VCs are an asset to the U.S. economy, yet they need to adapt as well. More deals in less cash intensive operations and lower expectations ($50MM rev, 5-7 years to get there). How to do it? Much , much lower valuations. That should be the founders contribution to fixing the mess - letting the VC in with $3M - $5m in series A for 40% - 45% of the company.
tspeirs
· 1 year ago
Not sure the model is broken. It is just going through traditional economics of supply and demand. During a period, VC funds offered higher than average returns. This drew in additional capital. As you pointed out, this increased the fund sizes and dollars chasing deals, thus reducing the returns. As the returns drop relative to other asset classes, we will see money leave these funds. Over time, the market will stabilize.
Michael F. Martin
· 1 year ago
Ressi has some good points. Although it's never been cheaper to communicate with a large audience, private investment is still confined to a relatively tiny set of networks.
The problem is that these networks are protected from competition with any real alternative means of financing by... the SEC. The rules for private placements effectively prevent entrepreneurs from leveraging new technology to their advantage in reaching out to potential investors. Until the SEC rules change, not much is going to disrupt the power structure within VC and PE.
On the other hand, I think the serious mismatch between the supply of new product ideas and the supply of business teams to execute good ones is going to get corrected by investors with a renewed focus on IP.
elliottdahan
· 1 year ago
Yes, the VC model is broken. But, let's work on the assumption that the VC industry is really is loosely segmented into 2 parts: Seed level investing ($250K +/-) and Series A/B +++ investing (let’s call this the “traditional VC industry”).
As for the traditional VC industry - It is real hard to upset folks who are pulling down big bucks cashing in their 2% management fee checks. And, it is real hard to upset folks who sanctify those who have sold profitless companies to overvalued companies. The first problem to be solved must be the Business Model/Economic problem.
The answer is in realigning the Business Model/Economic part of the traditional VC industry. The answer to the Economic part of this problem is based on the same solution to any Buyer/Seller negotiation – somewhere between Adam Smith’s “self interest and division of labor” and the Wayans’ Brothers “Mo’ Money.”
The most broken part of the Venture Capital Industry is the Seed level. And, in addressing the needs and opportunities of the Seed level of the VC industry, you also reform some of the broken parts of the traditional VC industry - Series A/B through Equity Event.
The data shows Angels investing more dollars – but in fewer companies. The data shows Angels investing more and more in follow on rounds. The data shows that traditional VC firms recognize the Seed Funding problem by setting up in-house “seed” funds such as Charles River’s “Quickstart and offerings from Venrock, Battery and others.
At the same time, the data shows, as Mike Maples said, “$500,000 is the new $5 million.” By solving the problems of Seed level investing you bring stronger companies to traditional VC investing with less money. You bring companies to traditional VC investing which can negotiate on a much more level playing field.
The solution to realigning the Venture Capital industry so that the Seed level efficiently does what it is supposed to do require addressing 3 areas:
1) How do you Source good Seed level companies and provide post-investment oversight in a cost justifiable manner. Sure can’t do it by having entrepreneurs email in their business plans to the high rent / high compensation offices of the traditional VC? The Seed investing business model is different than the traditional VC investing business model – simple as that.
2) How do you generate investment in the large number of strong Seed companies needed to make Seed Funding a viable business and not either a Hobby or a Public Relations gambit? How do you overcome geographic constraint?
3) How do you change the attitude of “Entrepreneurs Genuflect while VCs Pontificate?” – most entrepreneurs would either have a root canal than see a VC or suffer from Stockholm Syndrome and are actually thankful when a VC returns a phone call.
The Business Model/Economics of traditional VC investing will not be fixed until the Seed investing level is fixed. The Business Model/Economics of traditional VC investing will not be fixed until VC firms truly understand the concept of vertical integration and division of labor.
The Business Model/Economics of traditional VC investing will not be fixed until traditional VCs understand that 2 separate entities must be established: (1) a Seed Fund which works with and supports the Entrepreneurial Community and (2) a traditional Venture Capital Fund which brings companies to an equity event.
