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is the venture capital model broken

Page history last edited by PBworks 11 years, 9 months ago

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Table of Contents:


 

The VC model 

 

Couldn't VCs help more with what sounds like business fundamentals?

 

This is what people don’t understand: decades ago, when a VC put money into a Cisco or HP and sat there and worked with them, they were managing a $2 million fund. Now, with funds the sizes they are, do VCs really have the time to work with all these companies when they don’t know which will be the winner? No.

 

How about raising smaller funds and backing fewer companies?

 

They have to put money into so many companies. Who else is going to bet on ideas? Thats what venture capital is. Did you ever think you could take a cell phone with you to Italy and talk with people as if you were home? Paradigm shifts like the kinds were enjoying and will continue to enjoy cost money. I think the venture model is perfect the way it is.

 

 

Tech start ups need less money than ever

 

Early Stage Seed Capital:  startup incubators  

model:  introduce new companies to Venture Capitalists...offering startups seed funding, guidance, and connections in exchange for equity.

 

 

Example

 

5pm, a product of QG Software, is some pretty slick project management software, and it’s brought to you by two guys from Cincinatti, Ohio and two programmers in Eastern Europe–all with out any funding.  5pm offers the same project management tools as most others, including grouping, time reports, security levels, email notifications and attachment support. An interactive timeline gives you an alternate view of projects and tasks (one of its best features, soon to be editable–see screen shot below), but the reason it stands out is its easy-to-use interface and simple design.

 

read more....

 

 

Discussion:

 

http://online.wsj.com/article/SB119889558568757053.html

 

4/2008:  Fred Wilson yesterday wrote the best VC blog post so far this year, about how early-stage Internet investors need a new path to liquidity. His gist is that the IPO window has been effectively closed for years, and that too many VC-backed Internet companies languish after being acquired by big strategics like Microsoft, Google, Yahoo, etc. That last past obviously doesn’t matter in terms of venture ROI (since those sales are usually for cash), but still troubles Fred as both a Web 2.0 geek and mentor to his entrepreneurs.

The post has promoted a phenomenal conversation over at Fred’s blog (I’m a bit jealous), and I certainly encourage you to set aside some time to read through the comments and/or add to them. As for my own two cents, I’ve decided to add them here by reprinting Fred’s post with just a few of my own comments interspersed.

 

Here you go:  comments in red below are from PEHUB

 

 

We Need a New Path to Liquidity

 

Watching all these machinations between Microsoft, Yahoo!, Google, AOL, News Corp/MySpace, and their ilk makes me sick. They are playing around with Internet assets like they are toys. And meanwhile the services we have come to rely on like Flickr, AIM, Delicious, Yahoo Groups, FeedBurner, etc are an afterthought.

 

 

The Internet is decomposing into a vast array of micro-services that we, the end user, stitches together to make our own unique web experience. It is the de-portalization of the Internet and it is very real. And yet, these large behemoths are trying to do their normal consolidation play on the Internet. First of all, it's not going to work. They are destroying value with all of their M&A efforts and the bigger they get, the more value they will destroy, for them and their shareholders.

 

 

But honestly I could care less about them. The only company on the list at the top of this post that I am a shareholder of is Google and I don't see them bidding for assets, just sitting on the sideline trying to figure out how to extract some value out of this game of musical chairs that their competitors are playing. But even Google is not without fault. It has bought a number of assets over the years and several of them have languished. I see them making some decisions about how to consolidate these web services inside of Google and I scratch my head. And that's Google, the best Internet company in the world.

 

 

Here's the problem. The company/web service creation process needs some kind of end game. The entrepreneurs who spend years and risking a ton need a way to get paid for that effort. And those of us who finance their efforts need to get some return on our investment. We can argue about the magnitude of the return we need and a host of other things, but the fact remains that without a path to liquidity, all the innovation that is being created by the entrepreneur/VC equation will stop happening.

 

 

Here’s an alternate problem: The above paragraph encapsulates what is wrong with so many of today’s Internet entrepreneurs. Rather than working hard for the long-term to build sustainable companies that produce profit, they work hard for the short-term to build services that they hope someone else will figure out how to make profitable. They would rather launch three or four companies to sell to Google, rather than figure out how to create the next Google. Ditto for the VCs, who too often are content with singles and doubles rather than homeruns and grand-slams. Yeah it’s harder to go yard, but that doesn’t mean you should complain about how much chicks don’t big the base hit.

 

 

The IPO market is closed and frankly hasn't really been that robust (at least for technology/web offerings) since the crash in 2000. And even when it's open, it's nuts to take any company public that cannot deliver consistent and predictable growth and earnings quarter over quarter for years. That's what the public market investors demand and they should demand that as they have no control over the companies they invest in. The public markets should be for the best companies. Apple, Google, Amazon, eBay - those are good public companies. Skype, YouTube, and the current Facebook are not.

 

 

YouTube and Facebook aren’t yet good enough public companies because they haven’t spent enough time trying to figure out how to make money. One could argue that going public would force them to face up to that issue, thus helping them become among the best.

 

 

So if you can't take a company public, how do you get out? M&A has been the primary answer in the web/tech sector for the past eight years. And it's been a great period to sell companies. We've sold three in the past couple years out of our Union Square Ventures portfolio, delicious, FeedBurner, and TACODA, to Yahoo!, Google, and AOL, respectively. Were we happy to take their money? Yes. Were we happy with the outcome? Yes. Were they good buys for their new owners? On the face of it, yes.

