Is VC back? Posted On Dec 2, 2009 | by Jon Over the past few weeks we’ve seen extremely high activity in new venture investments. Starting in September, we witnessed the return of multiple term sheet deals, short fuse situations, and a renewed urgency to most fund-raisings. I heard last week of a hot late stage deal attracting ten (yes 10) term sheets. It’s a really great company, but just one quarter ago that number would have been much lower. FastCompany’s Q3 picks up some of this, with Q3′s activity marking a high for 2009, and growing 14% from Q2.
The same VCs who hunkered down in January were back in the game in September, and they were back in force. Venture is back. In Barron’s this weekend, Michael Santoli quoted a March 2007 Speech by Fed Reserve governor Kevin Warsh in which he said “Liquidity is confidence.” Just as analysts and pundits were decrying the “end of the venture experiment,” 2009 was quietly becoming an extraordinary year for venture exits, both in IPO and M&A form.
VC Maths problem. Yesterday Albert and I visited one of the investors in our fund. The good news is they are happy with the job we are doing. The bad news is they are frustrated with the venture capital asset class. We got to talking about the venture capital asset class and it wasn't long before we got to the "math problem". The venture capital math problem is pretty basic, maybe something you'd do in high school calculus or even pre-calculus. Here's how it works. The venture industry has been raising between $20bn and $30bn per year for the past few years. Let's be generous and say that the average is $25bn per year (it's actually more). Here's how I go about solving it. First, the money needs to generate 2.5x net of fees and carry to the investors to deliver a decent return.
Then you need to figure out how much of the companies the VCs normally own. Using the 20% number, that $75bn per year must come from exits producing $375bn in total value. And I assume that the biggest exit each year is $5bn. Back to the roots? I just came across a great report by Industry Little Hawk entitled the Venture Capital Rebound (pdf). In the report, the authors reach a similar conclusion to Paul Kedrosky (read Paul's great research for the Kauffman Foundation here) -- that too much capital has gone into venture capital. Paul has argued that we need to shrink the amount of venture funding by 50% -- a statistic that almost every VC agrees with. (Ironically, 100% of VCs would argue that their fund should be in the half that survives). What is refreshing about the Industry Little Hawk white paper, however, is that they don't just advocate reducing the capital allocated to venture. Instead, they advocate allocating capital to smaller funds. And they articulate a number of reasons for their position (smaller funds are better positioned for the current exit landscape, better alignment with entrepreneurs (per my last post) and with limited partners, etc).
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