Stop trying to force the needs and opportunities of Seed level investing into the rules and requirements of traditional VC investing and vice versa.
What is needed is a Seed Fund that works with, supports and compensates the Seed Infrastructure (Incubators, University Tech Transfers, Economic Development Agencies).
The solution can be found in the powerpoint presentation for The START Fund.
scott
· 1 year ago
I actually don't think VC's are to blame at all. It's the institutions that are to blame, if anything... Sure VC investments are risky; however, VC's don't have the money to say yes to 25% -- If you want things to change, go to the government, go to Calpers or any of the big money pots and ask them to increase their VC allocation :-)
That's cool he created a slideshow to demonstrate his idea. But ideas are worthless. Act.
hypermark
· 1 year ago
Crisp narrative, Matt.
I been plugged into three major financial crashes during my career (S&L Crisis, Internet Bubble burst, Now), and the one consistent thread that I have seen is that whenever there is an excess supply of capital, it will inevitably be deployed in inefficient and (ultimately) destructive manners. Period.
After all, who among us has the discipline to say "ENOUGH" when the funds are available on favorable terms, our comp is tied to same, we are fundamentally optimists and we have enough proof (based on past performance) to suggest that we can hit the ball out of the park in a game designed for homerun hitters?
Hence, even if your/Kagle's conclusion is right, less clear is what the post-implosion world looks like.
Fewer mega-funds doing deals the same way as today, smaller funds designed for scaled down liquidity prospects…?
davemc500hats
· 1 year ago
excellent piece matt.
(and good commentary by Elliot Dahan above, altho i disagree with some of his conclusions).
i think elliot is correct to segment & analyze performance of seed-stage investors separately.
the real problem / opportunity is that: 1) only big VC funds are broken; small ones can do very well 2) however, most small funds & angels have the same crappy filtering & selection as big funds 3) seed funds / small investments (<$2-5M, ideally $250K-$1M) with appropriate selection can have excellent returns
most VC funds have been raising larger & larger amounts fo capital, while the capex rqmts for startups have been getting ever smaller & smaller, and exits while more numerous have also been getting smaller & smaller (more smaller M&A, less big IPO). the VCs are *way* out of whack with market realities, and have not adjusted their fund size or investment size to match.
small seed funds that invest $250K-$2M, and who are quite happy with exits in the $10-50M range, will do very well in this new market environment (assuming their investment selection is good, and their niche expertise is helpful). these folks -- Mike Maples, Jeff Clavier, Ron Conway the incubators like Y-Combinator, TechStars, SeedCamp, and a few larger VC funds like First Round & Union Square Ventures -- are positioned to do very well in this new structure.
Brand-name Big firms like Sequoia, Benchmark, Accel & a few other will probably still do well also, but everyone inbetween is going to get creamed.
hard.
elliottdahan
· 1 year ago
Dave -
Thanks for reading my post. You write "altho i disagree with some of his conclusions" - which conclusions ? I'd like to have as defensible a presentation as possible - I'd als0 like to leap tall buildings in a single bound.
Your point about smaller funds doing better makes a lot of sense to me. I think the community would be well-served to see a return of the evergreen fund with smaller pots. That way, the incentive is not in asset gathering to mooch off the management fee but rather to generate great returns. Returns are greatest in the seed stage, even if your scenario of smaller exits with increased frequency remains true.
sudeep
· 1 year ago
I think point #2 is right on the money. Too many mee-too firms gets funded and this casuses wasted investments.
Like all asset classes, VC industry has attracted too much capital to be allocated prudently. The shakeout is long due
John Furrier
· 1 year ago
The only thing broken about VCs is the lack of liquidity which causes the junior VCs to freak out when ventures don't go the way that they "think".
Dave: You forgot to mention True Ventures who are doing quite well and actively investing.
