I listened to a few panels on (or related to) venture capital during my days at Digital Hollywood May 2010. Below is a state of the industry 2010 based on those panels and some common sense “interpretation” on my part. Rarely will I identify the speaker because doing so will clutter up the commentary. I’ll list the names of the venture capitalists (and in one case a lawyer) who were on the panels. Anyone wanting credit for points below feel free to comment or email me and I’ll post credit.
The past ten years have flipped venture returns into negative territory and their own investors are being much slower to fund new venture investments. Some newer funds are likely to disappear and it’s only the large granddaddies (the Sequoias, NEAs… with their $500 to $700 million funds) that can chase large valuation companies.
Over the past few years there have been few venture exits – almost no IPOs and M&A activity is down dramatically (with valuations also having dropped). The exits have predominantly been in the $30 to $70 million range. While venture targets a ten times return (almost impossible to get in today’s environment) they need a four to five times (investment) return.
Out of ten investments, a VC hopes for one to two that do very, very well; three to four will at least double their money; with the rest likely being written off or sold for scrap.
In today’s environment, a “capital efficient” company can still generate a venture return. That term essentially means that hiring can be reasonably priced, not a lot of equipment is required and minimal investment is needed. Those parameters may sound constraining but more and more can now be outsourced or is cheaper (Google AdSense, Amazon hosting, cheaper bandwidth and equipment). Capital intensive businesses – such as chip or hardware companies – are finding financing a tough go.
Since some of the basic start up costs have plummeted VCs are more focused on other factors including defensible IP, quality of the team, evidence of traction and a network effect. Indeed, over the past year the VCs have been able to invest in what would have been, in the past, a B Round at what used to be an A Round valuation – while getting the benefit of seeing the company at that later and more developed stage.
In 2009 almost all companies did down rounds – if they could do a financing. All panelists agreed that today it’s wise to keep valuations reasonable in round A because a down round on B or C or not having existing investors participate in the next round is the kiss of death – you’ll look distressed and get a distressed valuation if you can get money at all (hotly contested by many audience members). Surprising on the upside is better in the long run for the company than getting a high initial valuation (10% of a $300 million company is the same as 50% of a $60 million company).
Areas of opportunity:
For larger companies in tech and media – practically – development no longer exists and they need to buy growth. Therefore, in designing a business plan just don’t just target an amorphous exit – think about which large companies could buy you and start working with them on business partnerships/development opportunities (think Ankeena and Juniper). True growth comes from small companies since they don’t have a legacy overhang and the large companies won’t eat their babies (existing cash cow businesses) no matter how dire their industry changes are.
Find an “unfair sustainable competitive advantage”. Build multiple revenue streams. Closed versus open is debatable (Twitter was so open they may have killed their true opportunity and aren’t monetizing their business; Facebook was so closed they’re now opening up). An app alone is not a company. Customize.
The value of the studios will keep going down over time. Quality content is where value rests; the supply of distribution channels will continue to grow.
Sports, games (especially social network related games), companies that can shift ad dollars their way, creative ecommerce with proven monetization models, core data center components, location based.
Mobile is in its very nascent stages of development being where the internet was in the late 1990’s
In closing, the overall message was that now is a great time to start a company! Lots of disruption is swirling through numerous markets, it’s cheaper to ramp up and capital exists for the right idea.
List of VCs who’s comments helped shape the above: Jon Chait – Dace Ventures; Tim Chang – Norwest Venture Partners; Neal Hansch – Rustic Canyon Partners; Alex Hart – Revolution Partners; Paul Lee – Peacock Equity Fund; Ross Levinsohn – Fuse Capital; Erez Levy – TriplePoint Capital; Schuyler Moore – Strook & Strook & Lavan LLP; Robert Raciti – Raciti Capital Advisors; Len Rand – Granite Ventures; Kevin Spain – Emergence Capital; and Richard Yen – Saban Ventures.