by Jason Mendelson — June 29, 2009 @ 7:59 pm
I agree with John, and I am curious on how many entrepreneurs think VC is broken, my guess is it's much higher than 52.9%.
I have never had to have so many meetings in my life as I have had to recently to raise capital. And it looks like I still have a lot more to go before I'm done.
Personally, I feel VCs and Angels are holding onto the cash a bit too much.
Comment by Joel Strellner — June 30, 2009 @ 12:01 am
I agree. Only 52.9% of the industry is broken. Which half are you, oh I mean me, in. Hmm, I'm up late at night posting. Does that mean anything?
Comment by Jeff Bash — June 30, 2009 @ 5:47 am
Dead on. Its all in the use of the capital. VC was never intended to be deployed at 50 and 75 million dollar clips. The essence of venture capital was to help fund the early life-cycle of high growth companies. Billion dollar funds can simply not deploy effectively to return the kinds of multiples that investors are expecting over the long haul. Sure the internet bubble forced this issue as capital was pouring in, but it is our responsibility to shepherd the industry for the long haul. Opportunities are excellent right now and the industry will change as new entrants come with different models.
Comment by Geoff Schneider — June 30, 2009 @ 3:28 pm
If VCs made such smart bets at DIY social media and the likes, would you mind point me out to a single exit other than a trade sale to deluded mega company engineered by well-connected VCs with ties to acquirer's board (e.g. Skype to eBay, MySpace to NewsCorp or YouTube to Google)? A few years ago, some forlks got burnt to over $1bn at Vonage – a perfect example of a business all buzz and all in red. Is it what you advocate as a viable VC model? If so, it is not a mass model – only a few chosen can practice it.
Comment by Papasik — June 30, 2009 @ 5:12 pm
I’ve never been involved in an “insider” deal as you point about and don’t think that you need to sell a company for $1bn to make a great VC return. For me, it is about investing in capital efficient businesses that create great technology and usually sell and sometimes go public.
Comment by Jason Mendelson — June 30, 2009 @ 5:20 pm
Correct me if I am wring, but VC returns of the last decade published here http://www.pehub.com/43145/did-vc-fund-size-cuts-... do not look great at all. A money market account would yield more.
Comment by Papasik — June 30, 2009 @ 6:24 pm
Interesting comments. I think there is more to it than simply "VC is broken" or "VC is not broken". I have spent 20 years working in start-ups AND as a VC. I've seen it from both sides of the table. In my opinion, VC as a concept, on paper, is not broken. But the times have changed and the people who implement it are not the same as when the concept was conceived. VC is like an old law that is still "on the books"….it may not be broken, but it might not be appropriate for the times and should be updated. An imperfect analogy might be "gun policy". 100+ years ago, it was common for adolescent males to be proficient in responsible use of firearms for both food and sport. Nothing was wrong with that "gun policy". But in today's environment, can anyone imagine what it would be like to have wdespread accepted use of firearms by 14 year-olds in LA, NY, DC, or yes, even in some of the more rural areas. Times change and rules should change.
Now, before everyone gets themselves in a fuss, here are some points:
Comment by Anon — June 30, 2009 @ 7:01 pm
1. First of all, there will always be some VCs, say the top 10%, who, because of brand equity, will still be able to do VC as they see fit (i.e. by their own rules, etc). These folks live in their own world (bubble?), and will likely continue to have success since they have good experience (most likely) and because of their "brand" they will tend to have first choice at the best oppportunities.
2. There are WAY too many VCs. But there is no easy was for the market to sort itself out and regulate this in an easy and quick way. Fund cycles are long, so 'bad' VCs are going to be around for a while, and even if you assume the market will sort it out these people can cause alot of damage along the way. There are just not many 'GOOD' VCs out there. Too many MBAs without operating experience who try to financial engineer a return. (More on this financial engineering later). The best solution here would be some kind of licensing procedure to self regulate the VC practice. Otherwise, how do you limit the nmber of VCs? You can't tell LPs that they cannot invest in the class, so it is better to limit the supply of VCs. (OK, this is just an idea…..)
Comment by anon — June 30, 2009 @ 7:01 pm
3. I get a kick out of the lack of perspective by so many people who comment on the way that VC should be now. Hey, people, the investment class of 'modern venture capital' is only about 30-40 years old. As everyone knows fund lifespans are 10-12 years. It is completely within the realm of possibility (and certainly in my opinion, more realistic!) that there will be certain gyrations and swingsof the pendulum back and forth until the proper balance (or more likely range) of LP interest, VC activity, gov't regulation, etc. is found. Folks who say that VC is fine and we should do it like we've done it before, really don't know that because the industry (and I am again talking about modern VC) is just too young!
