Word of the Day: Spin-in

Summary:
Spin-ins are startups founded by people from a more established parent company. They usually work to develop products and technology aligned with the goals of the mothership, but keep track of everything (including venture capital raised) on a separate balance sheet. If certain technical milestones are hit, the spin-in is then absorbed back into the company, which it can then ride to profitability or leverage to raise further rounds. Cisco Systems has long been a major proponent of this strategy, and it’s clearly worked for them.

Notes:
But there’s also another way to do it. A spin-in doesn’t have to be a simple technology play. Instead, the parent company works with investors (since it has the clout) and the management team to build a real company with real revenues of its own. That way, if it gets gobbled back up after two or three years, it can be immediately accretive to the parent company. This is an attractive option for bigger companies looking to balance their investment in innovation against dilution of corporate earnings. Not to mention that it will help both venture firms and management teams address the issue of liquidity in a world where IPOs, mergers and acquisitions are becoming few and far between.

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Back to bust? High technology on course for harder times - FT.com

Summary:
The IT industry may be about to face its toughest period since the dotcom bust due to the slowdown in the economy. Corporate demand, the IT industry's main source of prosperity, will fall significantly. Instability in the financial markets, declining new hires and weakening corporate profits will result in a lowering of capital expenditure and a premium being placed on operational efficiency. This is likely to play out over the next 9 months, with tech stock, already down 19% over the last 12 months, to fall further. Other recent trends that will compound the impact of the economic slowdown are the increase in choice leading to price deflation; the rise of software as a service and virtualisation. Consumer spending and spending on advertising, an important source of revenues for many Web 2.0 startups are also in decline. The downturn, however, may be less painful than the dotcom crash. There is less overcapacity in the industry, and increasing demand from the emerging world for IT services is compensating for the slowdown in the US and UK. (Published: 14/08/08)

Notes:

• information technology industry may be about to face its toughest period since the dotcom bust
• forgotten side of the technology world: industry's main source of prosperity is the corporate customer
  
• the engine that powers Silicon Valley and the rest of the technology industry
• "flashy gadgets such as Apple's iPhone and online consumer services such as Facebook may have captured the popular imagination and created new technology fortunes, but they are not the industry's main source of prosperity"
• companies account for 60-65 per cent of the end-market for technology
• consumer technology represents only about 20-25 per cent
• governments make up the rest
• with a pronounced economic slowdown in the US and the UK, this engine has started to sputter:
1. weakening corporate profits
2. decline in new hires
   
3. instability in the financial markets
   
• these have historically all been warning signs of lower capital spending ahead
• based on the usual lag, the turmoil in credit markets of the past year virtually guarantees that corporate spending on technology will fall over the next nine months or so
• technology demand, which has been growing recently at an annualised rate of 5-6 per cent, could decline by 10 per cent
• tech stock investors
  
• investors in tech stocks are invariably drawn by the promise of superior growth
• made the sector a stock market stand-out for much of last year, as a slowing US economy made growth stocks rarer
• industry's seemingly endless hype cycle feeds this optimism
• there's always a new computing architecture about to go mainstream, a new must-have gadget, and a Next Big Thing
• optimism is often justified given the big markets that new technologies can create
  
• but: investors frequently pay dearly for that potential
• "If it doesn't work, you get your neck broke"
  
• tech stocks have fallen 19 per cent over the 12 months to the end of July
• nearly double the rate of the overall market
• operational execution at a premium
  
• "I expect the slowdown to profoundly impact Silicon Valley internet, networking and technology companies over the next 12 to 18 months"
• "Technology start-ups should already be tightening their cost controls and turning their attention to the nuts and bolts of operational efficiency."
  
• "There are still numerous long-term growth opportunities across Silicon Valley, but operational execution is at a premium and much more of a differentiator than it has been in many years."
  
• Jim Breyer, partner in VC firm Accel Partners
• recent trends in the technology industry compounding the impact of the worsening economic environment
• availability of choice -> price deflation
  
• thanks to the rise of the internet and other standards-based technologies
• made it easier for buyers to shop around
  
• many corporate buyers have come to count on these to help them continually reduce the overall size of their tech budgets
• When the 1990s tech boom reached its peak, corporate buyers were often tied to proprietary systems from single suppliers
• that is no longer the case
• result: a severe price deflation has taken hold in some corners of corporate technology
• rise of "software as a service" and virtualisation
• two of the most powerful recent technology trends that exemplify this change
  
• software as a service (SAS)
• involves shifting corporate computing tasks to online services
• e.g. using a company such as Google to provide an e-mail service
• "I don't have to buy servers, I don't have to buy storage, I don't have to do back-ups"
• many of these service companies have priced their services at rock-bottom rates
• relying on attracting large volumes of customers to spread their large fixed costs
• "We're talking about products that are one tenth the cost of things that were hawked in the last recession"
• virtualisation
• makes it possible to run several computing workloads on a single server,
• greatly reducing the number of machines that companies need to buy and maintain
• trends like these have created new markets and supported the rise of new companies
• but 1: they have also exposed those whose technologies or business models are not suited to the changing times
• e.g. Sun Microsystems
• soared in the dotcom boom as its proprietary servers became the mainstay of Web 1.0
• but has struggled to adapt to the latest generation of low-cost, standards-based machines and open-source software
• but 2: even tech companies that have been better positioned to ride this wave are starting to feel the pinch.
• due to weaker corporate demand
• companies taking a more "pragmatic" approach to their tech budget
• putting off buying new services
• not just weaker corporate demand
• consumer spending on tech, though far less significant overall and traditionally less prone to big dips, could also be hit in a wider downturn
• another big source of growth, the rapid rise in online advertising, has slowed notably this year in the face of a wider softening in consumer advertising
• after growing nearly 26 per cent in 2007, online advertising in the US, is predicted to grow by only 17.5 per cent this year and 14.5 per cent in 2009, before growth eventually pushes back above 20 per cent in 2011
• search still dominates
• people are cutting back on typical display ads
  
• this slowdown in advertising could not have come at a worse time
• many of the consumer web companies created since the dotcom crash have been avidly building an audience in the expectation that they will cash in through advertising

• downturn will not be anywhere near as painful as the one that hit the industry at the start of this decade
• late-1990s tech binge was more than a bubble in stock market valuations:
  
• it also reflected a massive bubble in tech spending
• internet euphoria
• fear that many older IT systems would not be able to handle the date shift at the turn of the millennium
  
• combined to produce a boom in corporate spending
• we don't have the overcapacity in IT systems we had going into the last downturn
• capital spending in the US has been low by historical standards for the past four years
• will cushion the blow from any fall now
• demand from emerging world growing
  
• after many years of investment, these markets are finally on the brink of becoming significant money-earners for some of the industry's biggest players.
• at its current growth rates, these "growth markets" may account for nearly 30 per cent of its revenues in five years' time
• Silicon Valley is once again turning into a place of "haves" and "have-nots"
• those start-ups that raised a comfortable cushion of cash from investors to see them through this more uncertain period and those that risk being left high and dry if business turns down
  

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Makeover Mandated for U.K. Life Science Sector - GEN