I predict that you'll see some reform in VC in form of a new kind of firm around some of the capabilities that Dave talks about. In general the capital markets (which the VCs are) are a good thing. No liquidity is a bad thing and has a 'trickle down' effect.
Allan
· 1 year ago
John,
I think that reform you speak of might come in the form of a return to evergreen funds that do not have a limited lifespan. They will also be smaller as Dave McClure suggests. This will keep the focus on sustainability and generating consistent steady returns rather than the big VC model of gathering as many assets as possible and living off the management fees while having to chase big deals in order to put sufficient money to work. I was part of the founding team at the largest student-run venture fund and we were lucky to have had two billion dollar IPOs on the NASDAQ and we found that managing a smaller pot was more feasible and forced us to invest selectively with discipline.
Susanna K.
· 1 year ago
I agree that the VC network seems to be highly localized. There's Silicon Valley, Boston, NYC, etc. If you're trying to develop something outside one of the main geographic areas, you're outside the network, and pretty much invisible.
Diogenes
· 1 year ago
Unfortunately institutional investors go on auto pilot in their continuing funding of bad VC firms -- especially the super-sized ones. In particular, Stanford is and will be one of the particularly unfortunate ones with its dependence on the VC asset class.
In addition, when was the last time you met a truly innovative VC? More like a herding sort of beast than an original thinker. The VC industry is starving for both entrepreneurs and VCs that actually *do* think outside the box and will take the heat for it.
mdangear
· 1 year ago
The VC model is broken indeed, thank you for bringing it up. I discussed it in my blog ("the end of an era" one year ago - http://bizcoach.blogspot.com/2007/10/are-vcs-de...) and I agree with Eliott earlier comment that where the issue is most critical is at the seed level, this is where we need to focus if we want to fix the system, and this is where we can make the biggest impact, because entrepreneurs are the one who will fix the world issues that we face. This is why I have been focusing on the Entrepreneur Commons (http://www.entrepreneurcommons.org), and I see the current crisis as an opportunity to finally get people's attention on the issue. Because as Diogenes points out in the previous comment, LPs have kept things on auto-pilot so far, and for a good reason: VC investment is "alternative investment" for them, crumbs in their plate really, and they have much bigger issues to deal with (see my post "$20B crumbs" http://bizcoach.blogspot.com/2008/07/20b-crumbs...). We should feel lucky that all this is happening, it is time for change, a time for opportunities if we know to react smartly.
Sarah
· 1 year ago
The problem isnt that VCs are Harvard MBAs, the problem is that the companies are being founded by 26-year-old Harvard MBAs.
It used to be that tech companies were founded by geeks who created a cool technology and got funding to take it big time. Now, we have an annual migration of MBAs heading West to get their class project funded. TechCrunch and Demo are positively choked by all that crap. And see Cyprus. 26-year-old MBAs should not be funded, as a rule, unless their pet project actually gets momentum first (ala Facebook). We're not running a babysitting agency here.
The other thing is VCs need to stop relying on EYEBALLS. What is it 1999??? One well-known Web 2.0 company that told me in a BD meeting that their investors only cared about traffic numbers, not monetezation or revenue plans (when I asked). Advertising is not the way. Insist on products that someone might actually want to buy. I know that sounds shocking, but...
That's the one good thing about this bust. Those kiddies head back to whatever midwestern town they originally hailed from before professors and alums filled their heads with Tesla dreams, and the geeks get back to innovating. I'm seeing some cool stuff happening in garages all over the Bay, no MBAs needed. I hope the VCs are noticing.
