Five Years Too Late

April 1, 2009

Liquidity Perspective

Filed under: downturn, venture capital — Tags: — fiveyearstoolate @ 10:17 am
Eric Wiesen

Eric Wiesen

Courtesy of this morning’s VentureWire, the numbers for venture liquidity in Q1 are out. And I’m sure you will all be shocked to hear that they aren’t very good. In fact, overall liquidity across the venture industry was just $3.2B, the lowest for any quarter since 2003.

Full stop. Lowest quarter since 2003. So in the midst of the worst financial contraction of the modern era, venture capital liquidity was bad, but better than it was in 2001 or 2002. I think that, while not to be a Pollyanna about where the industry is today, it’s important to note that during a quarter where the public markets had their worst Q1 in 70 years, the venture liquidity numbers are bad, but better than they were the last time things went badly.

Further, and also of interest, median hold times were down dramatically in Q1, from an average of almost 8 years in Q4 to about 4.7 years in Q1. Part of this is just a shifting “market mix” where more companies are getting taken out early. It will be interesting and important to see if this trend continues into Q2 and beyond.

Ultimately, this data is not dispositive about where venture capital is headed. When I was at the most recent Kauffman Fellows module in Palo Alto last month, we had a number of high-profile industry experts offer a range of perspectives on where the venture business is going, and some of them were powerfully pessimistic about returns, shrinkage within the industry and the amount of capital that will be deployed over the next few years. Here at RRE we continue to believe that there is a core need for this type of capital, and that while this cycle is worse than any we’ve seen, the fundamental business purpose behind the venture business remains vital.

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December 2, 2008

How Deep is too Deep?

Filed under: downturn, venture capital — Tags: , , — fiveyearstoolate @ 6:24 pm
Stuart Ellman

Stuart Ellman

Now that the markets have tanked and pensions and endowments are selling off their private equity holdings to rebalance their portfolios, many people have gotten religion. VCs realize that the environment for raising new private equity funds is not great. If they are near the beginning of their new funds, as RRE happens to be, it is a very fortunate position because they have plenty of fresh cash to put into companies at attractive prices. If they are near the end of their most recent fund, it is not a pretty time. With little fresh capital to put in their existing companies, the first word out of their mouths is to cut costs at their existing portfolio companies. This makes sense, but only up to a point.

For some of our portfolio companies, especially web 2.0 companies that exist “in the cloud”, it’s realistic to burn very little money and grow virally. But, this model simply doesn’t work for companies in other sectors and with other cost structures. I sit on the board of a terrific company in an extremely attractive space. Given the current environment, some of their large contracts have been pushed out. With valuations down and the company on a path to burn through its cash, it seems obvious to cut the expenses and make the cash last as long as it can. This company will only remain the leader in its space if it continues to have engineers crank out the hardware and software that constitute its solution. It will only be a winner if it participates in most of the beta tests, trials and RFP‘s that most of its large customers are demanding. It needs to partner with many of the Fortune 500 companies and support these relationships. These things are not cheap. But we can only create value for the company if these things are done. The key is spending enough to remain on the “leading edge” without going overboard and hurting ourselves on the “bleeding edge”.

The takeaway here is that the board of directors (and each individual director) has to set aside the desires of their specific class of shares and do what is best for all shareholders. If, for example, my fund is out of fresh capital to put in a company but the company needs to spend money to retain or create value, I must vote to dilute myself in order to be doing my duty as a director. This is not obvious to all board members, but reflects that Director’s duty to the company. Directors must work to maximize value to all shareholders, unless the company is in distress and worth less than the amount of debt. Then, the duty of a board changes and the directors must work for the benefit of the debt holders. This is tough medicine, but we have all lived through this before in 2001-2003. Things will turn around but we must all do the right things now to let these companies survive and flourish in the future.