Summary:
UK Trade and Investment (UKTI) believes that the UK biotech industry’s recent battering by the press gave a very one-sided view of the true international potential of the country’s life science sector. Not only is the UK second to the U.S. in terms of biotech industry size but it leads Europe with its pharmaceutical exports. But the U.K. has been slow in publicizing its strengths. Therefore, the UKTI was charged by the government with marketing the U.K.’s life sciences internationally. The result was the UK Life Science Marketing Strategy which was drafted earlier this year. Workstreams aim to optimize how U.K. academia and industry sells itself internationally, in terms of comprehensive and consistent messaging, financing (using marketing to increase the amount of international VC funding in the U.K.), and also how best to communicate with potential partners and investors in key countries. A tool kit has been developed that will allow any UK life science company to access and take the most relevant messages with them in terms of UK innovation, support industry, tax incentives, and academic background. UKTI and the Strategy Implementation Board hope that executing and further developing the U.K. life science market over the next five years will significantly boost the country’s standing within the international arena, increase inward investments, business, and collaborations, as well as make the U.K. industry a more cohesive force. (Published: 01/09/2008)

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VC Funding for Biotech Companies Withering - GEN

Summary:
Despite an abundance of funding as well as scientific and technological progress, the environment for investing in the life science industry seems to have changed dramatically. The change has been most dramatic for the biotech sector. In theory, the level of VC investments made in life science at any time should not be significantly affected by short-term fluctuations in stock market activity or the economy. Drought of new public money coming into venture-backed companies through IPOs, however, as well as increasing caution on the part of acquirers have biotech venture investors hanging on tighter to their wallets and checkbooks. Money is still there but it is going to be harder for biotechnology companies to obtain. Particularly true given the increased competition for investment with medical device and equipment companies as well as new competition from biofuels and alternative energy companies for investment dollars. (Published: 01/09/2008)

Notes:

• Q1 2007: record highs in venture investments in biotechnology, medical device, and healthcare firms
• average investments in these areas maintained nearly the same levels through the end of the Q1 2008
• Q2 2008: venture investing in general made a major downturn
• no public offerings of any venture-backed company
• life science
• far fewer venture dollars went to a smaller number of life science companies
• in Q1, U.S. life science venture capital firms made 315 investments aggregating nearly $3 billion
• in Q2, there were 215 such investments aggregating $1.9 billion
• biotech: change even more dramatic
• number of biotechnology venture backings fell by nearly 50% (to 89 investments)
• dollar amount invested fell by more than 40% from Q1 ($919m vs. $1.5b)
• outside the U.S., the venture financing value fell nearly 50% in the same period
• proportion of life science dollars going to biotech has also shifted compared to medical devices and equipment as well as other healthcare ventures
• biotech firms’ share of investments made in the life science industry fell to below 40% from approximately 45% in 2007
• average amount invested in biotechnology, though, remained high in Q2
• more than $10 million
• investments have ranged from $8.4 to 11.8 million over the past six quarters
• Factors behind the change
• biotechnology investments, like most venture capital investments, are inherently risky
• in today’s uncertain economic climate, many investors are opting to sit out and wait for more certainty in the market before they invest
• biotech investments generally take longer to mature than nonbiotech investments
• for those life science investors who are nervous about the long term in the current environment, investments that have a shorter return time, such as those in medical devices and other healthcare ventures, have become more attractive
• emergence of clean energy as an alternative investment category that is growing in favor with long-term investors
• venture capitalists whose portfolios include longer-term investments are shifting their dollars from biotechnology to solar energy, wind power, and other sustainable energy solutions
• constriction/lack of liquidity in the public equity markets
• compare
• in 2007 there were 31 IPOs of life science companies, 11 of them for biotechnology companies.
  
• in the first half of 2008, four life science firms including one biotech, Bioheart, made IPOs
• decline may result from a number of factors some of which are not specific to life science investing
• general investor apprehension
• the debt crisis
• Sarbanes-Oxley and related regulations
• lack of liquidity in the public markets has also resulted in public companies taking on private investments from venture capitalists
• e.g. Cadence Pharmaceuticals, Antisoma, Xanthus Pharmaceuticals
• investment of venture capital into public companies and later-stage private companies means that even less is being spent on early-stage companies
• lack of liquidity in the U.S. markets has also led a number of biotechnology companies to go public through the London Stock Exchange’s Alternative Investment Market (AIM)
• life science acquisitions have also taken a beating
• compare:
• 47 venture-backed life science companies were acquired in 2007
• only 12 have been taken over in the first half of this year, eight of which were acquired in the first quarter
• take-over values down from 2007
• total value of the 36 acquisitions made last year for which transaction values were made public was $7.4 billion
• so far this year, the aggregate amount of the seven deals for which financial terms were disclosed was $2.2 billion.
• in theory, the level of VC investments made in life science at any time should not be significantly affected by short-term fluctuations in stock market activity or the economy
• drought of new public money coming into venture-backed companies through IPOs, however, as well as increasing caution on the part of acquirers have biotech venture investors hanging on tighter to their wallets and checkbooks.
• money is still there but it is going to be harder for biotechnology companies to obtain
• particularly true given the increased competition for investment with medical device and equipment companies as well as new competition from biofuels and alternative energy companies for investment dollars

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There is hope yet for science park toilers - FT.com

Summary:
Jonathan Guthrie sees evidence that the level of innovation in the UK appears to be declining. Not much coming out of universities anymore. We're living through a fallow period for innovation, fundamental innovation is slowing up after a remarkable 40 year boom. Internet investment bubble, Schumpeterian explanation: copycats to pile in on the upswing of an innovation wave. Was a fiasco for VC investment in UK. Returns negative for average fund set up after 1996 over 5 to 10 year periods. Confidence has weakened further with the credit crunch, which has closed the market for flotations. Less money was invested in European technology start-ups last quarter than at any time since 2001. Venture capital is more fragile this side of the Atlantic than in the US. Technology investment in UK will probably recover. VCs need to market themselves, focus on the lofty top decile, not the mediocre median. Early stage technology investment is attractive as a way to lay small bets on risky, glamorous propositions. Also need a handful of breakthroughs that are immensely remunerative. Biotech lost cost. Renewable energy and power savings big hope. (Published: 30/07/08)

Notes:

• little backing from City for fledgling tech companies on UK's science parks
• Jon Moulton, a private equity investor who backs technology start-ups as a hobby
• “In the UK the level of innovation appears to be declining. Universities are being picked over very hard for ideas, but not a lot is coming out of them.”
• likens UK early stage technology investors to ufologists
• instead of joining hands and imploring Martians to land, they hope, equally fruitlessly, for a worthwhile return on investment
• living through a fallow period for innovation
  
• Walter Herriot of the St John’s Innovation Centre
• “There is a slowing up in fundamental invention, though not in the creation of niche applications.”
• reflecting on the advent in the past 40 years of personal computers, the internet and mobile phones, he says: “I cannot see an equivalent explosion in the near term.”
• similar to Schumpeter's view
• proposed that innovation progresses in waves
• profitable breakthroughs occurrs in the troughs of economic cycles
• encourages copycats to pile in on the upswing, feeding economic instability
• cfr internet investment bubble
• now looks more like a belated dash into a maturing technology rather than the new era it was billed as at the time
• fiasco has constrained any advertising claims for venture capital based on recent performance
• funds set up after 1996 have typically lost 1.4 per cent a year over five years and 1.8 per cent over 10 years
• according to the British Private Equity and Venture Capital Association
• Confidence has weakened further with the credit crunch, which has closed the market for flotations
• less money was invested in European technology start-ups last quarter – €950m (£747m) – than at any time since 2001
• Apax, progenitor of European venture capital, launched a fund last spring with no venture capital component
• Braveheart is concentrating on follow-on financings;
  