The venture capital business is fundamentally a financial services business. My belief is that like most other financial service sector industries now, it will be forced to consolidate and shrink, due to under-performance. There is still too much money chasing too few deals that will ever exit for decent returns.
mdangear
· 1 year ago
Actually you are right that VC have evolved towards being financial guys, when really they should not. Vinod Koshla said it all in a recent interview (http://venturehacks.com/articles/khosla-society): >> We make money by building entities over the long term. We’re not in the business of transacting or doing deals. We don’t even allow that word here. It’s not buying and selling, that’s a transaction. You don’t invest in something and say I can sell it tomorrow or next year. We take a five year, ten year view and say we can build a company that can significantly change the landscape. << VCs should be about building businesses, not being financial guys. This is what got the system broken, and this is why they should to go back to the original model of working with Entrepreneurs to help them build their business if they really want to do it right. Back to helping rather than profiting from entrepreneurs, and back to seed rather than later stage.
samwhitmore
· 1 year ago
He may have secured an audience at HBS but someone should tell Ressi that "canary" ends in a y, not an ie.
Greg
· 1 year ago
To me it looks like companies get more caught up in funding than creating something people will pay for.
Ellen
· 1 year ago
I don't think the VC model is broken per se, it's that VC's tend to approach investment opportunities through a limited - financial and technology - set of perspectives. Investments are typically made based on business models driven by new technology or new uses for technology. While this has worked in the past, the market is too saturated for this to work any longer.
VC's (and the entrepreneurs looking for funding) need to learn to identify the true needs of their markets, then then develop solutions that satisfy those needs. Some are fairly good at identifying market needs, but where I see it fall down again and again is in the inability to translate those needs into a viable offering. This requires an understanding of how end-users will perceive the offering, rather than what they say they want or like. Consumers are too empowered now to work around product or technology deficits.
I've been doing this work for a long time and have helped large companies who make tangible products and services to reap billions of dollars in new revenue. Yet when I talk to VC's or entrepreneurs about this, it usually falls on deaf ears. I think Greg hit it on the head - they are too caught up in funding than creating something people will pay for. I would add that they also get too caught up in perfecting the thing they are making, than honing and communicating the value it will provide.
We need VC's to get better at this. When and how can we get them to listen?
Hank
· 1 year ago
sarah- your comment about kiddies heading back to "whatever midwestern town they originally hailed from" is indicative of what is wrong with this business... far too many in the self absorbed "Bay" have this attitude. Get off your holier than though asses and find companies and ideas that solve problems, fill needs, etc. not just some lame new gadget that only "cool" people like you will pretend to care about for a minute or two.... or you will all be eating government cheese. And deservedly so.
Robert
· 1 year ago
I think John hit the nail on the head earlier when he said "There is no liquidity."
There hasn't been a great IPO market since before the 2000/2001 bubble burst. So it's kind of M&A or bust, and now we are in a recession and it's tough to justify buying Facebook for 10 billion (I would imagine).
Which means that all these hot startups with huge valuations have a problem. No IPO market + shrinking M&A pricetags means all you can do is hang around and wait until it gets better.
Could they find buyers hypothetically? Sure. But not for 500 million to buy a widget.
VCHack
· 1 year ago
Oh please - how the hell is a VC who spends money on behalf of others now attributing themselves to be the drivers of the US economic value creation. Tim Draper and his cohorts should take a close look at the mirror and realize that they are nothing but a post-box system transferring money from an investor to an idea creator.
Btw, economic circumstances have changed too such that smaller companies are able to go much further on their own....so much for VC assistance....the last time I heard advice on my business from a stuffy HBS grad VC, who by nature of being an MBA, has no risk-taking capibilities, I nearly died of laughter on how off market and non- operational he was.VCs are only talented in one thing - "buying" their way onto other peoples' Boards with other peoples' money.
Matt
· 1 year ago
I agree very much with the overall theme of this presentation and commentary, VC is "broken". However, I strongly disagree with the conclusion that we actually need fewer, "better" VCs. In my view, part of the reason that VC performance has become so stale is that the compensation system for venture capitalists drives them ever upward in terms of fund size. If they have success with a "small" fund they will raise a larger one.
A friend just recently closed a $250mm fund after being part of several smaller funds. Over dinner his comments to me were essentially that the partnership did not actually expect they would make returns in this new, larger fund. But, on the other hand, the 3 partners would be splitting over $8mm per year in fees between the various funds. He is activity investing in real estate on the side. Have any of you ever met a VC partner that wasn't "rich"? The data would indicate that the majority of these people are not making money for their investors?
