In many ways, 2010 was an incredibly surprising year for the VC industry. The pace of investment activity picked up considerably following the economic turmoil in 2008 and 2009. The number of companies started, investment valuations and the speed at which financings were completed all increased dramatically relative to the prior two years. At the same time, the long awaited restructuring of the VC industry started to become reality with fewer traditional funds being raised, more small (angel and micro-VC) funds launching and many VCs leaving the industry for other careers. Finally, the M&A market picked up and the IPO market cracked open a bit, creating more liquidity than the past couple of years.
2011’s even faster start has surprised not only many outside of the VC industry, but also many VC professionals. There has been extensive commentary on what is perceived to be an overheated or irrationally exuberant market, but I believe that we are simply experiencing the “new normal”, at least for the next few years. The reality is that there remains too much investment capital in pursuit of funding the handful of companies started each year that will generate outsized returns for limited partners. VC industry returns have been abysmal for the past decade, so missing out on those winners could mean the inability to raise new funds for many firms. At the same time, the cost of starting companies is lower than ever and angels and funds of all sizes are competing to finance the same, increasingly capital efficient businesses. More sources of abundant capital mean more companies being started and increasingly low odds of predicting which companies will emerge as winners. All of this creates a dynamic in which the first inkling of success for a young company yields multi-million dollar financing offers at seemingly inexplicable valuations ($100 million has become the new $10 million) and proven success generates multi-hundred million dollars financings at unprecedented valuations.
Unfortunately, this is likely to be the difficult reality of the VC industry for at least the next few years. For now, this new normal seems to be limited to the private investing market, not the public market, suggesting that this is not a bubble like the one experienced a decade ago. Further, in the VC market, dollars invested today don’t prove themselves to be ill spent for several years down the road. The repercussions of poor investing take even longer to unfold. The new normal in the private market will not quickly disappear with the bursting of a bubble, but rather slowly give way like an aging balloon bleeding air.
While many VCs will lose playing this new game, the good news is that there has never been a better time to be an entrepreneur, or in all likelihood, a consumer. Capital is freely and cheaply available to those willing to accept the startup challenge, both here in the US and around the globe. The startups that do emerge from the current financing frenzy as market leaders will have created innovative products and services for which consumers will be the ultimate beneficiaries. Those entrepreneurs will have created enormous wealth for themselves. The VCs that supported those entrepreneurs may or may not have generated returns for their investors. Which would you bet on?
It seems that the hullabaloo over Angelgate is finally dying down but I’ve been in Austin the last couple of days and I was surprised to hear how curious people here are about all that has gone on in the echo chamber of the Valley. I’ve been sharing my not particularly unique perspectives (Mark Suster wrote a super post on the topic) with folks here and elsewhere so I thought I would publish them for a broader audience as well.
1) If you think that some of the smartest angels in the industry were simple-minded enough to get together and attempt to collude in any real way, you just don’t understand how the angel and venture capital investing industries work. The reality is that it would be impossible to collude in a market where the supply of capital is so fragmented, especially for the best investment opportunities. Further, all it would take is one investor to break from the too large group of potential colluders to make it all fall apart. There is nothing unusual about investors getting together to talk about investment trends and overall market dynamics. That happens regularly, just as entrepreneurs regularly trade notes on the fundraising environment, firms, partners, etc. Move along, because there is nothing to see here.
2) I agree with Ron Conway and Matt Cohler. There are professionals who invest mainly other people’s money, called venture capitalists, and there are professionals who invest their own money, called angels. These two groups have always existed, but historically there have been more similarities than differences. What has happened is that many of the “old school” VCs have gotten bigger and moved to writing larger checks in mainly growth and later stage companies or to investing only in businesses that have the potential to change industries and produce outsized returns. At the same time, the cost of starting companies has fallen and the exit environment for startups has increasingly shifted to outcomes of less than $100 million. All of this created a larger funding gap in the market than existed previously, opening the door for an entirely new generation of angels and venture capitalists (now called micro-VCs for some inexplicable reason). Markets have a natural tendency to fill gaps and that is exactly what has happened in the venture capital industry.
3) The not newsworthy truth of the venture market is that there is far more cooperation and camaraderie than some would have us believe. As an example, we at Battery have made over 20 seed investments in the past 2.5 years and in nearly every case those investments were made in partnership with angels, “micro-VCs” and/or “old school” VCs. As long as expectations are aligned at each step in a company’s development, there is no reason that this type of cooperation won’t continue even as the market adjusts to its realities.
4) Raising money is not for everyone. I always tell entrepreneurs that one of your primary goals in any financing should be to maintain optionality. If you want to build a business that will generate great cash flow but not necessarily grow at an incredible rate (a so called lifestyle business….a pretty good one if you ask me) or that you can bootstrap to profitability, I would highly encourage you to do so. But if you’re going to raise money, know that there are consequences to doing so. All investors, angels and VCs alike, want to help entrepreneurs but they also want to make money. So know what the expectations of your investors are when you agree to take their money. Josh Kopelman likes to say that when considering financing, entrepreneurs have the choice of taking the local train (smaller amounts of money typically associated with angels) or the express train (larger amounts of money typically associated with VCs). If you choose the local train, you can likely get off (sell the company) at any stop along the way. But if you choose the express train, you’re on board for the entire ride. And that long, tumultuous ride isn’t for everyone. Be honest about your ambitions, both to yourself and to your investors. You’ll find that the differences between angels and VCs are truly merely about expectations and not whatever nonsense that many with selfish motives and grudges like to spew.