• 3i has pulled out of early stage investment altogether
• Venture capital is a more fragile flower on the eastern shores of the Atlantic than in the US
• Sir Ronald Cohen, founder of Apax,
• “The perception is that the early stage is tougher, you raise less money when you float, and there is less liquidity afterwards.”
• is technology investment is doomed to dwindle away to nothing in the UK?
• will probably recover
• dotbomb losses will drop out of short-term performance statistics during the next few years.
• returns need not then be spectacular – a long-term average is 4.5 per cent – to lure investors back
• trade bodies such as the BVCA, meanwhile, can do their bit by quoting returns exclusive of “exceptional losses” chalked up on internet plays
• marketing emphasis should be on the lofty top decile, not the mediocre median
• early stage technology investment is attractive as a way to lay small bets on risky, glamorous propositions
• absorbs just more than £1bn a year in the UK
• no backers stake money they cannot afford to lose
• in some respects it resembles alternative investments, such as art or wine, more than big buy-outs or quoted shares
• task that science park toilers face is to produce a handful of breakthroughs that are immensely remunerative
• little can be hoped for from biotech
• stricken by unprofitability as persistent as a hypochondriac’s bad back
• materials scientists have engineered a UK nanotechnology sector so tiny it is virtually invisible
• most to go for in renewable energy and power saving systems
• "scope for technological leaps equivalent to the shift from mainframes to PCs” (Sir Ronald Moulton)

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Despite economic slowdown VC returns remain positive in Q1 2008 - NVCA

Summary:
Venture capital returns, as measured by the private equity performance index (PEPI), have been falling across all investment horizons ending Q1 2008, but still compare favourably to stock indices like the NASDAQ and S&P500 according to NVCA. The economy’s biggest effect on the venture market has been indirect — the IPO and mergers/acquisitions markets are hurting, which means VCs have to pump more money into later-stage companies. Causes lower returns. According to Mark Heesen, returns will fall even further if the exit market doesn’t improve. (Published: 29/07/08)

Notes:

• one-year private equity performance index (PEPI) showed the greatest change from
  Q4 2007
• 7.6 point decrease to 13.3% in Q1 2008.
• historically, short-term horizons show significant fluctuations quarter over quarter based on large exits impacting the return
• next largest consecutive quarterly change occurred in the ten-year time horizon
  
• PEPI decreased by 1.1 points quarter-over-quarter
• three year performance also posted a modest decline from the previous quarter
• decreasing .2 percentage points from 9.7% in Q4 2007 to 9.5% in Q1 2008
• five-year and twenty-year performance figures showed modest quarter-over quarter increases
  
• to 9.1% and 16.8%, respectively

• Venture returns across all horizons, except the five-year horizon, outperformed public
  market indices, NASDAQ and the S&P 500, through 3/31/2008

• Mark Heesen:
• "The IPO market has now been essentially shut down for venture-backed companies for over seven months. Combined with a skittish M&A market, shorter term performance returns are and will continue to be impacted."
• "Our asset class continues to out perform many other investment alternatives
  including the public markets over the long term. But we will need to see the exit markets improve dramatically to maintain that position in the coming year."
  

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When to start - Seth Godin

"The best time to start was last year. The second best time to start is right now." - Seth Godin

Notes:

When to start

• The best time to start is when you've got enough money in the bank to support all contingencies.
• The best time to start is when the competition is far behind in technology, sophistication and market acceptance.
• The best time to start is when the competition isn't too far behind, because then you'll spend too long educating the market.
• The best time to start is when everything at home is stable and you can really focus.
• The best time to start is when you're out of debt.
• The best time to start is when no one is already working on your idea.
• The best time to start is when your patent comes through.
• The best time to start is after you've got all your VC funding.
• The best time to start is when the political environment is more friendly than it is now.
• The best time to start is after you've got your degree.
• The best time to start is after you've worked all the kinks out of your plan.
• The best time to start is when you're sure it's going to work.
• The best time to start is after you've hired the key marketing person for the new division.
• The best time to start was last year. The best opportunities are already gone.
• The best time to start is before some pundit declares your segment passe. Too late.
• The best time to start is when the new generation of processors is shipping.
• The best time to start is when the geopolitical environment settles down.

Actually, as you've probably guessed, the best time to start was last year. The second best time to start is right now.

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How to fix a broken venture capital model - EETimes

Summary:
Interview with Matthew Nordan about why the current VC model is broken, especially in the case of materials, energy and environment sector investing. The linear path from angel to VC to IPO no longer works due to greater costs, longer gestation times, greater technological uncertainty and ill-defined problems. This is a time of great experimentation and visible discomfort. New type of VC machine needed. Smartest venture firms cultivate relationships with the buyers of technologies. Nordan also has four rules for venture companies: Make non-obvious matches of technologies and solutions; be suspicious of exponential growth; maximize options to avoid surprises from left field; and avoid focusing on an ideal technology to such an extent that you fail to see a "good enough" technology in its wake. (Published: 22/07/08)

Notes:

• Matthew Nordan, Lux Research, President
• ideas on how to make startup financing work again
  
• old machine
• linear path
• angel funding -> VC financing -> (some cases growth equity/PE) -> public markets
• works really well for IT
• don't need tremendous amount of money; pretty capital efficient investments
  
• also for life sciences
• because there's a rule book that you can follow by using the FDA and EMEA approval cycles as a way of determining how far the company is
• none of those rules exist in the materials, energy and environment world
• and you need more money over longer periods of time (gestation times in excess of a decade)
  
• frequently break 10 year close-ended fund cycles that VCs as a rule have
• with greater levels of technology risks further down the cycle, down into the land where you have 10s of millions of dollars of investment being made by PE and growth equity funds
• machine doesn't work; need a new machine
• new machine
• some innovations promising; but you don't know what works till folks have seen a 25% IRR on doing it in a new way
• interesting: fund that raises small amounts of money to be able to go out and seed companies to get them to a stage that they are ready for a venture fund
• cut of that first part of the technology development cycle and get it to fit into a 10-year close-ended structure
• interesting: project financiers beginning to construct joint venture vehicles where there may be a carve-out slice of equity for the venture financiers that may get them some returns (some meat to take home to the cave for the LPs) before the company is able to achieve the liquidity of it
  
• particularly for water and waste technologies
• venture funds have responded by specializing
• Rockport and Kleiner Perkins Caufield & Byers
  
• invest in early-stage technology
• Riverstone and FourWinds
  
• invest in deployment of semi-mature technologies
• only a few funds like Vantage Point try to span the gamut of development and deployment
• new model of "clear-cutting" VCs
• exemplified by Khosla Ventures
• represent funders of last resort
• ultimately this a time of great experimentation and visible discomfort
• will be 5 to 10 years before we know which of any of those ingredients are going to work out
• bringing in the growth equity partner between VC and IPO
• growth equity is coming back
• VCs are not prepared to extend funding into the hundreds of millions of dollars
• smartest venture firms cultivate relationships with the buyers of technologies
• smart venture firms talk to the customers of potential startups to say what problems do you need solved five years down the line?
• ranging from OEMs in the semiconductor field to utility companies in the energy field
• then build a startup based on the wish-lists of those customers
• business plans get ripped apart five times over before the company ultimately decides what it is that it's supposed to be doing
• difference from an energy environment perspective is that the problems are generally less well defined; lack of definition
  
