VC in crisis for a decade: a reality that has been widely commented on and embraced, including recently and eloquently by James Surowiecki. I read elements of the equation all over the place and will try to bring it all together into a framework that I can relate to. I want to argue, without a hint of complacent for the change required, that venture capital is not dead and that the reinvention required constitutes primarily a return to our roots: it’s back to VC 1.0 … with a better dress sense and a Twitter account. Please read on.
ROOTS: Ingredients of a long crisis
The sixth Paradigm (go Sean!) or how “Connection Technology” changes the world: at the heart of the mess we are in, a fundamental long-term trend that has been going strong for 50 years and keeps accelerating. Call it the technology enabled globalisation, the world at the speed of light. As with all mega-trends, you overestimate the impact in the short-term (1999, year of the eyeballs) and underestimate the impact in the long-term. Why am I making this obvious point: the world needed a new, high-speed method of funding the type of innovation that provided the foundation for this change, and venture capital provided that. Look to clean tech for a similar mega cycle of boom/bust/massive impact (say: solar/smartgrid/non-fossil energy). If you want to think about it differently, for a while no one thought they could afford not to be in venture (read this for a recent take on this Pascal Wager).
First wave of mega successes and resulting poor diet: what better to create a major overflow of capital than some funds returning monstrously well. Benchmark’s 1995 fund had a TVPI of over 40, Matrix had two vintages in the 90’s at c. 20 TVPI, Accel ’96 had a similar performance !! From $11bn in 1995 US venture investment grew to $153bn in 2000, whilst fundraising grew from $14bn to $158bn in 2000. 10X returns drove 10X cash. No prizes for guessing what happened next.
Mega funds, Series A thru E, nano exits: it seems like many people feel it’s normal to do $6M Series A, $10M Series B, $15M Series C and so on (except if you are in semi, you have to). It may come to be seen as the habit of a lost decade of venture capital, a bit like the era of conveyor belt blockbuster movies in Hollywood (the blockbuster era started with Jaws and lasted 25 years). $35M is not the right amount of capital to raise for a software business that may one day sell for $500M but will most likely sell for $100M or go bust trying.
Nice management fees ! VC’s can sometimes be rational human beings too. So guess what happens: optimisation of a non-sustainable kind. The early, highly entrepreneurial VC crew retires or grows tired, and a new generation realises that making money is really hard but that since no one will find out for 10-15 years whether you are any good, might as well optimise the management fees in the meantime. Hence the glazed office, golf-playing, fund-raising venture capitalist that seems to inhabit public conscience these days.
If you assume venture folks are smart enough to spot good markets, you make it “the” aspirational thing to do for young bucks and you throw enough money at the wall by convincing yourself you cannot afford not to be in it, you will logically destroy the industry’s average return durably. QED.
CONFUSION: Venture 2.0 and its partial answers
1. VC is dead & long live the super angel
I am all in favour of super smart angel guys like Maples and Robin Klein and others building high optionality porfolio’s and using ecosystem (I was almost going to say … keiretsu, CMGI is back :-)) dynamics to source and support these business and I think this has an important role to play. It’s nice also because it puts the classic VCs on the defensive and helps with evolving the VC-Entrepreneur social contract. Hence I think it’s an important part of the solution. But don’t confuse Ultra Lean Startup with Ultra Cheap startup (via Steve Blank): having a financial partner that has follow on muscle does matter, and being a fund with no follow-on money makes it really hard to defend your portfolio and performance in a downturn.
2. Barbell BS
Barbell as a strategy is credible for the very few, and it’s overused and overexposed. In a tough market, focus on super-early or super-proven, and don’t touch a Series B. OK, so now late-stage deals get priced perfectly efficiently to allow you to make a (say) 8% return and you are supposed to make a great fund on that ? Or your early stage company has to enter a market where Series B is so disliked it gets priced down to zero, and somehow that will work ? I think it works well for the absolute best firms because they can either access the deals at discounted prices or have fab founder attraction in early stages, and their brand carries these companies through the middle rounds. But clearly, this is not a strategy for everyone and by construct it does not apply to “the industry”.
3. Late stage, late stage, late stage
Run for the hills, early stage is doomed, let’s focus on safe companies and don’t default. Gimme cash flow. Ability to create truly unfair differentiation in a late stage business is low. If you are disciplined and do this well it’s not a bad segment to be in, but returns should not be that amazing. If enough firms do that, perfect pricing will ensue.
Conclusion: if there is confusion, it’s because there SHOULD BE confusion. Venture is no longer a “pure” asset. I invite you to read the fantastic Peter Rip on this topic.
