Five Years Too Late

September 9, 2008

Is Tech VC Dead?

Filed under: venture capital — Tags: , , , — fiveyearstoolate @ 4:52 pm

The idea for this blog originally came out of the ongoing whispers that “VC is dead”, dramatic as that sounds. We’re now 7 or 8 years from the crash of the “dot-com” boom economy, depending on how you count. Those who follow trends in the tech economy and the venture capital industry know that these years have seen lower returns, longer hold times, a weak IPO market and consolidation within the ranks of the erstwhile acquirers for technology startups. So it makes sense to ask, rhetorically or otherwise – Is tech VC Dead?

The short answer is: no, we don’t think so (or we wouldn’t still be doing this).

The longer answer is: Dead compared to what? If by “Is Tech VC Dead” you really mean, “Are the returns and short hold times enjoyed by internet and software venture capital funds raised between 1993 to 1998 likely gone for the foreseeable future?” then the answer is … probably, but that’s a poor standard.

From 1995 to 2000 we saw an unprecedented era in venture capital. Companies merely needed wide distribution (Netscape) or simply an online delivery mechanism (Pets.com et al) to gain astonishing valuations in both the private and public markets. That ended, as all speculative excesses eventually do (five years too late for condos in Florida…), but a lot of venture investors did extremely well while the merry-go-round continued to spin. So if we’re going to compare returns, hold times and the influx of capital into technology investing to those heady days, we’re probably going to conclude that technology VC is no longer attractive or, if you prefer, dead.

And there are some real challenges today, particularly as regards valuation on exits. We have telecom investments that, as businesses, are doing extremely well. But the way that the market views these investments today relative to ten years ago is dramatically disparate. A company with $100M in revenue in the late 90s in the space would have been worth a couple of billion dollars (see the likes of Siena and Cerent back in those days), but today (given the multiples being assigned to the likely acquirers of these companies) such a business is worth maybe $300-400 million. At 3-4x trailing revenues, one has to ask why an investor would seek out this type of company today.

With enterprise software we see a similar dynamic. Many of the great VC funds were built on the success of enterprise software in the 1980s and 1990s, huge software packages that cost high six or seven figures, took 180 days or more to sell and came with a perpetual license business model. Many of these companies turned into enormous wins for VC funds back then, but today the model is quickly being abandoned as the willingness of firms to pay for such unwieldy software diminishes and the world moves to a Software-as-a-Service model. The problem there is that these business, at least so far, have proven difficult to build to scale. With the exception of Salesforce.com (a $6.6B business as of this writing), how many large companies have been built with SaaS?

And finally there’s the Web 2.0 sector, where so many have gone in the face of decline in sectors like those mentioned above. We think Web 2.0 is interesting, depending on how you define it, but we question some of the money that went into this sector chasing things that were shiny, but weren’t necessarily solving real problems. And many of the acquisitions that have come out of this space have been small – great multiples but small in actual dollar terms.

All that being said, if we step back and take a longer view, we start to think about what technology VC has always been about, what it’s for. For the last few decades, the lifetime of modern venture capital, our capital has been used to build out the leading edge of different evolutions of technology, from large computing to smaller, from semiconductors and devices to software and web services. And this is still what it’s for today.

The questions we’re asking ourselves a lot these days are:

  • How much do we worry that information technology has been superceded by newer technology fields like cleantech or biotech?
  • What do we make of the influx of capital from hedge funds, sovereign wealth funds, the increasing importance of angels, etc…?

The first is a longer discussion, one that we’ll be thinking about substantially in this space. The short answer is – we think that biotechnology is a fascinating field that has relatively little relationship to what we do. Life sciences venture capital is a scientifically and capital-intensive business with binary outcomes that requires a totally different skillset and attitude toward company-building than IT investing.

On the cleantech side, we are much more interested, but more as IT investors who think the energy sector is a fascinating vertical. We have three investments that can be considered “green”: RecycleBank, Tendril and Ember (and a couple more in the hopper). In all three we leveraged what we are already good at – identifying strong technology entrepreneurs and helping them build great businesses. To us, the emergence of cleantech is an opportunity (of sorts) for IT investors, in that it is revealing a whole new galaxy of problems that need to be solved with innovative technologies.

As for the second – we think it’s something of a non-issue at this point. Angels have long been and continue to be an important part of the tech ecosystem. As VCs we rely on them to help entrepreneurs get businesses of the ground develop products and often devote their time (as well as their money) to getting some momentum going so that the company is ready for firms like RRE. As for hedge funds and others – there’s a lot more to this business than providing capital. Ultimately people come to RRE or to other VCs for our expertise in building companies, our access to partners and customers, and our judgment as much as for the dollars we put in.  Don’t mistake – we know financing is at the core of what we do, but the right VC can add a lot of value. We do as many repeat deals with the same entrepreneurs for a reason.

So is Tech VC dead? Ultimately the business is harder in 2008 than it was in 1998. But it was also harder in 1988 than it was in 1998. We are optimistic about today’s opportunities. We’re excited about clean energy, mobile, cloud computing, the business and consumer webs, digital media, and the continuing use of modern IT to change how business is done and life is led. These areas need innovation, and innovation comes from startups, often venture-backed. Are there questions around the decreasing cost of web startups, consolidation among large software companies and the appetite among LPs for venture capital investments? Sure. But the overall trend is up. And those are future posts anyway.

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2 Comments »

  1. The exaggerated comment is more normally Software/IT VC is dead, rather than ‘Tech VC.’ It seems you would agree with the premise “The best days of IT VC are behind it, and other tech sectors will have to pick up the slack if they can.”

    Comment by Scott Rafer — September 13, 2008 @ 7:32 pm

  2. Scott – to an extent yes, we agree directionally in the post that the business of IT venture capital is more difficult than it was 10 years ago. But there are two subpoints that deserve attention. The first is simply that the bubble represents an unrealistic yardstick. Real estate investing over the next 10 years will be more difficult than it was from 2001 to 2006, but that doesn’t mean US real estate as a sector is dead in the long term. Second, it really depends on your definition of “IT”. To the extent that you are defining IT to mean traditional sectors from the 80s and 90s (enterprise software, security, network infrastructure, telecom) we probably agree. If you broaden the definition to include information technology sectors that aren’t previously mentioned (consumer web, cloud computing, virtualization, information services, etc…) then no, we don’t necessarily agree that the best days are behind us. Challenging environment? Absolutely, but we are not as pessimistic as your comment implies.

    Comment by fiveyearstoolate — September 14, 2008 @ 7:59 am


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