• as opposed to software: explicit problem that they're trying to solve upfront
• e.g. Green Fuel Technologies Corp., algae company
  
• intended to use algae to process wastes from natural gas plants and ferment biomass fuels
• turns out that you can get a lot more revenue from the same unit of algae, not by fermenting it to make biofuels, but by selling it as fish feed, or as an additive
  
• the desiccated algae itself are more valuable than the biofuels that you can make from them
• at least in the current state; may change over time

• four rules for venture companies
1. make non-obvious matches of technologies and solutions;
   
2. be suspicious of exponential growth;
   
3. maximize options to avoid surprises from left field and to be aware of unexpected breakthroughs;
   
• e.g. emerging "solar antenna" that can tune in to 800-900 nm waves, thus obsoleting several small-scale solar technologies
• also involves carefully quantifying all externalities
• e.g. the water-use requirements for ethanol and biodiesel make so-called clean energies look dirty when total inputs are taken into account.
4. avoid focusing on an ideal technology to such an extent that you fail to see a "good enough" technology in its wake

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Venture capital retreats from tech initiatives - FT.com

Summary:
Outlook looks bleak for technologists in Europe who are trying to raise money to get new ventures off the ground. Venture capital investment in Europe’s fledgling technology companies last quarter fell to its lowest since the dotcom crash. In the UK, investments fell by only 5% year-on-year, but in Germany they fell much further. Biotech will be particularly vulnerable if the downturn in venture capital funding continues, although cleantech should be more robust. Evidence of nervousness among specialist investors about the world economy in the wake of the credit crunch. The already high risks of the asset class have been increased in the eyes of investors by global financial instability. (Published: 23/07/08)

Notes:

• outlook looks bleak for technologists who are trying to raise money to get new ventures off the ground
• nervousness among specialist investors about the world economy in the wake of the credit crunch
• Europe: mere €950m ($1.5bn) invested in Q2 2008
  
• €450m less in Q2 2008 than in Q1 2008
  
• €350m less in Q2 2008 than in Q2 2007
• UK: decline of just 5 per cent year-on-year to €311m
• has a culture of equity investment
• Germany: investment fell much more heavily
  
• Richard White at Library House
• “The fundamentals should be strong, because the majority of fund raisings do not have a debt component, but it appears that venture capital investors are as much prey to the current psychological uncertainties as everyone else”.
• already high risks of the asset class have been increased in the eyes of investors by global financial instability
• biotech
• will be particularly vulnerable if the downturn in venture capital funding continues
• cleantech
  
• should be more robust
• “There are strong forces at work here, as governments seek to combat climate change.”

• Venture capital investment is tiny by the standards of private equity but is a vital stimulus to the commercialisation of ground-breaking technological research

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Dow Jones: VC investments drop 12 percent from last year, fewest deals since 2005 - VentureBeat

Summary:
According to Dow Jones VentureSource, Q2 2008 VC investment in US companies is down by 12% from last year, as opposed to flat according to an NVCA report. The number of deals is at its lowest in three years, and the majority (54%) of deals were later-stage. Worst hit sectors are healthcare and IT (with the exception of IT services, e.g. Web 2.0). Energy and cleantech, on the other hand, posted record quarters. The top three venture capital deals in the second quarter were all solar companies. According to Dow Jones VentureSource, the drop isn't too significant, deal activity and investment are still considerable. VCs aren’t consumed about the darth in IPOs and acquisitions. They’re focusing on what’s next – and that’s reflected in the healthy early stage investment we’re seeing in areas like renewable energy, information services and business support services. (Published: 19/07/08)

Notes:

• Q2 2008, US VC investment:
  
• $6.64b
  
• 12% less than Q2 2007
• as opposed to flat according to NVCA report
  
• VentureBeat: Dow Jones research on venture investments has generally been the more meticulous over the years
• 602 deals
• lower than any time since 2005
• later-stage deals continue to attract the lion’s share of venture capital
  
• $3.48b (~54% of the quarter’s investment total) put into 225 rounds
• pushed the median deal size of a later-stage round to a record $12 million in the first six months of 2008
• first sign of a downturn in the VC sector
• if continues, will mean VC backed start-ups may have to turn frugal, shed jobs or take other moves to survive in more leaner times
• healthcare investments: took particular beating
• Q2 2007: $2.53b invested in 181 deals
• Q2 2008: $1.98b invested in 149 deals
  
• down 22%
• deal flow is at its lowest level in three years.
• IT industry
  
• saw deal flow drop 27 percent from 390 in Q2 2007 to 286 in Q2 2008
• lowest deal count since the first quarter of 1997
• investments down 26 percent from nearly $3.50 billion to $2.60 billion
• the lowest quarterly investment total since 2003
• information services sector
• includes the majority of today’s “Web 2.0” companies
• only area within IT to see positive gains
• $688 million invested in 80 deals
• a 20 percent increase over the $572 million invested in 94 deals during the same period last year
• one bright spot: energy and cleantech
• energy and utilities
• Q2 2008:$817m invested in 32 deals
• record quarter
  
• Q2 2007: $314m invested in 23 deals
• up 160 percent
• renewable energy
• $650 million in 26 deals
• also a record
• top three venture capital deals in the second quarter were all solar companies
• Jessica Canning, Dow Jones VentureSource:
• "drop isn't that significant"
• “While the U.S. investment total is down compared to last year’s impressive second quarter, we still saw steady deal activity and investment in the first half of the year, which is encouraging. Venture capitalists commonly take the long-view when it comes to investing. While IPOs and acquisitions may be rare now, VCs aren’t consumed about that. They’re focusing on what’s next – and that’s reflected in the healthy early stage investment we’re seeing in areas like renewable energy, information services and business support services.”

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The Equity Equation - paulgraham.com

Summary:
When offering to trade stock for investment or the services of an employee, use the Equity Equation: i >= 1/(1-n), where i is the expected increase in value due to the contribution, and n the share of the company offered in exchange. Even though stock grants can not always be reduced to a formula (there are other factors to consider in a VC deal; it's never just a straight trade of money for stock) and ultimately you always have to guess, it is useful to run the trade through 1/(1-n) to see if it makes sense. You should always feel richer after trading equity. If the trade didn't increase the value of your remaining shares enough to put you net ahead, you shouldn't have done it.