In general, I believe it is much harder to make good returns with larger funds. If a company is raising $50mm there will be intense competition by investors trying to get money to work. On the other hand, in today's environment, if a company needs $3mm they are dead in the water no matter how good the company and deal. So few investors are doing those deals. For a fund group with $500mm under management a 10X return on a $3mm investment just doesn't "move the needle" and it isn't worth the hassle.
So, I think the right answer is that the groups that invest in funds need to think hard about sponsoring the next generation of fund managers. We need to create 10 $50mm funds for every one $500mm fund. I know this will be difficult because pension funds are massive and it is tough to deploy into small funds. But, if we don't somehow restart the "farm team" system I fear the end of venture capital is not far off.
JDD
· 1 year ago
Matt - you should talk to Paul Deninger at Jefferies/Broadview – he agrees that there is far too much VC money chasing a few good deals here in the U.S., and I believe he has stats showing that European VCs have a much better “asset class ROI” than their U.S. counterparts. He was emphatic about it on a panel discussion I attended a few months ago.
harryy
· 1 year ago
VCs are financial intermediaries. As such, there are two sides to the equation: the entrepreneur side and the investor (LP) side and each has a role to play in the system. While the entrepreneur side knowledge base developed over the last 20 years tremendously, the LP side remains almost unchanged, despite the fact that LPs have the higher stake in the success/failure of VC backed companies.... Clearly, this is the broken component in the system, inducing its inefficiency to the other side too. I don't think the system is broken but is clearly not optimal and now is the right time to fix it. Debates like these (Adeo, Matt and al.) are essential to trigger a change, even if the optimal equilibria is not clear.
Maxwell
· 1 year ago
"Too much money has swept in, with too few deals to accommodate it. This has distorted the economics badly. Valuations are driven up for the good companies, making it prohibitively expensive for VCs to invest. Everyone loses."
You touched on the crux of the issue right there, but it applies to the financial industry as a whole and not just VC. Capital is overvalued and the new bubble. While investment in human capital (the infrastructure that makes people more productive has been in steady decline for the last half century.) There is a magic formula of capital + labor + innovation (technology and entrepreneurship) that equals success. Developing and empowering our human capital for long term success has taken a back seat to throwing money around to the point where there is no longer return on investment for the most part.
Adeo
· 1 year ago
Here are some further thoughts on the presentation and the VC model in a written form:
I'm so glad that we we are working to make some change in this field. with Grow VC. www.growvc.com will be more than current VC or Angel business model on steroids. Grow VC will break the mold and restructure a new better working model for new international start-up ventures. Grow VC will change the way new ventures will be funded...
Dereck
· 8 months ago
One way or another capital will make some flow changes, but in the end will find it's interest. Always have been, always will.
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All Comments
During a period, VC funds offered higher than average returns. This drew in additional capital. As you pointed out, this increased the fund sizes and dollars chasing deals, thus reducing the returns.
As the returns drop relative to other asset classes, we will see money leave these funds. Over time, the market will stabilize.
The problem is that these networks are protected from competition with any real alternative means of financing by... the SEC. The rules for private placements effectively prevent entrepreneurs from leveraging new technology to their advantage in reaching out to potential investors. Until the SEC rules change, not much is going to disrupt the power structure within VC and PE.
On the other hand, I think the serious mismatch between the supply of new product ideas and the supply of business teams to execute good ones is going to get corrected by investors with a renewed focus on IP.
As for the traditional VC industry - It is real hard to upset folks who are pulling down big bucks cashing in their 2% management fee checks. And, it is real hard to upset folks who sanctify those who have sold profitless companies to overvalued companies. The first problem to be solved must be the Business Model/Economic problem.
The answer is in realigning the Business Model/Economic part of the traditional VC industry. The answer to the Economic part of this problem is based on the same solution to any Buyer/Seller negotiation – somewhere between Adam Smith’s “self interest and division of labor” and the Wayans’ Brothers “Mo’ Money.”
