The sun is shining, VC fundraising slowed in Q3 and the launch of “big new project” is just a couple of weeks away. In other words, it’s time for some Monday Mouth-Off…
Most of last week’s email was about Sevin Rosen Funds, and its decision to postpone fundraising just days before a scheduled first close. My ultimate conclusion was twofold: (A) SRF is sincere in its belief that the venture capital model is severely damaged; and (B) The postponement decision was partially prompted by SRF-specific issues like recent returns and intra-partnership dynamics.
George writes: “Those of us with enough years in the business remember when the vast majority of exits were from mergers rather than IPOs. It was only during the 1990s that IPOs allowed for VCs to get early monetization of investments — and when that ended, it became a tough business again. What is really going on is that the productivity cycle for semiconductors is not providing quantum-like gains as it did in the 80’s and 90’s, and so those firms who are hardware-oriented like Sevin Rosen are having to either change their model or exit the business. All of this creative destruction began with AOL and was accelerated by Netscape and Google and Yahoo. Venture capital will be around as long as there are people with ideas — it is just that the ideas are now in different areas.”
Jack: “How can you argue a business which takes $25 billion in a year and returns $10 billion ‘during good times’ isn’t broken? (and some of the $10b being distribute is from when we were investing $100b per year). Many Institutional investors think they will make 12% instead of 20% and are happy with that…but when they figure out the J curve is permanent at this investment rate and that they will lose principle, they will recognize what SR is saying is correct.”
Wayne: “Firms got really big after they discovered that partners could deliver mediocre returns and still get paid very, very well. Also, The LPs were naive: They didn’t have enough institutional memory within their own shops and thought the venture business was as scalable as anything else.So push more money across the table to fewer managers and rake in the profits.Life would be so easy…”
Jim: “Good to see you get the Sevin Rosen story right in the end. There always has been – and always will be – too much money chasing too few deals. That was true when Sevin Rosen raised funds in the 1980s, and remains true today. It also remains true that the only firms that will produce “venture-style” returns are in the top decile. Sure it was nice when everyone was generating 30%+ IRRs, but that was all built on inflated paper… Sevin Rosen is just using these timeless truisms as excuses.”
*** No one seems terribly concerned about the reported DOJ investigation into possible private equity collusion. Krishnan seems to sum up reader sentiment: “This investigation into private equity buyouts seems silly to me (though perhaps politically expedient). Let’s remember: (A) Public-to-private buyouts typically take place at a premium to the market price, so at that moment, if you believe public markets are efficient, the public shareholder stands to gain; (B) No one is forcing public shareholders to approve of the buyout and/or tender their shares, and this happens when the price isn’t high enough; (C) 80% of private equity gains go to LPs, many of whom are pension funds whose employees need these gains to refresh under-funded plans.” All true Krishnan, but largely irrelevant if the Feds can prove collusion.
*** K on LPs faced with follow-up funds for emerging VC managers: “Investors backing Emerging VC managers, especially in early stage investing, have to be prepared going in to re-up in Fund II without liquidity events. Unless there is a roaring bull market going on, it’s not logical to assume that there would have been time enough for Fund I to have generated a significant number (or any) liquidity events. But you are not flying blind, and in effect have a lot more data points upon which to make your re-up decisions. The key points are:
- Team Stability: Judging team dynamics is always the most difficult part of Due Diligence with a new group. After three years in the trenches investing together, you should have a lot better feel for whether this is a cohesive team.
- Deal Flow: For a first time fund, it’s always difficult to judge whether or not the deal flow is really there. Three or four years into the investment period, that should be a lot more obvious.
- Strategy: Does the deal flow match their stated strategy or was their take on the market totally wrong? And if their strategy is different then what was sold to you on Fund I, is that because there was a totally sea change in the market – or did they just get things wrong?
- Track Record Milestones: Though you are unlikely to have exits, you should have key milestones in the portfolio – up rounds, companies approaching profitability, strong syndicate partners.
*** Jason: “I’m not a conspiracy theorist or anything of the sort, but something doesn’t smell right with the online-gaming legislation timed right around the TPG/Apollo bid for Harrah’s.”
*** Finally, I want to extend best wishes to Danielle Fugazy, whose last day as Editor of Buyouts Magazine was on Friday. She is moving on to pursue a freelance communications career, with a continued focus on the private equity industry. Danielle and I used to share an office in Midtown Manhattan (the one that annoyed others with its loud music), and it was by far the most enjoyable environment I’ve ever worked in. Good colleague, great friend. She sends her regards to all, and can be contacted going forward at firstname.lastname@example.org.