Notes:

• Whenever you're trading stock in your company for anything, whether it's money or an employee or a deal with another company, the test for whether to do it is the same:
• You should give up n% of your company if what you trade it for improves your average outcome enough that the (100 - n)% you have left is worth more than the whole company was before.
• i >= 1/(1-n)
• where:
• i is the expected increase in value due to the contribution
• n is the share of the company offered in exchange
• (1-n) is the share of the company you have left
• i(1-n) >= 1
• i.e. the value of the remaining share in the company should be greater or equal to what it was before
• the trade has left you better of
  
• n <= (i-1)/i
• the share of the company a projected increase of i in value of the firm is worth
• e.g. determining the share value of a new employees contribution
• examples
• investor wants to buy half your company: how much does that investment have to improve you average outcome to break even?
• intuitively: has to double
• 1/(1-n) = 1/0.5 = 2
• if you trade half your company for something that more than doubles the company's average outcome, you're net ahead
  
• you have half as big a share of something worth twice as much
• investor offers to fund you in return for 6% of your company, when should you make the deal?
• you should make the deal if you believe the investment will improve your average outcome by more than 1/(1-n)
• i.e. 1/(1-n) = 1.064, or 6.4%
• if investor can improve your outcome by 10%, you're net ahead
• remaining 94% is worth 1.1 x 0.94 = 1.034
• you're just two founders and you want to hire an additional employee who's so good you feel he'll increase the average outcome of the company by 20%; how much is he worth in terms of a share in the company?
• n <= (i-1)/i = (1.2 - 1)1.2 = 0.167 = 16.7%
• suppose the company wants to make a "profit" of 50% on this new hire, how much stock is the employee worth after accounting for salary and overhead of $60k, if the company's valuation is $2m?
• most startups grow fast or die
• if you die you don't have to pay the guy; if you grow fast you'll be paying next year's salary out of next year's valuation
• next year's valuation should be 3x this year's
• if your valuation grows 3x a year, the total cost in stock options of a new hire's salary and overhead is 1.5 years' cost a the present valuation
• new hire could claim 16.7%, so in order to make 50% profit on the hire, subtract a third from 16.7%, i.e. 11.1%
• the total cost in stock of the new hire is 1.5 years' cost at present valuation
• $60k x 1.5 = $90k
• if the company's valuation is $2m, $90k is 4.5%
• the offer, therefore, should be 11.1% - 4.5% = 6.6%

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Four Reasons Most Startups Fail (And How Yours Can Succeed) - HBS Discussion Leaders

Summary:
Paul Graham (Y Combinator) says four principles determine which startups work and which fail: "Make something people want"; "Be willing to change your ideas" (cfr. Reddit); "Don't worry too much about the money" (probably only applies to web startups); and "Be benevolent." Being benevolent is particularly powerful: keeps morale and energy of employees high; people (customers) will rally around you with ideas, improvements, and word-of-mouth marketing; and it helps the founders to be more decisive: if you make every decision based on doing whatever is best for your users, it's that much easier to make decisions. (Published: 18/07/08)

Notes:

• Paul Graham
• Y Combinator
• Silicon Valley & Cambridge, Mass.
• Seed funding and hands-on advice to startups
• Invests a little money (<$20,000) and takes a small equity stake (~6%)
• Funds companies in batches
• Four principles that determine which startups work and which fail:
1. "Make something people want."
• entrepreneurs often fall in love with what technology can do as opposed to what customers need
• good question: "What are people forced to do now because what you plan to do doesn't exist yet?"
2. "Be willing to let your ideas change."
• a great idea isn't always the original idea
• successful startups often make dramatic changes not just in strategies and tactics, but in the very essence of what they do
• e.g. founders of Reddit originally wanted to help people order fast food on their cell phones
3. "Don't worry too much about the money."
• applies mostly to web startups
• it's become cheap to buy equipment, reach customers, and generate buzz on the Web
• power of investors and VCs is on the wane
• "It's so much easier to get the money you need than to make something great."
• "Unlike back in the mid-90s, you've got the MBAs working for the technologists, rather than the other way around."
4. "Be benevolent"
• in terms of how you do business
• act in the long-term best interest of customers, as opposed to the short-term best interests of yourselves
• most important rule for starting a company (the "Golden Rule")
• cfr. Google: "Don't be evil."
• benevolence is powerful for three reasons:
1. keeps morale and energy high
• in an age of constant disruption and realignment, employees want to be the "good guys" in their field
• makes sense for companies to act that way
2. people will rally around you with ideas, improvements, and word-of-mouth marketing
• more than ever companies require the active participation of customers, suppliers and industry enthusiasts
3. helps founders to be more decisive
• if you make every decision based on doing whatever is best for your users, it's that much easier to make decisions
  

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NVCA: Investments are flat, but good luck with those first-time deals - VentureBeat

Summary:
Venture investments held relatively steady in Q2 2008, despite dreary economic climate. Venture firms appear to be taking the longer view and betting that their portfolio companies can weather a temporary downturn. But more money going to later-stage deals, not funding of young startups. Reason: due to inhospitable IPO and acquisition markets, more venture dollars are needed to keep later-stage startups going as they wait for the exit environment to improve. Prominence of software industry waning in favour of industrial/energy companies. (Published: 18/07/08)

Notes:

• venture investments held relatively steady in Q2 2008
• despite dreary economic climate
• more money going to later-stage deals, not funding of young startups
• Q2 2008
• $7.4b invested in 990 deals
• only a slight drop from $7.5b of funding in Q1 2008
• flat compared to Q2 2007
  
• but well below peak of $8.1b in Q4 2007
• inhospitable market for IPOs and acquisitions
• no IPO in Q2 2008
• consequence:
  
• more venture dollars needed to keep later-stage startups going as they wait for the exit environment to improve
• why hasn’t venture investment taken a bigger drop?
• Mark Heesen: venture firms are taking the longer view and betting that their portfolio companies can weather a temporary downturn
• prominence of software industry waning in favour of industrial/energy companies
• placing second among the latter industries with $1.15 billion of funding, more than double the $571 million invested in Q2 2007

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What downturn? VC firms raised more money in second quarter - VentureBeat

Summary:
Despite tanking stockmarket and lack of IPOs in Q2 2008, fund raising by VC firms is up 3% from Q2 2007. The reason appears to be that investors see VC as a way to diversify now that many other parts of the economy are hurting. PE and later-stage investors, on the other hand, have been more impacted by stock market. Fewer VC firms have been raising money (a decline of 14%), although the proportion of new firms doing so has increased. (Published: 14/07/08)

Notes:

• $9.1b raised from investors in Q2 2008
• 3% more than Q2 2007 ($8.8b)
  
• despite stock market tanking
• cause: VC investing = long-term
• investors may see VC as a way to diversify now that many other parts of the economy are hurting
• PE and later-stage investors have been more impacted by stock market
• fewer VC firms raising money
• only 71 firms raised money
• decline of 14% from Q2 2007
• but: number of new firms raising money relatively high
• 22 firms raised money for the first time
• 49 "follow-on" funds by pre-existing firms were raised
• 1-2 ratio (compared to 1-4 ratio in Q2 2007)
• largest funds raised by
  
• Lightspeed Venture Partners VIII, L.P. (balanced stage; $800m)
  
• Foundation Capital VI, L.P. (early stage; $750m)
  
• Kleiner Perkins Caulfield & Byers XIII (early stage; $700m)

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Clean Energy Investments Charge Forward Despite Financial Market Turmoil - UNEP Press Release

Summary:
Overview of the "Global Trends in Sustainable Energy Investment 2008" report by New Energy Finance for UNEP's Sustainable Energy Finance Initiative. 2007 was a record year for investment in renewable energy and energy efficiency industries. Wind energy was most popular with investors, although the fastest growing sector is solar energy. Investment in energy efficiency technology also reached a record. Sustainable energy accounted for 23% of new power capacity added globally in 2007. The EU remained the leading region for investment, while in the US acceptance of sustainable energy is becoming more widespread. Mood slightly subdued in 2008, although in Q2 most areas of investment rebounded, despite the global turmoil in the financial markets. Also noted was that carbon trading is becoming more accepted, and that private interest in the post-Kyoto market is emerging. (Published: 03/07/08)