The most broken part of the Venture Capital Industry is the Seed level. And, in addressing the needs and opportunities of the Seed level of the VC industry, you also reform some of the broken parts of the traditional VC industry - Series A/B through Equity Event.
The data shows Angels investing more dollars – but in fewer companies. The data shows Angels investing more and more in follow on rounds. The data shows that traditional VC firms recognize the Seed Funding problem by setting up in-house “seed” funds such as Charles River’s “Quickstart and offerings from Venrock, Battery and others.
At the same time, the data shows, as Mike Maples said, “$500,000 is the new $5 million.” By solving the problems of Seed level investing you bring stronger companies to traditional VC investing with less money. You bring companies to traditional VC investing which can negotiate on a much more level playing field.
The solution to realigning the Venture Capital industry so that the Seed level efficiently does what it is supposed to do require addressing 3 areas:
1) How do you Source good Seed level companies and provide post-investment oversight in a cost justifiable manner. Sure can’t do it by having entrepreneurs email in their business plans to the high rent / high compensation offices of the traditional VC? The Seed investing business model is different than the traditional VC investing business model – simple as that.
2) How do you generate investment in the large number of strong Seed companies needed to make Seed Funding a viable business and not either a Hobby or a Public Relations gambit? How do you overcome geographic constraint?
3) How do you change the attitude of “Entrepreneurs Genuflect while VCs Pontificate?” – most entrepreneurs would either have a root canal than see a VC or suffer from Stockholm Syndrome and are actually thankful when a VC returns a phone call.
The Business Model/Economics of traditional VC investing will not be fixed until the Seed investing level is fixed. The Business Model/Economics of traditional VC investing will not be fixed until VC firms truly understand the concept of vertical integration and division of labor.
The Business Model/Economics of traditional VC investing will not be fixed until traditional VCs understand that 2 separate entities must be established: (1) a Seed Fund which works with and supports the Entrepreneurial Community and (2) a traditional Venture Capital Fund which brings companies to an equity event.
Stop trying to force the needs and opportunities of Seed level investing into the rules and requirements of traditional VC investing and vice versa.
What is needed is a Seed Fund that works with, supports and compensates the Seed Infrastructure (Incubators, University Tech Transfers, Economic Development Agencies).
The solution can be found in the powerpoint presentation for The START Fund.
That's cool he created a slideshow to demonstrate his idea. But ideas are worthless. Act.
I been plugged into three major financial crashes during my career (S&L Crisis, Internet Bubble burst, Now), and the one consistent thread that I have seen is that whenever there is an excess supply of capital, it will inevitably be deployed in inefficient and (ultimately) destructive manners. Period.
After all, who among us has the discipline to say "ENOUGH" when the funds are available on favorable terms, our comp is tied to same, we are fundamentally optimists and we have enough proof (based on past performance) to suggest that we can hit the ball out of the park in a game designed for homerun hitters?
Hence, even if your/Kagle's conclusion is right, less clear is what the post-implosion world looks like.
Fewer mega-funds doing deals the same way as today, smaller funds designed for scaled down liquidity prospects…?
(and good commentary by Elliot Dahan above, altho i disagree with some of his conclusions).
i think elliot is correct to segment & analyze performance of seed-stage investors separately.
the real problem / opportunity is that:
1) only big VC funds are broken; small ones can do very well
2) however, most small funds & angels have the same crappy filtering & selection as big funds
3) seed funds / small investments (<$2-5M, ideally $250K-$1M) with appropriate selection can have excellent returns
most VC funds have been raising larger & larger amounts fo capital, while the capex rqmts for startups have been getting ever smaller & smaller, and exits while more numerous have also been getting smaller & smaller (more smaller M&A, less big IPO). the VCs are *way* out of whack with market realities, and have not adjusted their fund size or investment size to match.
small seed funds that invest $250K-$2M, and who are quite happy with exits in the $10-50M range, will do very well in this new market environment (assuming their investment selection is good, and their niche expertise is helpful). these folks -- Mike Maples, Jeff Clavier, Ron Conway the incubators like Y-Combinator, TechStars, SeedCamp, and a few larger VC funds like First Round & Union Square Ventures -- are positioned to do very well in this new structure.