 

But if you look deeper, I wonder. Delicious grew nicely for a while under Yahoo!'s ownership but recently the user base has fallen off pretty dramatically. I double checked [a] chart in Compete and Alexa and they all show the dropoff.

 

 

Well, what about FeedBurner? Clearly Google has done a good job with that acquisition. Well I am not sure. I don't see any integration between Adwords and FeedBurner yet. I can't buy FeedBurner inventory through Google's text ad interface. I honestly don't see any additional money flowing to me, the publisher of the feed, since the Google acquisition. There's no way to know what the rate of signup by publishers has been since the acquisition, but I wonder if it's increased much.

 

 

Don’t I know it…

 

 

And TACODA? I know that TACODA had an incredible fourth quarter post the acquisition by AOL, blowing way past the numbers we were projecting in our annual budget. But in the first quarter, AOL fired Curt Viebranz, TACODA's CEO, and many of the top members of the TACODA team are now gone from AOL. Another acquisition messed up.

 

 

But who am I to complain? We got paid right? So sit down and shut up.

 

 

To a certain extent, yes. That’s surely cold, but a VC’s primary job is to maximize returns for its LPs, not to worry about the future and/or feelings of portfolio companies. In fact, LP interests are often in direct opposition to portfolio company interests. For example, what if a struggling startup says it needs another $5 million to maintain operations, but the VC feels there’s a 90% chance it’s putting bad money after good. The “right” move is to let the company die. If this feels too uncomfortable, give up being a traditional VC and instead concentrate on being an angel.

 

 

Except I am also a user of these services. I see what happens when a company gets purchased. The service languishes. The team leaves. It stops getting better. And often gets worse. And so even though I am happy to take the money, I am left wondering, frankly wishing, if there is a better way.

 

 

This topic came up in the comments to my Decline of the Firm post and one thing that was mentioned is Goldman Sachs's GS True market. As my friend Roger Ehrenberg (author of the awesome Information Arbitrage blog) explains on Seeking Alpha:

 

 

But now there is a new game in town, and it relates to IPOs: Goldman Sachs' (GS) GSTrUE ("GS Tradable Unregistered Equity OTC Market") program.

 

It turns out that there is another private liquidity market under development called Opus-5.

 

 

The idea behind both of these new emerging (and currently illiquid) markets is to provide a place for private equity investors to trade securities with each other. The companies remain private, do not have to file with the SEC, and do not trade daily like public stocks do. When an entrepreneur or investor wants liquidity on a position they own, they come to these private markets, offer their position or part of their position for sale, and a trade is made.

 

 

These emerging exchanges are certainly interesting, but I’m not sure how well they’ll work for the types of companies Fred invests in. Later-stage VCs are one thing, but true private equity firms want to invest in strong cash-flow – something too many VC-backed Internet companies are lacking. And, if the company does have strong cash-flow, it could have a decent shot in the public markets.

 

 

We don't even need liquid markets to develop to allow this to happen. We already have entrepreneurs selling pieces of their ownership in the later private rounds to VCs. And when we we decided to sell the Flatiron portfolio company Bigfoot Interactive three or four years ago, three of the top five bidders were private equity firms who wanted to buy out the VCs. We could have easily gotten as good of a return on our investment in that company by selling it to a new set of financial owners instead of a strategic buyer.

 

 

See above comment. An additional reminder here is that General Atlantic ultimately backed off of that Levinsohn/Miller rollup of Auttomatic, Broadband Enterprises, Federated Media Publishing and Sphere. The main reason was that the revised Facebook valuation made each company think it was worth more than General Atlantic --- or any other self-respecting financial sponsor -- was willing to pay for them. The digital tech industry sometimes lives within a TechMeme echo chamber that artificially inflates everyone's own self-worth. 

 

 

This post has already gotten too long. It's looking more like a pmarca post than an AVC post, so I will stop here and let the discussion start. And I am sure it will be a good one.

 

Because the comments are always better than the post here at AVC.

 

 

All of this reminds me a bit of the old Sevin Rosen argument about the VC model being broken. I disagreed, saying that the real problem was how too many early-stage firms had floated upstream, and cited firms like Union Square Ventures as examples of how to still make good money by investing small sums in small startups with big potential. And I still believe that, with a caveat: Early-stage firms need to recognize that they’re early-stage firms, and that a proper VC-backed lifecycle often can and should include expansion-stage and later-stage. In other words, you accept the dilution because it will pay off in the long run.

 

I know Fred knows this, and methinks he may be chasing a ghost: The perfect exit, in which everyone lives happily ever after. It’s a concept worthy of discussion, but only so far as to get closer – not to arrive. The industry has never really been structured that way, and I’m not sure anyone has enough incentive to change it. Not the entrepreneur (primarily cares about his company), not the VC (primarily cares about his return), not the strategic buyer (primarily cares about his stock price) nor the potential financial buyer (primarily cares about taking control of, and improving, a cash-flow generating company for the purpose of selling it to someone else).

 

 

 

is the venture capital model broken?

 

Another VC firm says VC model is broken — One of the oldest venture capital firms in Washington state will not raise a new fund, a decision that Northwest Venture Associates founder Tom Simpson said is driven in part by the tough economics now facing venture capitalists (see John Cook’s piece in the Seattle PI ). “I think the fund model is very broken for a variety of reasons,” said Simpson. “One, there is just too much money out there… As a result, valuations are getting bid up. Number two, you are seeing a huge number of ‘me too’ companies being formed… This follow the move by Sevin Rosen Funds last year to return up to $300 million to its investors after making similar complaints about the landscape.

 

 

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