Notes:

• 2007:
  
• record-setting year of investment in the renewable energy and energy efficiency industries
• Total sustainable energy transaction volume: $204.9b
• $148.3b in new funding entered the sustainable energy sector globally
• up 60% from 2006
• $98.2b went into new renewable energy generation
  
• wind energy again attracted the most investment: $50.2b
• especially in the US, China and Spain
• installed capacity passed the 100 GW mark
• solar power: $28.6b
• grew most rapidly: at an average annual rate of 254% since 2004
• driven by the advent of larger project financings
• heavy investment to ease the silicon bottleneck and new thin-film technology beginning to reach scale
• $50.1b went into technology development and manufacturing scale-up
• Investment in energy efficiency technology reached a record $1.8 billion
• an increase of 78% from 2006.
• According to the International Energy Agency, each $1 invested in energy efficiency an average avoids more than $2 needed to create new supply.
• $56.6b changed hands through mergers and acquisitions.
• even as a credit crunch began to roil financial markets
• 31 gigawatts of new installed generation
• sustainable energy accounted for 23% of new power capacity added globally in 2007
• about 10 times that of nuclear.
• Sustainable energy companies accounted for 19% of all new capital raised by the energy sector on the global stock markets in 2007.
• EU: remained the leading region for investment
• European asset finance up to record level of $49.5 billion
• 62% of asset finance worldwide.
• particularly later-stage financing
• supportive policies, as well as an investor base that is comfortable with financing renewable energy projects and more intense competition for deals
• US: acceptance of sustainable energy becoming more widespread
• extending beyond its traditional heartland of California
• Texas leading the wind energy charge
• new administration in 2009 is expected to make renewable energy and energy efficiency a political priority
  
• recent uncertainty in the US (particularly over the possible introduction of a CO2 regulations) has put a significant number of coal-fired generation plants on hold
• China: "Beijing Olympic Games (2008) has sharpened the country's political resolve and strengthened programmes to promote cleaner generation and cut energy intensity."
• investment in non-hydro renewables capacity in China increased by more than four times, to $10.8 billion
• new wind capacity doubled to 6 gigawatts.
• surge of Chinese solar companies listing on US and European stock markets
• public market activity is also growing at home
• e.g. Chinese wind manufacturer Goldwind raised $243 million last year in the Shenzhen Stock Exchange's first IPO related solely to renewable energy.
• Brazil: world's largest renewable energy market
• thanks to its long established hydropower and bioethanol industries
• sustainable energy investment in Brazil continued to be dominated by ethanol
• investor interest shifted there from the beleaguered US ethanol market
• investment in sugar cane cogeneration, biodiesel production and wind generation are also picking up.
• India:
• asset financing grew significantly, to $2.5 billion
• mostly for 1.7GW of new wind projects
• these installations place India fourth in the world
• both in terms of new capacity added in 2007 and total installed capacity.
• funds raised on Indian stock exchanges reached $628 million
• although: companies increasingly looked to foreign markets for new capital,
• raised $1.4 billion overseas in 2007
• public market activity was marked by a series of Foreign Currency Convertible Bonds (FCCBs) from established Indian renewable energy companies
  
• e.g. Suzlon($500 million raised) and Moser Baer($150 million).
• 2007 also saw several aggressive cross-border deals involving Indian or Chinese acquirors
• e.g. Suzlon's $1.6 billion acquisition of Repower
• China National Building Material Group's purchase of German turbine blade manufacturer NOI Rotortechnik.
• $13 billion invested in carbon funds by the end of 2007
• important source of investment for "Clean Development Mechanism" (CDM) projects in developing countries
• most new investment was into private funds
  
• carbon trading becomes more established.

• 2008: picture somewhat subdued across the sector
• only mergers and acquisitions up
  
• several substantial wind developers sold their portfolios
• many realising that with the tightening up of the credit markets they could not finance the growth themselves
• US ethanol industry undergoing restructuring
• But: Q2 2008: most areas of investment rebounded
• even as global financial markets remained in turmoil
• sustainable energy venture capital and private equity in Q2 2008 was up 34% on Q2 2007
• new build asset finance was up 8%
• public market investment showing a strong recovery with the IPO of Portuguese utility EDP's renewable energy business, EDP Renovaveis
• Q1 2008: emergence of private interest in the post-Kyoto market
• investors beginning procuring post-2012 CDM credits eligible for trading in the EU Emissions Trading Scheme.

• "Investment in the sustainable energy sectors must continue to grow strongly if targets for greenhouse gas reductions and renewables and efficiency increases are to be met"

• "Investment between now and 2030 is expected to reach $450 billion a year by 2012, rising to more than $600 billion a year from 2020. The sector's overall performance during 2007 and into 2008 sets it on track to achieve these levels."

• "Carbon Capture and Storage(CCS) is the only sector where we did not see as much progress as we had expected, with the regulatory and funding environments for these projects remaining murky and timelines for the first commercial projects being extended."

• Source: "Global Trends in Sustainable Energy Investment 2008" by New Energy Finance (UK) for UNEP's Sustainable Energy Finance Initiative

• Achim Steiner, head of UNEP, UN Under-Secretary General

• "Just as thousands were drawn to California and the Klondike in the late 1800s, the green energy gold rush is attracting legions of modern day prospectors in all parts of the globe. A century later, the key difference is that a higher proportion of those looking for riches today may find them. With world temperatures and fossil fuel prices climbing higher, it is increasingly obvious to the public and investors alike that the transition to a low-carbon society is both a global imperative and an inevitability. This is attracting an enormous inflow of capital, talent and technology. But it is only inevitable if creative market mechanisms and public policy continue to evolve to liberate rather than frustrate this clean energy dawn. What is unfolding is nothing less than a fundamental transformation of the world's energy infrastructure."

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The “Crisis” In Venture Capital - TechCrunch

Summary:
TechCrunch article summarising latest NVCA report (no IPOs in Q2 08). Some interesting comments. Most commentors blame the VC crisis on irresponsible VC investing in internet startups rather than the problems in the financial sector (Web2.0 companies with fake revenue forecasts; startup founders running away with the money; VC and internet are a bad mix). Many VC s are also believed to be ignorant about the technologies they are investing in (e.g. cleantech, energy). Other commentors blame it on a mixture of poor VC investing and loose credit markets. Several commentors believe there will be a flight to quality investments that take 4-6 years to build. The downturn could be a good time to invest, given that it may take 4-6 years before the markets have recovered. "Loose money creates waste and inefficiency and encourages stupidity. When money is dear, innovation really blossoms." (Published: 02/07/08)

Notes:

Comments

• blaming the VCs, startups, Web2.0
  
• "investing lotto style in all these web 2.0 businesses with fake revenue forecasts right"
• "All you have to do is look at the stupid crap companies (like Twitter) that are getting attention and the solution is clear."
• "Venture Capitalists and the Internet is just a bad mix"
• "The reason banks won’t invest risk capital into startups is because some people start LLCs or corps to shield themselves, then they get lots of capital and lose it. Here is an example since we are on the subject of TC being pushed into the deadpool. I dunno whether it will or not, but here is some history.
• “Edgeio recieved $1.5 million in angel funds from the likes of Louis Monier, Frank Caufield, the RSS Investors Fund, Jeff Clavier, Ron Conway, Michael Tanne, and others. $5 million in Series A financing followed in October of 2006.” So 6.5 Million, then the total of their assets gets sold at an undignified auction for $280,000
• The bank knows this, and they’re like “where did the 6.22 million go?” There is no answer. It disappears into the abyss of web 2.0. An accounting mess of weird and flashy expenses."

