1. the king is dead, long live the king
the once and future state of venture capital
david aronoff
general partner
flybridge capital partners
david@flybridge.com
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2. agenda
• the VC model needs an upgrade
• clues from history
• implications for entrepreneurs
• semi-random thoughts
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3. some facts
• 1972 to 2007, ~2500 VC-backed IPOs in US
– 13% of all public firms at end of 2008.
– 8% of market capitalization ($2.0 trillion)
– 6% of total employees.
• Particularly true in high-technology industries.
• VC appears ~3 to 4x more powerful than corp R&D
– From late 70s to mid-90s, VC was only 3% of corporate
R&D, but responsible for ~10%-12% of privately funded
innovations.
source: Lerner
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4. the way it was
• basic premise:
an overabundance of great ideas
+ an undersupply of capital
= only “best” ideas get funded
• a sector supports 4-5 players
– 1 is a home run
– 2-3 are “ok” outcomes
– 1-2 holes in the ground
• “healthy” industry loss ratios
• LPs can afford to remain patient
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5. the way it is
• situation:
an overabundance of similar ideas
+ an oversupply of capital
= nearly every good idea got funded
• sectors have 10+ combatants
– 0-1 is a triple. 0-3 are “ok”
– 6-10 holes in the ground
• vc loss ratios go through the roof
© Robert Mankoff, New Yorker
with thanks to Prof Bill Sahlman, HBS
• LP patience waning b/c returns
suffer & great recession impact
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6. the dream exposed
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7. time for an upgrade
US Venture Capital Returns: Inception to 3/31/08
Source: Venture Economics, Prof. Paul Gompers HBS n=1927
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8. product refresh underway
Less Capital Being Committed Fewer Professionals Investing
US VC Fund Raising and Funds Closed Venture Professionals
653 10,000
$120 700
9,000
$100 600 8,000
VC Funds Closed
451
$B USD Raised
$105 500 7,000
$80 6,000
321 400 5,000
$60 $55
239 241 251 300 4,000
206 211 221
$40 $39 3,000
163 200
$29 $32 $36 2,000
$19 $28 70
$20 100 1,000
$9 $12
$- $6 0 0
1980 1987 1988 1997 1998 2007 2008 2009E
Includes: General Partners, Managing General Partners, Venture Partners
Dollars Firms
Source: NVCA
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9. we’ve seen this movie before
PEAK
Accelerating 1999/00
1983
Free Fall
1997-99 1969 2000-2002
1981-83 1983-85
1967-69 1969-71
Vintage Year IRR
Top Quartile
10%
Median 2%
26%
12%
Firming Bottoming
2009-? 2003-08
2009
1991-96 1990/91 1986-90
1975-80 1974 1971-74
TROUGH
investing through the trough offers strong opportunities
Source: Brooks Zug, Harbourvest Partners
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10. so …
• clearly VC has been very important driver of
innovation and wealth creation
• but:
– low returns for past decade
– tremendous randomness in exit markets
– far too many companies funded
– calculus of funds doesn’t solve
– embroiled in secular & cyclical trough
• has become at best a short-tail phenomenon
and at worst a random-walk.
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11. what happens next
• the number of VCs must shrink
– NVCA estimated 10% in 2009, 15% more in 2010
– PCG predicts 1500 firms to 500 within 5 to 7 years
• accordingly, amount of money and number of
limited partner investors will decrease
• this won’t happen overnight
– VC partnerships are 10-12 years in duration, and
they’ll drag out last fund in hope of hail maries
• trickle down impact
– fewer numbers of startups will get funded
– smaller financings due to decreased VC fund sizes
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12. set the wayback machine
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13. that 70’s show
• VC circa 1970’s
– take the good
• small funds (in dollars & professionals)
• generalists wrt industry focus / versatile
• collegial approach / lots of syndication
– size of funds & firms -> so smaller financings
– longer horizons until liquidity
– ignore the irrelevant
• bootstrapped companies - no startups (mid/late 80’s phenom)
– adapt the model to the current environment
• Much of this is happening organically already
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14. implications for entrepreneurs
what the new model means:
• focus on capital efficiency until inflection point
– garage: bootstrap model – over longer period, CFBE
– seed-like: quicker time to lift-off (or crash) on short $$
– supersized first rounds: will be harder to come by
• concentration on new areas w/huge potential SoM
– new media, energy-technology, revolutions
– fewer me-toos (salami model)
• financing models morph
– angels /seed funds /VC get along because they have to
– full-funded staged approach?
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15. implications for entrepreneurs
what the new model doesn’t mean:
• venture investors won't invest in early-stage ideas
– it’s the charter of our fund and most others
• investors only look for epic returns (10/100x)
– my crystal ball is really no good
• VCs are replacing angel investors
– but we’re actively making seed investments
• bellbottoms are back in style
– did they ever really go out?
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16. semi-random thoughts #1
• VC performance is highly persistent
– good continue to do well, but so do poor performers!
• this is true for entrepreneurs and investors
• deal sourcing is key factor
– successful entrepreneurs have returns that are 50%
greater than first timers or those who failed last time
• success more likely for first timers than those who failed last time
– 50% of the outperformance of top fund is due to higher
concentration of serial entrepreneurs
• VC value-added is greatest with first timers
source: Gompers, Lerner, Sahlman
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17. semi-random thoughts #2
• funding/opportunity size ratio
– not all big opportunities require big financings, at least
at first, sometimes at all
– but some types of investments require huge rounds
early on; don’t know if they’re good bets, just know I
won’t place them
• being first matters a lot
– the tao of glen garry glen ross
• mike maples’ “thunder lizards”
• “gap” vs “gretzky”
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18. semi-random thoughts #3
• home-run mentality
– Are VCs bound to the home-run model or should they be more
focused on OBP?
– I suggest that both the home-run and OBP models don’t work,
but a hybrid of both is warranted (shameless self-promotion)
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19. discussion
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