Sometimes when you play provocateur people lie down and agree, which can be a little disconcerting, as a moderator discovered in a recent panel at Harvard on the future of venture capital. He said that the industry was screwed, and the assembled VCs nodded sagely:
[Harvard Business School] professor Bill Sahlman threw down the gauntlet at a discussion on technology venture investing at the 11th annual Cyberposium conference held at Harvard Business School on November 19.
As an industry, he suggested, venture capital has little to recommend it. “In the future, I see a median rate of return of zero or less,” stated Sahlman, observing that the top thirty venture-backed firms contributed 50 percent to 70 percent of distributions in the industry in the past ten to fifteen years. With so much global liquidity, he added, it will become even more difficult to earn a respectable rate of return as too many dollars chase too few opportunities.
“What’s going to prove me wrong?” he asked a panel of venture capitalists.
At first, Sahlman found little resistance to his gloomy forecast. “You’re right in the aggregate,” conceded Stan Reiss (HBS MBA ’00), a general partner at Matrix Ventures. “We’re in the lottery business—but we know we’re in the lottery business.
[via alarm:clock]
Here’s the thing: This should be no surprise. The venture industry has always been a hits-driven business, and the best funds do fish from the best-stocked ponds. Discovering that the venture investing pickings are crummy and getting crummier for everyone outside the top funds is not news. The real discussion should be about what venture funds can do to shape their deal flow, to create the best deals, be the best value-added partners, and be more than mere money — which, from a VC, is a commodity worth less than one dollar on the dollar.
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Don’t know much about VCs or Silicon Valley, so this might be way off. Seems to me, though, the biggest players in the VC space, in terms of influence, are cash-rich players like Google and Microsoft.
Based on cool software trends of late (Foldershare, Evernote etc) it feels like the new model is ‘stay free until you get bought,’ or ‘stay free permanently and generate good will for the behemoth that bought you.’
This is a great trend for consumers — kick-ass software for FREE, who can beat that — but it sucks for investors. Kind of like the whole dot-com space back in the day… investors bidding Amazon et al to the moon didn’t realize that CONSUMERS were the big winners in the dot com revolution, not dot com companies themselves.
So perhaps its only natural for the VC space to crumble, if most of these guys are little more than space-fillers and latchers-on… thanks to mountains of cash and competition-destroying business models (free software, nearly-free services like Craigslist), you get a small handful of corporate winners / top drawer VC winners and a whole universe of consumers who benefit.
As Milton Friedman observed, profit margins are supposed to asymptote above zero when capitalism is at its best… and such a phenomenon naturally creates a 90/10 winner distribution on the business side.
With all due respect to the VC Community, it is their investors who are in the lottery business… VC’s themselves are not, considering the management fees.
Paul, shaping deal flow and value added partners are important, but sometimes the economics can be overwhelming.
Putting a billion dollar fund to work is difficult. It’s especially difficult when some of today’s most innovative and attractive investment opportunities are so capital efficient.
Paul,
I don’t think it’s a question that the VC market has excess capital or that it’s harder to generate substantially positive IRR than it was a decade ago. Yet, all investment markets face cyclical challenges. As you mentioned a few days ago, the hedge fund world has gotten too big to move the needle consistently, real estate investors are sure to have tough times as the interest rate nirvana cools, debt investors have dealt with a flat yield curve. We all adapt, and those who overcome the increased challenges are all the better for it.
I blogged on this myself in case you’re interested…
http://woodrow.typepad.com/the_ponderings_of_woodrow/2005/12/vc_aint_ez_harv.html
Jason
I’m gonna try to post a proper entry on this, but the point is the same:
Whether vc is screwed or not is not important if there is no body to replace this model of financing.
VCs them selves a virile bunch. They’ve survived crashes that would wipe out 99% of other industries (if they experienced them in the way the VCs did). So, I think the venture guys are pretty smart and they’ll dig them selves out of any hole they’re in. They’ve done it before.
Now…the problem with vc will get serious if the VCs get disrupted but a method of financing which is fundamentally different and better to what your average $250 mill offers to your average tech startup.
Is there such a disruptor looming on the horizon? I think yes. I think they’re the Angel Capital Association (ACA). Now, you’re asking, “What?”, “Angels?”, “Get’outa’town!”, which is a perfectly rational response, but it’s also one exemplary of what happens when disruptive innovators enter new markets.
Bottom line: I think within 5-10 years the ACA is going to evolve into something to really screw things up for early stage VCs and this problem needs to start getting managed now.
While the top-tier funds getting the outsized returns is not new news, the industry is definitely maturing. Typically that means “Get big, get small, or get out”
So excellent returns still available for small, focused funds. Geographic specialists or technology niche specialists. Guys investing $10s of millions rather than $100s or $1000s.
So that implies the fat middle, like has happened in every industry from steel to PCs, will go.
I recently went spent a year seeking funding for an Enterprise Security Software Start Up.
We had a compelling idea. We met with the usual suspects: USVP, Venrock,TPG, Sequoia Capital and a half dozen others.
We had top advisors, Mike Pliner who started Sytek and Verity, and Bill Yundt who founded BARRnet and was CIO of WebTV and Walter Lowenstern, one of the founders of ROLM.
However, after all of the meetings it became apparent that we were not the “A” team. Our other draw back was that although we had a brilliant founder, he didn’t have the pedigree of someone who has been delivering papers at the RSA conference for the last ten years.
My conclusion is that the VC community is extremely risk averse, unless they are not the first one in the pool. Then no one wants to be left out.
If you want to do a software start up, boot strap it and then go after money once you have got a product. Active Ink which markets a forms product to PC Tablet Users is one such company.
Everyone needs a Mike Markulla or a Bob Noyce on their team. Look even Steve Jobs got funded. By the way Markulla invested $250k. Arther Rock said he won’t have invested if Mike wasn’t running the show at Apple whose total initial funding was about $600k.
All in all, this was a good idea that lost the window of opportunity.
By the way I thought the VC community was honest and fair with us. During the dot.com boom, I was waiting for the VC’s to return to sanity which took far too long.
Stan Weitzman
It’s not screwed it’s just not working. There is no need in technologies as for now.