I'm Not Dead Yet!

According to an article in the New York Times, “The venture capital business is anything but serene these days. Profits for venture capitalists have dropped sharply and a shakeout is now gathering momentum. And fundamental changes in the business raise questions about whether venture capital, the pilot light of America’s high-technology world, can continue to ignite innovation.”

Sounds grim.  However, it makes me feel better to know that this quote came from an article reported 21 years ago when venture capital was declared dead for the first time.  Thank goodness those 1980s venture capitalists had invested heavily in reincarnation technology, as the field enjoyed its most prosperous period ever in the 1990s.

Recently Cambridge Associates and the NVCA published statistics that demonstrate negative 10-year returns for the venture capital asset class.  Many articles have been written about this phenomenon, prophesying again the imminent demise of the venture capital field.  In one recent example in the San Jose Mercury News, an article entitled Grim Numbers Point to the End of the Venture Capital Era columnist Chris O’Brien says, “Venture capital investing, the lifeblood of the valley’s innovation economy, has become a sucker’s bet.”  Ouch.

I have to say, my reaction to this willingness by so many to write-off the venture capital industry as a failed experiment is to say: Seriously?  A bad cycle means venture capital has become the rotary phone of American finance–obsolete and laughably quaint?  Good thing no one told this to the stock market each time it has crashed…seems to me that it has roared back from the brink of death more than once.

While it is definitely true that venture capital has had a tough 10-year run if you look at it in aggregate as an asset class, it is equally true that many individual firms have had a good last 10 years, producing positive returns for their investors.  No doubt the venture capital field got too far ahead of itself.  Yes, people acted like they did in the Gold Rush era, hurtling towards Northern California in search of riches, relying on smart phones and stock options in place of picks and panning equipment.  Yes, consolidation is happening and it is probably a good thing.  Too much money chasing too few deals…yeah, yeah.  All true.  But that is not the same thing as, “ding dong, the witch is dead,” which is clearly the chant from certain quarters.

If you look through comments posted by the public in response to articles discussing the current venture capital turmoil you see such gems as:  “[VCs] got big, fat, and lazy and now they are paying for it – simple as that,” and “it’s time for investors to collaborate with entrepreneurs instead of milk them.”

Well, that about sums it up, right?  Here we all sit, a bunch of Jabba the Hut look-alikes, holding the reins of our CEOs like so many Princess-Leia clones, making our own messy bed so we can roll out of it into the abyss. Unfortunately, these arguments suffer for lack of being true.

While I am sure that there are VCs who might some fit these criteria (in fact I’ve met a few myself), my own view is that the vast majority of successful venture capitalists work really hard to support their portfolio companies and make serious efforts to establish productive partnerships with the management teams we have backed.  Since so many VCs have themselves come from the ranks of the entrepreneurial culture, it is pretty clear to most of us that “milking” the CEOs with whom we work is a prescription for failure.

It is true that, at times, the relationship between management teams and their venture backers goes south, but that is not always the result of venture capitalists’ character disorders.  Sometimes, as they say, a cigar is just a cigar, and those management teams fail to perform.  When that happens, well, they gotta go.  It’s not pretty, but it’s also not wrong for VCs to play the role of active investor looking out for the best interests of their portfolio companies and their own investors—that’s pretty much the job description.  And it’s a far cry from “milking” entrepreneurs.  Those of us who have been doing this job for any length of time know quite well that gross misalignment of incentives between us and our portfolio CEOs doesn’t help us to bring home the bacon.

I find it odd that people have no qualms about trash-talking the CEOs of public companies and discussing how they need to be fired for the good of the company, but when a struggling venture-backed company comes up, it is a different kind of discussion.  Those same people who pillory the CEOs of Hewlett-Packard or Goldman Sachs for their terrible results or poor management skills are often quick to stand up for the venture-backed founder/CEO when things go awry, assuming it is the virtual foot on the CEO’s neck (shoe warn by General Partner XYZ) that caused the problem.  In fact, sometimes those founder CEOs just aren’t good at running companies.  Sometimes they make terrible mistakes.  Sometimes they are not nice people.  And sometimes they are great.   The job of the venture capitalist, as board member, is to know enough about the company to know the difference and act accordingly.  In my humble opinion, there is just nothing wrong with that.

As for the idea that venture is dead, well I think it is just resting.  First of all, no one invests in “venture capital, the asset class.”  Rather they invest in one or more selected funds based on their investment philosophy, team and returns.  No doubt there are some institutional investors out there still prospering from some of the venture capital investments they have made over the last 10 years.   I know that as we at Psilos look a our fund, we feel great optimism about what the next several years have in store for us.

Secondly, there are a number of American industries ripe for innovation and some of those are far too capital-intensive to get traction with the bootstrapping method.  Alternative energy, the “green” economy and healthcare (particularly in areas touched by health reform) are three such areas where the venture economy has a huge opportunity to make a difference and a profit.

Thirdly, despite the continued uncertainty in the greater economy, venture capital is seeing some signs of life.  There was a 42% increase in the number of M&A deals in Q2 2010 as compared to Q1 2010.  There were also 17 IPOs of venture-backed companies in Q2 2010, marking the third consecutive quarter for increased offerings, by number and by dollar amount.  Yes, it’s true:  average M&A deal value is down from 1 year ago and some of those IPOs haven’t held up in the aftermarket.  However, the trend seems to be moving in the right direction.  Time will tell of course, but opportunities for positive exit seem to be growing, not declining.

For anyone to call it “game over” because the ten-year venture capital trends are overall negative just doesn’t seem right.  The NASDAQ is far from its year 2000 high and no one is talking about shutting it down.  While the Dow flirted with its year 2000 high in 2006 and 2007, it has continued to skulk along below that high for a while.  Should we write off the stock market too?

Of course, there are plenty of stocks that are currently experiencing their own high points despite the fact that the asset class as a whole is not.  Apple Inc., a company that traded in the $10.00/share range 10 years ago is now trading near its high point at over $240.00/share.   I like this example because it is a company that many thought was dead 10 years ago, figuring they would get sold for core technology assets but could never amount to much on their own.    Guess those guys are having the last laugh as so many of us seem to be directly depositing our paychecks into the Apple Store.

I’m not suggesting that the venture market hasn’t had some hard times and that it can’t stand some improvement. I’m not disputing that some firms have done poorly and lost a lot of money. No doubt the field would benefit from some consolidation, which is already underway, and from greater discipline in the deployment of investment models.  It is impossible to argue with the premise that the exit market ain’t what it was in 1999.  However, it seems a little Monty Python-esque to me when people start writing obituaries for whole industries when they still have some very clear signs of life.   I know that many of my fellow VCs will join me in saying, “I’m not dead yet!”

Oh, and by the way, I’ve got this Reincarnation 2.0 business plan I think some of you should look at…..