• "Hopefully this will generate a flight to quality among entrepreneurs. I’m sick of conferences where slick haired guys in t-shirts sit on a stage and talk about how the way of the future is their app that lets you throw a facebook fish at a myspace user. The world may be desperate for an app that lets you view a twitter feed on an android phone, but its not so desperate that it will pay for it. I hope people start looking for real problems to solve, rather than sitting in starbucks saying “wouldn’t it be cool if . . .” Maybe if the VCs stop funding cool, and start funding useful, that will happen."

• "Anybody who thinks that the “crisis” in venture capital is due primarily to the credit crunch doesn’t know what he’s talking about. The credit crunch and SOX aren’t helping VCs but the “crisis” is due to the fact that far too much VC money has been invested in startups that don’t interest anyone on Wall Street anyway because they aren’t real businesses. Apparently VCs didn’t get the memo: the .com boom was an anomaly in the IPO market and it isn’t likely to happen again anytime soon (we’ve moved on to creating other bubbles). VCs hoping that cleantech is the answer are in for more disappointment. I work for a hedge fund and over 25% of our investments are in the energy sector. We looked at several investments in cleantech startups that had raised VC money in earlier rounds and the VCs I talked with were clueless. They had no understanding of the energy business and looked dumbfounded when we told them that they had probably invested in a startup with an interesting technology that probably isn’t going to be commercially scalable. Bottom line: VCs are in “crisis” because most of them are clueless tools who couldn’t even run a dry cleaners."

• blaming the financial sector
  
• "The global liquidity crunch is very real. Look at the market caps of our largest banks: In the past year, Citibank has fallen from $52/share to $17/share today, Bank of America has fallen from $54/share to $24/share. It is inevitable that the crunch impact valley firms."
• blaming a combination of both
• "Loose credit markets result in liquidity events that are often irrational, yielding a poor return on investment. The combination of poor investment decisions by VCs combined with easy credit has resulted in limited liquidity events or “exits”."
• "This is a result of the continuing fallout from the extreme dot com boom/bust cycle of 1999 - 2003. The investment world (and regulatory system) has never really recovered from its skepticism about new, “IPO-ready” technology companies as a whole, regardless of individual success stories, so when other factors (credit crisis, economic uncertainty) increase the risk premium, the memory of being burned and scarred by tech companies is still vivid, and investors flee to quality, or sit on their hands."
• blaming Sarbanes-Oxley
• "I’d really like to see a more detailed investigation on Sarbanes-Oxley: Is it likely to be repealed? Is it likely to be relaxed? What do the two presidential candidates think about? What’s the consensus on SOX in the senate / congress? The negative effects of Sarbanes-Oxley on the economy are hard to overstate. I’d like to understand the chances of an improvement."
• Prospects for the industry
  
• "Cleantech investments may reflect the development cycle of a medical device company (so 5-7 years before an exit). Internet companies may not have any meaningful exits as there aren’t a whole lot of interesting players at the moment that are worth acquiring for any meaningful valuation (say > $250 Million). So I think we’re seeing a lull between the shift of investment into a heavier-load of long-cycle investments."
• "There’s typically a flight to quality in this type of scenario. If your startup is top 5-10% for whatever reason, the competition to invest in you will likely continue to be extremely fierce - maybe even more so. For everyone else however, I wouldn’t be surprised to hear that “the books are closed right now”."
• "There are several fundamentals to building a business that VC’s should seek in their investments, but don’t value much anymore. Particularly:
1. A clear business model
2. A scalable plan for growth with defensible intellectual property
3. Preexisting “sweat equity” by founders
• These fundamentals are severely lacking in most VC investments today, but they are the ones which result in business liquidity over the long term.
  
• Loose credit markets result in liquidity events that are often irrational, yielding a poor return on investment.
  
• The combination of poor investment decisions by VCs combined with easy credit has resulted in limited liquidity events or “exits”."
• "The Recession is going to be one hell of a mess. I view it as an opportunity. Loose money creates waste and inefficiency and encourages stupidity. When money is dear, innovation really blossoms. The Depression was a fruitful time to start a company. High gas prices are going to launch the next GM, I guarantee it."
• "The best time to invest is during economic downturns… not during the upswing. It is amazing how few investors get that given that this trend has played out over and over again over the past century. This is especially true for VCs who need to wait 4-6 years before the companies they invest in have a chance to exit."

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No venture-backed IPOs issued in Q2 '08 - NVCA

Summary:
For the first time since 1978, there were no venture-backed IPOs in the second quarter of 2008 according to the Exit Poll report by the NVCA and Thomson Reuters. The absence of any offerings this quarter follows an exceptionally slow first quarter when only 5 venture-backed companies went public. This number is a fraction of the first half of 2007 when 43 companies went public. The report also shows a drop in the number of mergers and acquisitions. According to the NVCA, the situation is concerning enough to be characterized as a capital markets crisis for the start-up community. The three largest factors to which venture capitalists attribute the current IPO drought are: skittish investors (lower appetite for high-tech stocks), credit crunch/mortgage crisis and the increased costs created by Sarbanes Oxley regulation. 81% of venture capitalists do not see the IPO window opening in 2008. (Published: 01/07/08)

Notes:

• Mark Heesen, president NVCA:
• “Venture-backed companies that successfully enter the public markets represent a critical job creation engine for the United States economy, and that engine has completely shut down.”
• “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. We view this quarter as the ‘the canary in the coal mine’.”
• survey of VCs around the country:
• 81 percent of venture capitalists do not see the IPO window opening in 2008.
• Two-thirds of venture capitalists believe that venture-backed companies are less
  likely to want to go public today than they were 3 years ago.
• The three largest factors to which venture capitalists attribute the current IPO
  drought are:
• Skittish investors (77 percent)
• Credit crunch/mortgage crisis (64 percent)
• Sarbanes Oxley regulation (57 percent)
• Only 8 percent of venture capitalists characterize the current IPO drought as “not critical” to the future health of the venture capital and entrepreneurial communities.
• Dixon Doll, chairman NVCA:
• "While we clearly recognize that the IPO drought is being driven largely by a weak economy, there are other systemic factors that are making the IPO exit less attractive for high quality venture-backed companies."
  
• "Our government and the private sector should be doing all that it can to encourage these innovative, high quality companies to enter the public markets and grow from there."
  
• "The acquisition will always be an attractive and viable exit path for venture-backed companies, but the public offerings create visible, long term economic growth."
  
