Posted on July 3, 2008
Filed Under VC Insanity |
Earlier this week, the “crisis” that has hit the world of venture capital. Last quarter, not a single VC-backed company went public.
Mergers and acquisitions activity is also down. According to a Dow Jones VentureSource report, last quarter saw the “slowest pace of merger deals involving venture-backed companies in at least a decade.”
The National Venture Capital Association (NVCA) is obviously concerned and as most American industry associations do when times get tough, is putting the government on alert. In , NVCA president Mark Heesen stated, “We need to put regulators, legislators, presidential candidates, and the private sector on notice that this situation represents a serious problem that will have long reaching economic implications if not addressed.”
Cry me a river.
According to the NVCA, 77% of VCs cite “skittish investors” as the reason for the IPO drought, 64% cite the “credit crunch/mortgage crisis” and 57% blame Sarbanes-Oxley regulation.
While these are certainly contributors to the current VC “crisis,” I have argued that the VC world’s problems have a lot more to do with their investments and bloat.
What I have found most interesting is the thoughts VCs have posted about the “crisis.”
Todd Dagres of Spark Capital called the NVCA data “artificial.” In an email he reportedly stated:
Facebook and several other privates could have gone public but chose not to. The issue is overall liquidity. If a private company sells to a public company — it’s similar to going public with less risk.
Dagres fails to distinguish between being able to go public and going public successfully and I think it’d be hard to argue that companies like Facebook would be warmly welcomed by Wall Street because while they have sufficient revenues to go public, they haven’t been able to turn profits and their long-term sustainability is highly-questionable.
As it stands now, some Facebook shareholders trying to dump their shares at a discount to recently-reported valuations apparently aren’t having much luck, giving some indication as to how hungry wealthy individuals and institutions are for Facebook’s stock (not hungry at all).
Of course, it’s worth pointing out that Dagres’ firm, Spark Capital, has invested in a number of Web 2.0 flavors of the month, most notably Twitter. Twitter’s last round valued the company at somewhere just under $100 million despite the fact that the company has no business model and its problems “staying up” increasingly evoke memories of Friendster.
Bill Gurley of Benchmark Capital blames regulation:
This passionate desire to be public is completely gone in Silicon Valley. For reasons you could easily list – Sarbanes Oxley; 12b1 trading rules; shareholder litigation; option pricing scandals; personal liability on 10-Q filing signatures – it is simply not much fun being a public executive.
He notes that the Benchmark portfolio has 15 companies with more than $50 million in revenues that are still private and laments the fact that “most of these companies would ALREADY BE public” had it been 1995 (or pre-bubble). He complains that “no one wants to manage a public company” today.
He also goes on to dismiss Paul Kedrosky’s argument that “there is nothing that the industry is producing that investors want,” stating:
Having had several conversations with mutual fund managers in the last three months, I personally disagree with this perspective. Many funds are starved for growth and appreciation. Many of the leading large capitalization technology companies have seen flat stock prices for as many as seven or eight years. Without a robust IPO market, these investors are not able to balance this lack of growth in their current portfolios. Moreover, the investors themselves lack the exposure to the new trends and disruptions. At a recent Wall Street conference, several investors were visibly upset that the venture community was not bringing more companies public. I feel very strongly there is no a “demand problem” when it comes to IPOs.
First, I would note that running a public company was never supposed to be “fun.” While regulations may be tougher, I personally don’t see them as being an insurmountable barrier to companies with solid financials and management.
In my opinion, Gurley’s statements reflect an attitude of “entitlement” that plagues venture capital. The truth is that just because a company hits a certain revenue milestone doesn’t mean that it’s an ideal candidate for an IPO. VCs should get used to the idea that just because certain milestones gave companies the ability to go public in the past doesn’t necessarily mean that those milestones will give companies the ability to go public in the future.
Second, as it relates to the mutual fund managers Gurley speaks of: most mutual fund managers are as clueless as most VCs. The fees mutual fund managers charge investors are almost always impossible to justify given the true returns. It’s also worth noting that few mutual fund managers invest in their own funds, revealing just how confident most of them are in their own money-making savvy.
Given the unimpressive facts about mutual funds and the people who manage them, it’s not entirely surprising that mutual fund managers would desire the return of over-hyped IPOs that can mask the fact that they rarely outperform the market. Of course, mutual fund managers are unlikely to find decent returns when less-than-compelling companies go public but it’s the thought that counts, right?
Fred Wilson of Union Square Ventures is another VC citing Sarbanes-Oxley and other regulations as a prime culprit in the VC “crisis.” He states:
Sarbanes-Oxley and other post bubble, post Enron regulations have certainly made it harder to be a public company here in the US. I know every time I sign a 10K or 10Q, my hand shakes a little. Honestly, it takes a very big opportunity to make me want to be a significant shareholder or a director of a public company. The risks and hassles are just so big.
Not surprisingly, Wilson has voiced his support for “secondary markets” where shareholders in currently-illiquid startups would be able to sell stock to “sophisticated” investors without all of the “hassles” that the SEC has created:
The idea behind both of these new emerging (and currently illiquid) markets is to provide a place for private equity investors to trade securities with each other. The companies remain private, do not have to file with the SEC, and do not trade daily like public stocks do. When an entrepreneur or investor wants liquidity on a position they own, they come to these private markets, offer their position or part of their position for sale, and a trade is made.
The company/web service creation process needs some kind of end game. The entrepreneurs who spend years and risking a ton need a way to get paid for that effort. And those of us who finance their efforts need to get some return on our investment.
Again, an attitude of entitlement is apparent.
Note to Wilson: nowhere is it written that entrepreneurs deserve to get paid for their efforts. And nowhere is it written that those investors who finance entrepreneurs deserve to earn a return.
Making money is not easy. If it was, everybody would be wealthy. If you want big returns, you usually have to take bigger risks. And if dealing with challenges and jumping through hoops is too much of a “hassle” to earn a big payday, perhaps you’re in the wrong business.
In my opinion, secondary markets for stock in private VC-backed companies would create little more than sham marketplaces where startup employees and VCs would be able to more easily find - often “sophisticated investors,” like hedge funds, many of which are losing their shirts as we speak because they overleveraged themselves and made stupid investment decisions.
While there is certainly a lot to discuss and debate, I really don’t think the VC “crisis” needs to be overcomplicated.
The bottom line, as I see it, is quite simple: there is far too much VC money and far too much of it has been invested in startups whose value and long-term prospects have been overestimated.
As Paul Kedrosky :
- Sarbanes-Oxley hasn’t helped, admittedly, but that is not the core issue. Among other things, the industry hasn’t been able to find enough companies about which Wall Street can get excited.
- Venture capital still has too much money under management.
- Average fund size remains too large. Adjusted for inflation, and based on pre-bubble 1994 figures, the median VC fund size in 2008 would be $100m, not the current $200m figure.
Personally, I find the “venture capital asset class” to be less-than-appealing and while I don’t expect money to stop flowing into VC funds overnight, I think it’s worth taking a step back and putting venture capital in context with the world we currently live in.
To a large extent, I agree with the following:
We should expect prices for our most basic of needs, food and energy, to continue to rise until the supply and demand equations are back into balance. And it looks to me like that will be achieved mainly by demand destruction, which could take years to play out. This bear is going nowhere.
Meanwhile, energy and commodities, including agricultural commodity ETFs, are doing very well this year even as the rest of the market goes south. Along with traditional safe havens like gold and silver, bonds, T-bills and the like, they’re really the only place to be right now.
From this perspective, the question goes from “Why is there an IPO drought for VC-backed startups?” to “Why should anyone care much about VC-backed startups in the first place?”
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