One of my fund's portfolio companies OWN has developed a tablet based Point-of-sale system. The company has made rapid strides and developed a platform that has strategics, VCs and angels alike stampeding over each other to invest. Over a frenzied weekend, I watched the founders juggle several different investor meetings and receive rapid-fire text messages and calls until their cell phones ran out of juice. All of this when a recent WSJ report bemoaned the fact that Web startups have hit a cash crunch! Angel investing is getting slower, valuations are dropping and the end of the world is near, it said. Really!?
Indeed, when we look at how the angel investments pan out, it's no surprise. In any given year, angels invest as much or more than VCs, but the number of saplings they plant are about ten times more. According to Jeffrey Sohl, director of the University of New Hampshire Center for Venture Research, angel investments in 2010 were $20.1 billion. A total of whopping 61,900 entrepreneurial ventures received angel funding. In the same period, VC investments were totaled $23 billion in about 4,000 companies. Indeed, as studies show, only seven percent of the angel-funded start-ups generate all returns for angels. The vast majority of the start-ups will vanish. Fred Wilson, of Union Square Ventures and an early investor in Twitter, concurs in his blog that angels tend to get excited, make a bunch of investments and then pull back once the majority of the startups flop.
Bryce Roberts, co-founder of O'Reilly Alphatec Ventures and an early investor in Foursquare recently wrote that this is a case of a pig passing through the python. Bryce, who offered some valuable quotes for my recent book, points out correctly that seed investing is not about getting something going, but all about de-risking the business.
Historically, VC investments were used to build operational and business capabilities. But these days, many VCs just want to get their hands on a piece of one of today's tech darlings. In these cases, how the capital is used doesn't matter as much. Case in point: Twitter's $800M funding was a nice boost to the VC statistics in 2011, but $400M went to cashing out current stockholders. Airbnb's recent $112-million round also made its founders very happy -- they cashed out $22.5 million. One would hope that most of this money flows back into the market and finds a home at an up-and-coming startup. As we know, many angels were once entrepreneurs who now want to help other entrepreneurs. Valuations be damned!
Less friction = more liquidity = happy entrepreneurs: Historically, VCs found an exit though an IPO or an acquisition but no longer are investors bound by these two options. A thriving secondary market for private company stock has brought much-needed liquidity to venture funds, angels and founders. And for those who did not exercise these liquidity pathways, the LinkedIn post-IPO hold-up period of 180 days should end on November 19, 2011, which means more money should flow into the market soon. Entrepreneurs: get that Powerpoint or even just a napkin ready and head for those coffee shops!
The Python is constipated: Going back to Bryce Roberts and Fred Wilson's accurate observations, the VC industry is facing a fundamental challenge: money is drying up! The LPs, or those who invest in VC funds, are no longer frothing at the mouth. The 1999-2000 'bubble' era had $100 billion flowing into venture funds. Ten years and a lot of losses later, these LPs are bruised, and disillusioned. Only $12.7 billion has flown into venture funds in first three quarters of 2011.
When I spoke with Tim Recker, Chairman of Institutional Limited Partners Association (ILPA) recently, he pointed out that 'venture capital is not our only choice -- investors have plenty of other options to generate returns.' I don't think entrepreneurs have cause to worry as much as VCs do -- even if returns are back to triple digit IRR, only a few VCs will make it into the next decade. Thus the python may shrink. After all, between 2005-2010, two hundred VC firms vanished. Mark Heesen, President of the National VC Association recently remarked that VCs are investing more capital than they can raise. Or as Bryce may say, the Python is eating more than it can digest.
Irrespective of the debates, 2011 will still be a banner year for VC investments. Entrepreneurs should celebrate their seed investments while they can -- the Series A / B may take a while. Thus far, in the first three quarters 2011 -- $21.7 billion has been invested. That's pretty close to $23.0 billion invested in all of 2010. In the meantime, the debate rages on: Is this a bubble? Correction? Will the world end in 2012? Who cares? I see Christmas bonuses on the horizon!
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