Brand-name Big firms like Sequoia, Benchmark, Accel & a few other will probably still do well also, but everyone inbetween is going to get creamed.
hard.
Thanks for reading my post. You write "altho i disagree with some of his conclusions" - which conclusions ? I'd like to have as defensible a presentation as possible - I'd als0 like to leap tall buildings in a single bound.
My email = elliott@thegrowthgroup.com
Your point about smaller funds doing better makes a lot of sense to me. I think the community would be well-served to see a return of the evergreen fund with smaller pots. That way, the incentive is not in asset gathering to mooch off the management fee but rather to generate great returns. Returns are greatest in the seed stage, even if your scenario of smaller exits with increased frequency remains true.
Like all asset classes, VC industry has attracted too much capital to be allocated prudently. The shakeout is long due
Dave: You forgot to mention True Ventures who are doing quite well and actively investing.
I predict that you'll see some reform in VC in form of a new kind of firm around some of the capabilities that Dave talks about. In general the capital markets (which the VCs are) are a good thing. No liquidity is a bad thing and has a 'trickle down' effect.
I think that reform you speak of might come in the form of a return to evergreen funds that do not have a limited lifespan. They will also be smaller as Dave McClure suggests. This will keep the focus on sustainability and generating consistent steady returns rather than the big VC model of gathering as many assets as possible and living off the management fees while having to chase big deals in order to put sufficient money to work. I was part of the founding team at the largest student-run venture fund and we were lucky to have had two billion dollar IPOs on the NASDAQ and we found that managing a smaller pot was more feasible and forced us to invest selectively with discipline.
In addition, when was the last time you met a truly innovative VC? More like a herding sort of beast than an original thinker. The VC industry is starving for both entrepreneurs and VCs that actually *do* think outside the box and will take the heat for it.
This is why I have been focusing on the Entrepreneur Commons (http://www.entrepreneurcommons.org), and I see the current crisis as an opportunity to finally get people's attention on the issue. Because as Diogenes points out in the previous comment, LPs have kept things on auto-pilot so far, and for a good reason: VC investment is "alternative investment" for them, crumbs in their plate really, and they have much bigger issues to deal with (see my post "$20B crumbs" http://bizcoach.blogspot.com/2008/07/20b-crumbs...).
We should feel lucky that all this is happening, it is time for change, a time for opportunities if we know to react smartly.
It used to be that tech companies were founded by geeks who created a cool technology and got funding to take it big time. Now, we have an annual migration of MBAs heading West to get their class project funded. TechCrunch and Demo are positively choked by all that crap. And see Cyprus. 26-year-old MBAs should not be funded, as a rule, unless their pet project actually gets momentum first (ala Facebook). We're not running a babysitting agency here.
The other thing is VCs need to stop relying on EYEBALLS. What is it 1999??? One well-known Web 2.0 company that told me in a BD meeting that their investors only cared about traffic numbers, not monetezation or revenue plans (when I asked). Advertising is not the way. Insist on products that someone might actually want to buy. I know that sounds shocking, but...
That's the one good thing about this bust. Those kiddies head back to whatever midwestern town they originally hailed from before professors and alums filled their heads with Tesla dreams, and the geeks get back to innovating. I'm seeing some cool stuff happening in garages all over the Bay, no MBAs needed. I hope the VCs are noticing.
I liked your analysis. See my response to this post at: http://www.vccafe.com/what-broke-the-vc-model/
>>
We make money by building entities over the long term. We’re not in the business of transacting or doing deals. We don’t even allow that word here. It’s not buying and selling, that’s a transaction. You don’t invest in something and say I can sell it tomorrow or next year. We take a five year, ten year view and say we can build a company that can significantly change the landscape.
