The venture industry is entering one of its most amazing, fruitful periods of investment. In fact, I’m a believer that the companies funded in the next 10 years will produce $500 billion in venture returns, and top-quartile IRRs will be over 25% in the next decade. Certainly, this prediction goes against the beliefs of those who look back at the past decade of lackluster returns. But there are a number of very important factors that I believe will bring this vision for the future of venture capital to fruition.
The Right Now Economy
Every technology cycle is driven by a huge disruptive new trend in innovation, whether it’s the PC, the Internet/telecom boom or the rise of social networking. We’re in the midst of the latest cycle, and it’s particularly compelling because it marks the convergence of four important trends: mobile, social networking, cloud infrastructure and big data. These technological mega-trends have converged to create the real-time marketplaces of the “Right Now Economy,” which are disrupting trillions of dollars in aggregate market value.
What had to be planned can now be spontaneous. What was previously owned, can now be rented on demand. What was stored in inventory can be delivered or manufactured just-in-time. Matching supply more closely with demand leads to efficient pricing, better utilization of assets and less waste. Traditional supply chains are being disrupted, and this is presenting growth companies with golden opportunities to displace large and once-unassailable market leaders, in almost every industry sector.
Converging Mega-trends: Mobile, Social, Cloud, Big Data
Each technology mega-trend underlying the Right Now Economy is producing great opportunities for venture capital investment. First, there’s mobile. Consider that the smartphone was unimaginable in 2005, didn’t really exist until 2007, but is being mass marketed in the third world in 2013. Cell phones and tablets have overtaken PCs and laptops to become the predominant personal computing devices. Five billion people around the world will become “Right Now” e-commerce, gaming, media and education consumers in the next five years.
Platforms for reaching these consumers have evolved, too. Two-thirds of businesses now use Facebook for marketing, and 47% of Americans who are active on social networks say that Facebook has the greatest impact on their purchasing behavior.
And now we are connecting everything. It’s estimated that 50 billion devices will be Internet-connected by 2020. Today, the standard way to think of a television is as an Internet device, powered by companies like Menlo-backed Roku. Yet even refrigerators are connecting: LG has announced a refrigerator that will download recipes and give you a shopping list.
This connectivity, along with the rise of mobility and social networking, produces reams of data every day. In the realm of big data, there are many novel approaches being developed to quickly analyze and glean business insights from this data. We’re seeing innovative database technologies and algorithms to categorize, search and sort, not just structured tabular data, but unstructured data like web pages and images as well. Who would have imagined that a company called Splunk, which started just analyzing log files, could be worth over $4 billion?
To help power this analysis, we’ve got the cloud, which represents the most fundamental change in computing since the PC and client-server. The number of virtual servers in the cloud surpassed physical servers in 2010 and will continue to skew even more dramatically, thanks in part to companies like network virtualization startup Pluribus, in which Menlo is an investor. With underlying hardware in computing and networking becoming commoditized and even irrelevant, the new value is being created in software and systems for this new, multi-application, mixed workload, virtualized environment.
The Right-Sized Venture Industry
Besides the investment opportunities that lie ahead, the VC industry has returned to a healthier state. After a decade of lackluster performance, the industry has been winnowed to 200 or so active firms and $20 billion of annual inflows.
At Menlo Ventures, one of the most important stats we track is the five-year moving average of liquidity to commitments, which equates a rough measure of capital outflows to inflows on a funding-cycle time scale. These statistics track venture returns quite accurately, and show us that the market today is as inefficient as it has been since the early 1990s. That’s very good news for investors.
Value is Now Generated Pre-IPO
Naturally, for venture firms to deliver value to their investors, there needs to be a healthy exit environment. Many would say the IPO market still needs to improve. The bar is still very high for companies to go public, and IPO volume is quite low.
For companies going public before 2000, almost 75% of their eventual market value was realized in the public market, after the IPO. But since then, as it became harder to get small companies to market, the venture capital industry has played the role the public market used to play for micro-cap IPOs, and nearly all of the market value of public technology companies is accruing while they are still private. Compare the recent offering of Facebook to that of Microsoft.
So, I would argue that the only way to access the value that’s created in the best venture-funded companies — the ones that clear the bar to go public — is to be an investor in the VC firms that back them. And with the promise of very substantial returns thanks to the Right Now Economy, right now is a very good time to invest.
Mark A. Siegel is a managing director at Menlo Ventures. He focuses on investments in data storage, cloud computing, big data and digital advertising. His active investments and board seats include Dropcam, eXelate, Invidi, Media6, Mixr, Pluribus Networks, Tintri and Voltage Security. He may be reached at firstname.lastname@example.org.
Photo courtesy of Menlo Ventures