• "Imagine the implications if Genentech, Google, or Intel decided to forgo a public offering and become acquired because the public market option was unappealing. The “next Genentech or Google” may be making that decision right now. The best choice for that company should also be the best choice for our capital markets system and our economy.”
• Companies that were once venture-backed but are now public account for 10.3 million jobs
  and 18 percent of US GDP.
• source: a 2007 Global Insight Report.
• Sarbanes-Oxley
• NVCA has been advocating for Sarbanes Oxley reform for several years as the cost for small companies to go public has risen dramatically under the law.
  
• This cost, coupled with a decreased market appetite for smaller cap companies, a lack of analyst coverage, and a lower investor appetite for technology stocks, has raised the bar considerably for venture-backed companies hoping to go public.
  
• The median age of a venture-backed company from founding date to IPO hit a 27 year high in 2007 at 8.6 years.
• As of 6/30/2008: 42 venture-backed companies that have filed for an initial
  public offering with the SEC and are currently “in registration.”
  
• This number is down 40 percent from its 3-year high of 72 companies in Q3 2007
• M&A volume declines
• Q2 '08: 50 venture-backed M&A deals were completed
• IT sector: 36
  
• Life-sciences: 3
  
• H1 '08: 120 transactions
• down 28 percent from the first half of 2007
• What are the three largest factors you attribute to the current IPO drought?

• Venture Exit Counts - IPOs and M&A by Year
  

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Bleak VC Quarter? Why? - abovethecrowd.com

Summary:
VC Bill Gurley's reaction to the New York Times article on the IPO drought. Based on conversation with mutual fund managers, disagrees with gist of article that says that the buyside doesn’t want the companies being backed by VCs. 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. Gurley thinks the problem is with the supply side: as opposed to 1995, today no one wants to manage a public company anymore. Reasons are understandable: Sarbanes Oxley; 12b1 trading rules; shareholder litigation; option pricing scandals; personal liability on 10-Q filing signatures. (Published: 30/06/08)

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Venture Investors Wrap Up an Unusually Bleak Quarter - The New York Times

Summary:
Article on the Q2 '08 IPO drought. Causes being suggested are the general weakness in the financial markets; the shift, starting about 3 years ago, to cleantech and alternative energy sectors which needs more time to develop; and the VC industry still struggling to find its direction, never having fully recovered from the dot-com bust. One VC said there are two overriding factors: 1) Wall Street is being very selective in taking companies public, and blessing only those with particularly high revenue and growth projections. And 2) venture capitalists are wary because they worry that their returns will be limited in a depressed market. Another view is that part of the problem is that the VCs have been backing companies that lack widespread investor appeal. The VC industry is hanging by its fingernails. There is no VC industry if there are no IPOs. (Published: 28/06/08)

Notes:

• second quarter of this year not a single company backed by venture capitalists has gone public
• first time that has happened since 1978
• offering drought is being taken very seriously by the venture capital industry
• Public offerings serve a critical role for venture capitalists
  
• by giving them a way to sell, at huge profits, stakes in the start-up companies they invest in and build.
  
• Cause?
  
• General weaknesses in the financial markets
  
• have kept many companies from taking the plunge
• VCs say they have started to back technologies like alternative energy
  
• take relatively long to gestate before they are ready for the public market.
• Other VCs say the industry is struggling to find its direction and has never fully recovered from the dot-com bust
• Nancy Pfund, VC at DBL Investors, San Francisco
• two overriding factors:
  
• Wall Street is being very selective in taking companies public, and blessing only those with particularly high revenue and growth projections.
  
• And venture capitalists are wary because they worry that their returns will be limited in a depressed market.
• “It’s not a good time to go out. No one’s going to appreciate the value you’ve created, and it’s such a high bar.”
• a lot of energy start-ups still too early in their development to go public
• some venture capitalists are arguing that the pipeline for public offerings has dried up in part because of the considerable shift in the industry’s interest in the last three years into “green” technologies, which was taking time to bear fruit
• Paul Kedrosky, author
• deeper, more systemic problems for venture capitalists in addition to the cyclical challenges
• part of the problem was that the industry was backing companies that lack widespread investor appeal
• e.g. YouTube clones and dating and social networking sites.
• “There is nothing that the industry is producing that investors want. The stuff they’re investing in is idiosyncratic — it’s fun and appealing to them but Wall Street doesn’t care. The Valley is operating in its own little world, and the capital markets don’t care about the things that are getting the Valley excited.”

• “Here’s an industry struggling in a big way to hang onto its investors, let alone find new ones. They’ve been hanging on by their fingernails. The lack of a good way to cash out just makes things worse. There is no venture industry if there is no I.P.O. market.”

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The Incredible Shrinking Venture-Capital Industry - Wall Street Journal

Summary:
US Venture industry is still downsizing as a result of the tech bubble in 2000. Of the remaining funds, many only did a few deals, and 27% didn't back any new companies. It takes about a decade for fund to die (long after they have run out of capital to back new companies). The NVCA foresees a 15% decline in the next two years in the total number of venture firms investing in the U.S. (Published: 19/06/08)

Notes:

• 2007: 844 venture firms investing in U.S. companies
• 2006: 884
• 2000: 1200
  
• i.e. down 30% from the bubble year of 2000
• source: VentureSource
• Many of the active investors in 2007 did only a few deals.
  
• 45% completed four or more investments.
  
• 29% made just one investment.
  
• About 550 firms have made at least one investment in a U.S. company this year, according to VentureSource
• 224 (27% of the total) didn’t back any new companies last year
• indication that the ranks of active investors will continue to thin
• list of firms who made only follow-on investments
  
• contains some well-known players who have disbanded
• e.g. as St. Paul Venture Capital,
  
• or who have dropped plans for a new fund
• e.g. Worldview Technology Partners
• along with small firms who have not raised a new fund in years
• National Venture Capital Association (NVCA) is starting to see member firms drop out because they aren’t raising another fund
• Mark Heesen, president: “We are finally seeing what in our view is the beginning of the impact of the bubble.”
• Venture funds typically have a life of at least a decade and firms can soldier on long after they have run out of capital to back new companies.
• Heesen foresees a 15% decline in the next two years in the total number of venture firms investing in the U.S.
• many of them too small to meet the NVCA’s membership threshold of $5 million under management.
  
• NVCA has about 470 member firms representing 90% of the venture capital under management in the U.S

Comments

• "Unless the retail sucker market is there to allow for the fabled Exit Strategy, or perhaps the dumb money of a corporate acquirer, the VC is frozen in place. So as the macro market is reduced, the VC market attracts less and does less."
• "I think as growth is slowing in the developed world and is increasing in India, China, other Asian countries and Africa, VC’s are better off investing there. It does not make much sense to invest in a slow market."
• Did the change in options accounting or SarBox (Sarbanes-Oxley) have any impacts on the VC’s inability to drive an exit strategy?
• This subject merits more attention and I’d suggest the journalist focus on a firm such as Worldview to understand and report what’s really going on in the venture industry. Partner conflicts, pressure to ride with the herd (of other VCs all pouring money into the same companies), lack of respect for entrepreneurs, assuming “we know better than the entrepreneur”, killing the golden goose, hubris, etc. [...] That’s the Worldview story–most general partners left and are still leaving, most entrepreneurs were sold down the river and scarred, limited partners heard about all this and when performance lagged they refused to invest anymore. Talk to GPs that left, founders and founding CEOs of companies like Force10, Mirapoint, Cemaphore, PostPath, OnStor, CommVerge, ...
  

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