There is still a ton of money sloshing around. Read Fred Wilson’s “VC maths Problem“. Entrepreneurs may be distraught to hear this, but shrink further we will or at least should. New money being invested is still higher than money being returned, even though fundraising last year was “only” $17bn (US venture). Paul Kedrosky is probably the best advocate of further shrink, and I agree with him. And before you accuse me of trying to close the door behind us (after all we raised in 2008) let me tell you that I would continue to advocate very strongly for this even if I was on the firing line: the logic is inescapable.
The fundamentals of the business have changed. Technology is a quasi-commodity, the spread of ideas is instantaneous, competition is global, in other words the market is more efficient.
VC’s have damaged their brand and confused their customers. Read this great post from SagePoint Software or my writeup on the VC-Entrepreneur relationship and the Arrogant VC. Whilst I really don’t buy all the talk about VC’s not taking risk or not investing before product/market fit, we clearly have an image problem.
Finally exits are still M&A driven, and buyers know their stuff now. We live in an era of business-line sponsored acquisitions where the person championing the acquisition needs to define and hit some numbers for the acquired target. Sounds obvious, but there is a reason why median M&A nose-dived durably. Industrial buyers are cheapskates (again). Hard-nosed, tough and cheap. You’re going to need a bigger boat…
BACK TO THE FUTURE: Venture According to Me (Hey, I sound like Guy Kawasaki :-))
I have always had a fantasy of a really strong crossover fund where your public equity guys get informed by what the private startups can tell you about the evolution of order books and where a pure vertical focus delivers lasting alpha across asset classes. Even within that framework, my fit is on the early-stage side which is really what I feel best at. Since you cannot escape the maths (capital return and time to exit) and the market dynamics (loss of differentiation and commoditization), what you need is a niche strategy that you can excel at.
1. Focus, focus, focus: like a good startup, define a simple, well-understood product (i.e. an investment strategy) that the markets (LPs and Entrepreneurs) want and deliver on it flawlessly. Corollary: Death of the generalist VC. Long Live the “Personal Brand Thesis Driven GP” … like in the old days. Just keep evolving that brand !
2. Pick and shovel: show up and execute. Work the dealflow fanatically, meet, greet, think, argue, live and breathe your venture work. Pick and shovel also applies to startups: capital efficiency and ultra-leanness ethos.
3. Live in the real world: this applies to both entrepreneurs and VCs. Until you have a runaway business, be realistic about how much your business will sell for and how long it will take, and spend accordingly. If we live in a world of capital efficiency, let’s stop complaining about capital availability and build our businesses in a lean manner. When you DO have a runaway business, scale hard (yes, when to make that decision is really tough, I need to write on this someday).
4. Be a real lead investor: invest slowly and wisely in selected teams. Spend time, hone the product and team, execute carefully. Scale when you know what you’re doing. I am not discounting seed programmes by venture firms (I will write on the challenges of that approach separately) to add a sub-portfolio of options, but I do think together with Robin Klein that having your name and reputation on the line matters and is a core determinant of performance.
5. Embrace venture innovation: the fail-fast fail-early brigade is right. The crossover brigade is right. The super-optionality portfolio builders are right. Whilst clearly some will fail abjectly just like VC’s, all these innovations are fantastic tools to help surface investable businesses and to help entrepreneurs get a leg up. They fit the new market reality that we live in.
By the way that is not to say that I do not believe in late-stage (if that’s what you’re good at) or super-optionality portfolios (if that’s what you’re good at). I just think this will work for me/Atlas Venture provided LP’s are disciplined about investment amounts and we can kick arse within our area of focus.
In other words, let’s pick the best ingredients from around us for VC 2.0 Redux “a la Fred”:
– From super angels: a better social contract with the entrepreneur, global connectivity, speed, approachability
– From startups: simplicity, clarity, transparency, focus, leanness
– From the great venture capitalists of old: patience, discipline, consistency, true entrepreneurship applied to both venture and business building
– From our gut: passion, exuberance, irrationality, belief, conviction, and ultimately the money making intuition
I suspect venture capital was never meant to be an industry. I will leave you with a recommendation to read the Twilight of Venture Capital. Take it with a pinch of salt, because I think Bill is overly focused on tools and possibly not recognising where innovation is migrating, but I like the back-to-fundamentals approach.
I don’t think there is anything new or magical about what will make venture work for me. And I think we have a great future ahead of us. Old Skool is the New New Skool: it’s back to VC 1.0 … with a Twitter account.
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