<<
VCs should be about building businesses, not being financial guys. This is what got the system broken, and this is why they should to go back to the original model of working with Entrepreneurs to help them build their business if they really want to do it right.
Back to helping rather than profiting from entrepreneurs, and back to seed rather than later stage.
VC's (and the entrepreneurs looking for funding) need to learn to identify the true needs of their markets, then then develop solutions that satisfy those needs. Some are fairly good at identifying market needs, but where I see it fall down again and again is in the inability to translate those needs into a viable offering. This requires an understanding of how end-users will perceive the offering, rather than what they say they want or like. Consumers are too empowered now to work around product or technology deficits.
I've been doing this work for a long time and have helped large companies who make tangible products and services to reap billions of dollars in new revenue. Yet when I talk to VC's or entrepreneurs about this, it usually falls on deaf ears. I think Greg hit it on the head - they are too caught up in funding than creating something people will pay for. I would add that they also get too caught up in perfecting the thing they are making, than honing and communicating the value it will provide.
We need VC's to get better at this. When and how can we get them to listen?
There hasn't been a great IPO market since before the 2000/2001 bubble burst. So it's kind of M&A or bust, and now we are in a recession and it's tough to justify buying Facebook for 10 billion (I would imagine).
Which means that all these hot startups with huge valuations have a problem. No IPO market + shrinking M&A pricetags means all you can do is hang around and wait until it gets better.
Could they find buyers hypothetically? Sure. But not for 500 million to buy a widget.
Btw, economic circumstances have changed too such that smaller companies are able to go much further on their own....so much for VC assistance....the last time I heard advice on my business from a stuffy HBS grad VC, who by nature of being an MBA, has no risk-taking capibilities, I nearly died of laughter on how off market and non- operational he was.VCs are only talented in one thing - "buying" their way onto other peoples' Boards with other peoples' money.
A friend just recently closed a $250mm fund after being part of several smaller funds. Over dinner his comments to me were essentially that the partnership did not actually expect they would make returns in this new, larger fund. But, on the other hand, the 3 partners would be splitting over $8mm per year in fees between the various funds. He is activity investing in real estate on the side. Have any of you ever met a VC partner that wasn't "rich"? The data would indicate that the majority of these people are not making money for their investors?
In general, I believe it is much harder to make good returns with larger funds. If a company is raising $50mm there will be intense competition by investors trying to get money to work. On the other hand, in today's environment, if a company needs $3mm they are dead in the water no matter how good the company and deal. So few investors are doing those deals. For a fund group with $500mm under management a 10X return on a $3mm investment just doesn't "move the needle" and it isn't worth the hassle.
So, I think the right answer is that the groups that invest in funds need to think hard about sponsoring the next generation of fund managers. We need to create 10 $50mm funds for every one $500mm fund. I know this will be difficult because pension funds are massive and it is tough to deploy into small funds. But, if we don't somehow restart the "farm team" system I fear the end of venture capital is not far off.
While the entrepreneur side knowledge base developed over the last 20 years tremendously, the LP side remains almost unchanged, despite the fact that LPs have the higher stake in the success/failure of VC backed companies.... Clearly, this is the broken component in the system, inducing its inefficiency to the other side too.
I don't think the system is broken but is clearly not optimal and now is the right time to fix it. Debates like these (Adeo, Matt and al.) are essential to trigger a change, even if the optimal equilibria is not clear.
You touched on the crux of the issue right there, but it applies to the financial industry as a whole and not just VC. Capital is overvalued and the new bubble. While investment in human capital (the infrastructure that makes people more productive has been in steady decline for the last half century.) There is a magic formula of capital + labor + innovation (technology and entrepreneurship) that equals success. Developing and empowering our human capital for long term success has taken a back seat to throwing money around to the point where there is no longer return on investment for the most part.
http://www.adeoressi.com/2008/11/15/the-vc-mode...
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