search: results update below


browse funds: selections are stored



recently rated:

Rated by 3
2.1
 

top rated funds:

Rated by 12
4.1

Rated by 12
4.0
 

Rated by 11
4.0
 

Rated by 15
4.0

Rated by 21
4.0

Rated by 31
3.9

Rated by 41
3.9

Rated by 11
3.8

Rated by 44
3.8

Rated by 106
3.8

Rated by 32
3.8

Rated by 32
3.8

Rated by 64
3.7

Rated by 23
3.7

Rated by 27
3.7

Rated by 11
3.6

Rated by 18
3.6

Rated by 10
3.6
 

Rated by 62
3.6

Rated by 21
3.5

Rated by 12
3.5
 

Rated by 30
3.5

Rated by 28
3.4

Rated by 19
3.4

Rated by 14
3.4
 

Rated by 49
3.4
 

Rated by 16
3.4
 

Rated by 10
3.4

Rated by 13
3.4

Rated by 16
3.4

Please take a moment and make a financial contribution to TheFunded. If we have helped you, help us with resources to further grow the both the site and our entrepreneur training program, The Founder Institute.

Member Post

TheFunded.com is an online community of over 20,000 CEOs, Founders and entrepreneurs to discuss fundraising, rate and review angel investors and venture capitalists, and discuss strategies to grow a startup business. Enjoy the site, and be sure to join us at our Founder Showcase events to meet the community.

Sign-up for Membership

7
Agree
0
Disagree

Q1 2009 Venture Realities

TheFunded.com Open Letter

Posted by The Founding Member on 2009-04-20

PUBLIC:

The NVCA orchestrated the release of abysmal venture investing numbers for Q1 2009 on Friday and Saturday evening, after most media outlets had closed. The rushed articles that appeared over the weekend were either data driven, sensational, or wrong, and the story may not gather any more news cycles, which is a shame. As the Founding Member of TheFunded.com, I avoid writing editorial on this site, but I feel that the poor caliber of reporting on the 62% drop in venture financing from Q1 08 to Q1 09 deserves a response.

To start with, there is nothing surprising about the slowdown, but nobody seems to explain why it happened. Let's start by looking at the "real" reasons for the near halt in venture investing during Q1 2009:

1. Venture capitalists were asked to stop investing. Major limited partners (LPs), or investors in funds, asked their private equity (PE) partners to slow down investing and reduce the number of capital calls (here). Various LPs had engaged in a popular strategy of accumulating debt, and they did not have the cash on hand to honor every investment commitment after both the equity and debt markets collapsed. The number of first time investments fell by 65% from Q1 08 to Q1 09, as venture firms stopped making capital calls in order to preserve relationships with the LPs.

2. New compliance rules tied up venture capitalists. In Q1 09, a large number of LPs asked their PE partners to comply with a mark-to-market accounting rule, FAS 157, which is better at valuing mature private companies with public market comparables than six month old startups (here). Venture capitalists were forced to go through both a time consuming exercise to value their portfolio and a process to figure out the FAS 157 reporting strategy, distracting partners from new investment opportunities.

3. Cash strapped portfolio companies needed saving. Only the best portfolio companies could raise money from new investors in Q1 2009. This forced venture capitalists to undergo another time consuming process of evaluating the fund's portfolio and identifying which companies to support going forward (here). Some cash strapped portfolio companies needed immediate support, and venture capitalists did a large volume of "inside rounds," where existing investors set the terms for new rounds into portfolio companies. Without external validation of a company valuation by a new investor, inside rounds require an internal review process that frequently results in dreaded "cram down rounds," complex penalty terms, lower valuations, and smaller investment amounts. The average deal size to shrink by 30% from Q1 08 to Q1 09.

Despite logical explanations for the slowdown in Q1 2009, there is a much more alarming trend in the data.

The number of new venture funds that were backed by limited partners fell by 81% between 2008 and 2009 (here). Venture capital positions by top limited partners (here) have been sold for pennies on the dollar (here). Venture capitalists have been complaining that traditional sources for venture financing, such as university endowments, have stopped supporting the asset class.

I believe that these are all early indicators that the overall asset class of "venture capital" is being abandoned by limited partners. The 10 year returns are being held up by the last companies from the dotcom era of 1999, but the returns for funds raised since then are poor (here). When you apply strict FAS 157 valuations on private companies with different venture firms reporting different valuations on the same company, the asset class returns go from bad to worse. There is a silver lining, however.