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November 15, 2008

The more things change, the more they stay the same…

Filed under: downturn, venture capital — Tags: — fiveyearstoolate @ 9:31 am

Another guest post from a member of the RRE Team – here Jim Robinson IV shares a few thoughts and anecdotes about a lot of the discussion flying around the web about the VC model being broken. – EDW

James D. Robinson IV

James D. Robinson IV

As this discussion gets underway – again – I pulled together a bit of perspective. I call it, “Things I heard when I first joined the world of venture capital as an intern in 1991”.  For those more recent to this industry, during that period the business was down and out after the ‘88-90 debacle. Many funds had stopped investing, there were few IPOs, older guys were retiring, cents-on-the-dollar returns, etc… I remember thinking maybe I should have my head examined for coming into VC just as it was dying.  My boss at the time, Bill Hambrecht, wondered the same thing…

So here are a few of the things people were saying in 1991:

  • “The VC model is broken”
  • “There is too much money chasing too few deals”
  • “VC’s are too arrogant and the pitching process is too inefficient”
  • “Superfunds with $100 million or more are in trouble and will fail”
  • “Software companies are much more capital-efficient and this requires a new way of thinking about VC”
  • “Software is over as a category. Just like disc drives, there are too many me-too companies. Only the big ones will survive”
  • “LP’s are moving away from VC as an asset class given the return profile and future prospects”
  • “The number of firms will decline dramatically” (was about 600 then, depending on what you count)
  • “IPO’s are much tougher and will stay that way; exits – and returns – will suffer for a decade or more”
  • “Future opportunities are in biotech and ‘specialty materials’, not IT.

The above were not just random comments, but in fact the ‘prevailing wisdom’ of the day held by many, including lots of VCs, entrepreneurs, LP’s, etc.

By contrast, here is what I hear today….

  • “The VC model is broken”
  • “There is too much money chasing too few deals”
  • “VC’s are too arrogant and the pitching process is too inefficient”
  • “Superfunds with $200 million or more are in trouble and will fail”
  • “Internet companies are much more capital-efficient and this requires a new way of thinking about VC”
  • “IT is over as a category. Just like web 2.0 companies, there are too many me-too companies. Only the big ones will survive”
  • “LP’s are moving away from VC as an asset class given the return profile and future prospects”
  • “The number of firms will decline dramatically” (is about 1200 now, depending on what you count)
  • “IPO’s are much tougher and will stay that way; exits – and returns – will suffer for a decade or more”
  • “Future opportunities are in ET and Nanotech, not IT”

I actually agree with a number of the sentiments above. Of course, I did back then, too. Yeah, I know. This time it’s different. Right? I wonder, in 15 years, what we will say.

Whenever I read these kinds of discussions, it always gets me to a more humble place, where I realize history tends to repeat far more often than not, no matter how much we wish it were not so. It also reminds me of a bunch of my favorite famous quotes from the past…

“640K (of conventional memory) ought to be enough for anybody.” — Bill Gates, CEO and founder of Microsoft, 1981

“There is no reason anyone would want a computer in their home.” — Ken Olson, president, chairman and founder of Digital Equipment Corp. (DEC), maker of big business mainframe computers, arguing against the PC, 1977

“We don’t like their sound, and guitar music is on the way out anyway.” — President of Decca Records, rejecting The Beatles after an audition, 1962

“Transmission of documents via telephone wires is possible in principle, but the apparatus required is so expensive that it will never become a practical proposition.” — Dennis Gabor, British physicist and author of Inventing the Future, 1962

“There is practically no chance communications space satellites will be used to provide better telephone, telegraph, television, or radio service inside the United States.” — T. Craven, FCC Commissioner, 1961

“The world potential market for copying machines is 5000 at most.” — IBM , to the eventual founders of Xerox, saying the photocopier had no market large enough to justify production, 1959

“I have traveled the length and breadth of this country and talked with the best people, and I can assure you that data processing is a fad that won’t last out the year.” — The editor in charge of business books for Prentice Hall, 1957

“Computers in the future may weigh no more than 1.5 tons.” — Popular Mechanics, “predicting” the relentless march of technology, 1949

“Television won’t last because people will soon get tired of staring at
a plywood box every night.”
— Darryl Zanuck, movie producer, 20th Century Fox, 1946

“I think there is a world market for maybe five computers.” — Thomas Watson, chairman of IBM, 1943

“Who the hell wants to hear actors talk?” — H.M. Warner, Warner Brothers, maker of silent movies, 1927

“The radio craze will die out in time.” — Thomas Edison, American inventor, 1922

“That the automobile has practically reached the limit of its development is suggested by the fact that during the past year no improvements of a radical nature have been introduced.” — Scientific American, Jan. 2 edition, 1909

“Heavier-than-air flying machines are impossible.” — Lord Kelvin, British mathematician and physicist, president of the British Royal Society, 1895

“X-rays will prove to be a hoax.” — Lord Kelvin, British mathematician and physicist, president of the British Royal Society, 1895(?)