Comment by Anon — June 30, 2009 @ 7:03 pm
4. Financial engineering returns. For all the younger VCs who say that 'VC is not broken', in my opinion, they need to understand some key differences in how things work these days. Before all the wild gyrations in markets these days, VCs behaved a little differently than they do now. When less money and fewer VCs were in the business, we took more risks. We actually understood that, "Hey, we might lose our shirts on this invest if things don't work out". But when things went well, we got rewarded. Now, there is too much money and too few value added VCs in the industry. This uneducated competition forces VCs of all ilks (both "good" and "bad") to try to financial engineer their returns so that they can appear better (or less bad) than their vintage year peer group. As this practice advanced, more and more was taken out of the hide of the entrepreneur. (And yes, I'm a VC saying this….) The entrepreneur today is at a significantly more disadvantaged position relative to their investors than anytime I can remember. And frankly this is unsustainable. Which leads me to my next point…
Comment by Anon — June 30, 2009 @ 7:03 pm
5. Who needs VC??? I must admit that, especially on the IT side, costs of starting a business have dropped so significantly that I am actually talking to entrepreneurs about not using venture money at all. Capital requirements have driopped significantly. Really good VCs are too hard to find. Bad VCs on your board are too meddlesome. This is actually a time for "good" entrepreneurs to skip this investment source entirely. I fear that we have brought some of this on ourselves because of our own behavior, but I must say that if I were starting a company in this environment, I would be talking more to angels or strategic partners/industry, rather than put up with the VCs that I see in practice these days.
Now go ahead…flame away….
Comment by Anon — June 30, 2009 @ 7:03 pm
I think it’s great that folks can do it without VCs. This means that people will come to VCs who can help them build a business and be a good partner, not just because they need the money and I think that only helps the VC model.
Comment by Jason Mendelson — June 30, 2009 @ 7:06 pm
Problem is, the VCs who REALLY can be a partner and help build a company are few and far between.
Comment by Anon — June 30, 2009 @ 7:13 pm
I’m happy to hear that. J
Comment by Jason Mendelson — June 30, 2009 @ 7:34 pm
Then you and I have different definitions of "broken". If 50+% of VCs think their business is broken, I read that to mean that 50+% of VCs have business models that are unworkable given the assumptions on which they were built. When the majority of participants in an industry think it is broken, isn't it broken?
All of that said, if I'm part of a 3-5 person team with a $50-$150mm fund focused on low-cost software and information services companies I'm a very happy camper right now. But "the industry" (writ large) is not in that position, and is broken.
Comment by just.a.guy — July 1, 2009 @ 2:35 am
Lots of good debate points. I think the one fact that we need to remind ourselves of is that all business models must evolve or they die. Top of mind, if we did a sample survey of top execs from many industries today, a majority would tend to admit that their business model is "broken"…just look at Big Auto, Banking, Real Estate, Big Law
… and you will catch my drift here. I am far from an expert in the VC business model but I do follow some of the trends. Clearly the VC model is evolving, often by choice and sometimes by Darwinism..take a look at what Andreessen and Co. are up to now…..somebody must believe in thier "new" approach to the VC business model (IE a super angel fund approach…yep, what's old is new again)…http://www.businessweek.com/magazine/content/09_2...
The VC model will continue to evolve, and a good percentage of the existing funds will not be able to switch gears fast enough…and will crash and burn, while those that do will own a larger part of a "smaller market"….In with the new rules (for the VC biz model) and out with the old…
Rock On,
Frank
Comment by Frank Greces — July 5, 2009 @ 11:49 am
PS In rereading Susskind's "The End of Lawyers?"he talks about the "Technology Lag" (the gap between Data Processing and Knowledge Processing); bottom line, we have become very good at using technology to "capture, distribute, reproduce and disseminate information" in the form of data (otherwise known as DP), but now, in addition to all of the points that Jason bulleted above, we are becoming adept at Knowledge Processing, or building (often through entrepreneurial startups) tech platforms that allow us to "analyse, sift through and sort out the mountains of data that we have created". Think "glue" to use one of Feld's favorites. Susskind sums it up by stating that, "when knowledge based technologies allow us more effectively to manage these mountains of data…we will experience a paradigm (shift), moving from a print-based industrial society, to an IT-based information society"….one just need to look at the newspaper industry (another broken model; but that doesn't mean that we won't have access to our daily news over coffee every morning, right?) to witness this shift.
F
F
Comment by Frank Greces — July 5, 2009 @ 12:01 pm
Great Susskind reference. Yep, it totally works
Comment by Jason Mendelson — July 5, 2009 @ 3:42 pm
I cant resist – this is a perfect comparison to US auto industry when all the big ones were betting on SUVs, Hummers etc. and suddenly the market trend was toward Toyota Prius and the big ones had not taken this in consideration in their plans at all.
Can we say auto industry is broken? Yes and no, depending on who (and in what part of the world) are you asking..
Comment by valto — July 10, 2009 @ 11:30 am
amen – we have been working on "fixing this" for the past year already, and have launched our private beta about a week ago, this gives some hints on what's comming, but our full vision of the new model will be released by the end of the year.
Comment by valto — July 10, 2009 @ 11:36 am
[...] Every once in a while, I read something and go "huh?" The most recent was the report that 52.9% of venture capitalist think that VC is broken. [...]
Pingback by Should Venture Capitalist Sell Out To Secondary Firms? | Mendelson's Musings — July 20, 2009 @ 12:04 pm
a really good article, very interesting..
Comment by chris — July 23, 2009 @ 11:45 am