The three major causes for a slowdown in Q1 have passed. LPs have more liquidity with the rising value of public market equities, and most venture funds have addressed FAS 157 reporting processes and determined which portfolio companies to save. Q2 2009 investments will continue to be down, though higher than Q1, as venture capitalists take a step back and evaluate what investments to make in the new global economy, but new investments will start to surface towards the end of Q2 and in Q3 2009. Since new investments are smaller than later stage support, the amount invested in 2009 will be significantly smaller than any amount in the last 10 years, but the volume of deals will start to normalize by the end of the year.

Posted by jetskier on 2009-04-20 18:03:45

Interesting article, but I am not sure that I agree with the conclusion. As an LP, I am loathe to put more money in funds, as I would expect others are also. Investments in the public markets are not back to where they were and most LPs are still reeling from extremely poor performance of their investments in venture funds. In addition, institutional money has become much more conservatively focused. The M&A market has not opened to cause excitement (nor the IPO market); clearly, investment now is toward the future, but psychology is psychology. I don't see this one becoming more active for a while. It would be helpful if the government targeted some stimulus money in this direction as innovation is not being funded.

Posted by fnazeeri on 2009-04-20 18:31:33

I was comparing the numbers from the NVCA (how much VCs invested in startups) to some numbers TechCrunch posted on how much money VCs themselves raised. The comparision is interesting in that it looks like there is too *much* money going into VC, not too little.

Posted by Jjamison on 2009-04-21 03:46:11

I agree with the ideas and the conclusion. Sparked thinking for me about how venture industry might adjust over coming years.

Some big changes, some areas where shifts are already apparent.

http://bit.ly/SF1eq

Posted by cscottlong on 2009-04-21 22:08:03

I agree with with the conclusion. Recession or not, trust in venture funding has been on the decline for years, as are the returns on these investments according to the NVCA. Couple that with the inflated valuations on public companies, and you have a real problem on your hands.

This issue goes far beyond complaining about a GP treating you like crap, it is a systemic issue that requires dramatic changes to succeed. FAS 157 will be the poster child for why funding cannot be raised, but really is the start of some much needed accountability. Over valuations in the stock market is what triggered the 1929 collapse and depression, and it again played a very large role in the recession we face today.

I am not a big fan of regulations, but if people cannot play fair then screw them, it is now time to start making them accountable. Over valuations and false hope are what has driven venture funding for years, not realistic sustainable businesses.

I am working on funds in all parts of the country right now, and the issues are all the same. Most have no money. Most have lost many of their LP's as they have no money. Broke is broke, and it causes a lot of fear.

Many of the high wealth people that I know look like scared children right now. These are people that thought they had a net worth of 20 to 50 million dollars a year ago. What assets they had took a major haircut, then the banks called notes due, cancelled line of credit used to operate their business and then to add to the misery, sales dropped off a cliff.

It is hard to believe that business owners could get hit in that many directions all at one time. Now take that same person and try to guess where they are going to put their money once they begin to earn it back. Mattress or venture fund? Who knows.

Posted by Observer on 2009-04-25 01:32:12

Lots of good points raised, but two that jump out:
1) What's Wrong - Well, a lot with a lot. Most of all valuation and expectations. You point to 157's impact. IMHO, the big issue is what these long term investments are worth to the investors vs. to anyone right now. For now, well, the secondary market is best indication. Also see Fred Wilson's view on this:
http://bit.ly/169gVM
2) Spin - asset classes are about return to investors net fees and relative risk/return performance. While some venture funds have no doubt "added campuses not just buildings" to universities, venture returns need to be substantiated to avoid a lot of problems.

Posted by maxrevz on 2009-06-03 00:13:14

To the VCs: "do not follow where the path may lead go instead where there is no path and leave a trail." I hope you learned your lesson - this time. To the institutional players: time to reinvent yourselves, or get lost! To the private investors that used to support the "asset class:" You are entrepreneurs; self made, tough, energetic, creative, and tolerant. You relate to other entrepreneurs. When it comes to funding companies your experience is imperative (directly and indirectly). I look forward to your return.

Posted by goodform on 2009-06-03 11:07:27

VCs do not invest in "startups" or "seeds". VCs invest in growth companies that already have certain levels of traction (# users, revenue, strong validation partners) or they invest in the hot entrepreneurs of the day.

Having LPs slow down the money flow and having the VCs need to triage current portfolios is nothing more than the credit crunch / cash crunch that is rocking the rest of the world.

So - some banks fail and some recover.

But - please, no bailouts or people's money to the VC level of Risk investing.