“The phonograph has no commercial value at all.” — Thomas Edison, American inventor, 1880s

“Everyone acquainted with the subject will recognize it as a conspicuous failure.” — Henry Morton, president of the Stevens Institute of Technology, on Edison’s light bulb, 1880

“Drill for oil? You mean drill into the ground to try and find oil? You’re crazy.” — Drillers whom Edwin L. Drake tried to enlist to his project to drill for oil, 1859

“Rail travel at high speeds is not possible because passengers, unable to breathe, would die of asphyxia.” — Dionysius Lardner, Professor of Natural Philosophy and Astronomy at University College, London, and author of The Steam Engine Explained and Illustrated, 1830s

“…so many centuries after the ‘Creation’ it is unlikely that anyone could find hitherto unknown lands of any value.” — Committee advising King Ferdinand and Queen Isabella of Spain regarding a proposal to provide venture capital to Christopher Columbus, 1486

“Stock prices have reached what looks like a permanently high plateau.” — Irving Fisher, Yale University Professor of Economics, 1929 (two weeks later, the stock market crashed and the Great Depression started)

And finally, as it relates to predicting the future:

There are many methods for predicting the future. For example, you can read horoscopes, tea leaves, tarot cards, or crystal balls. Collectively, these methods are known as “nutty methods.”  Or you can put well-researched facts into sophisticated computer models, more commonly referred to as “a complete waste of time.Adams, Scott

Predicting the future is easy. It’s trying to figure out what’s going on now that’s hard.Dressler, Fritz

The more unpredictable the world is the more we rely on predictions. Rivkin, Steve

It’s tough to make predictions, especially about the future.Berra, Yogi

November 6, 2008

Self-sufficient is the New Sexy

Filed under: downturn, venture capital — Tags: , — fiveyearstoolate @ 5:59 pm
Stuart Ellman

Stuart Ellman

I was at a board meeting the other day and a portfolio company CEO surprised me. I was concerned that it was taking a little longer to sign up a key partner and therefore we would run short on cash. The CEO told me that he will never run out of cash. Not only has he run the company incredibly frugally, but he is only going to spend money when he is able to get that cash from revenues. In the short term, he will take on some consulting assignments that are relevant to his core business. Wow. This is music to my ears. This is a CEO that lived through the 2001 crash and knows what it is like to raise money during times like these. To VCs, this is incredibly appealing… even sexy.

Another CEO was telling a different story and not hearing what he wanted back from his investors. He has done a terrific job growing his company, the leader in a new and sexy space. He doubled his revenues last year and will double them again this year. His problem is that his company burns (and will continue to burn) a lot of money. He went out to market and assumed the environment would be easy given how great he is performing. But, as a very knowledgeable source said, many VCs are just out to hurt their friends right now. People only want to put new money in a deal at washout and vulture-like prices. I keep getting calls from other VCs to join them in deals at $0 pre-money valuations. Wow, I haven’t heard calls like that since 2001. So, this unhappy CEO is getting back indications of interest, but only at punitively low prices. As a result, he is looking to his existing investors to do the round. The problem is, existing investors do not have enough money to fully fund the company. Don’t forget, VCs also have time limits, percentage limits, and dollar limits on existing investments. That is not a happy boardroom. It is about as appealing as sitting in a middle seat on an airplane next to a smelly guy.

Right now, growth is not sexy if it’s accompanied by a high burn rate. To navigate through this climate, every CEO needs to perform a simple analysis: First, how much money is in the bank (not including debt)? How much runway does this give you at your current operational posture? And what are you going to do about it?

  • First choice, get to cash flow positive on that money.
  • Second choice, get the cash to last for two years..
  • Third choice, see how much money you can gather from existing investors to get to cash flow positive.
  • Last choice, go to outside investors to get the additional money. Yes, there may be exceptions to the rule, but it is not a pretty market for companies with a high burn right now, period.

If there is one thing etched into my memory from the last funding drought, it is that CEO’s always wished they had cut more deeply earlier. A company with 70 employees will think it is cutting to the bone if it goes down to 50 employees. “I just cant go any lower without killing the business.” That is true until they then cut to 35, and then to 25 employees. At 25 employees, the CEO always wishes he had done the hard cut earlier and saved the money and uncertainty. Yes, it is not fair to have to cut a company that has performed well. But, when markets change, you have to do it. Great CEOs have failed because they have not reacted appropriately to changes in the funding environment.

So, hear it from me, or hear it from the markets soon enough. Become self sufficient on the cash you have. Even at the expense of growth. Frugal is sexy again.

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