Funding for startups

VCs: 'We're Not Broken, Dammit!'

BOSTON -- Is the venture capital (VC) model broken? Judging from a panel of experts here at the NGN 2003 show, it's not easy to get a straight answer -- especially when all of the panelists happen to be... VCs.

The panel -- entitled "The Broken VC Model: Where Will Innovation Come from?" -- included four partners at venture capital firms. All of them had short presentations that could be best described in the "Glass Half Full" style, as they all predicted the industry was on the verge of bouncing back.

Not surprisingly, they encountered some friction in the form of questions from the crowd and also from moderator John McQuillan, the chairman of the NGN conference, who happens to be an "ex-VC" himself, in his own words. (His portfolio once included Maple Optical Systems, RIP -- see Maple on the Money Trail and Headcount: Miller's Oranges).

"This gives me a chuckle... 'Where's the innovation in the VC World?' " asked McQuillan, reading from one of the question cards from the audience.

In their presentations, the panelists pointed out that from an investment perspective, there's no way to avoid ratcheting back company valuations and expectations after the bursting of the bubble, because the exit valuations are no longer high enough to justify investing large amounts of capital in startups.

"Hope is not a strategy," said Rod Randall, general partner at St. Paul Venture Capital. He pointed out that the numbers simply don't work at sky-high valuations, and they need to be scaled back. He implied that the trend of the "zero-pre-money" round, in which a company receives a valuation of essentially zero before receiving its venture money, could continue for an indefinite period. And he said the most viable strategy for startups is to create products that add incremental improvement to existing networks.

But there were those who said they were still swinging for the fences. The most optimistic of the panelists was Roland Van der Meer, a partner at ComVentures, who noted that "great companies are formed in bear markets."

Also weighing in on the more optimistic side was Dave Furneaux, a managing general partner at Kodiak Venture Partners, who said his firm has invested in "34 new companies in the last 48 months."

But McQuillan -- and the crowd as well -- appeared to buy into little of it.

."I think the VC model is broken," said McQuillan, "And innovation is now more likely to come out of research departments of large companies."

The panelists did appear to concur that venture capital is a competitive industry, and that there were far too many venture capitalists than was healthy. "If you look at mutual funds, only about 5 to 10 percent of them outperform the market," said Van Der Meer, "and I think you'll see the same thing in venture capital."

There are probably too many VCs," said McQuillan. "There are 8,000 VCs funding just 1,000 companies per year."

McQuillan also dredged up another ugly statistic: Over the last three years, the average return on venture capital portfolios has been about -25 percent.

"Some investors aren't asking for a return on capital, they're just asking for their capital to be returned," said McQuillan.

This, course, leads to the question of how many of those panelists will keep their jobs. They didn't look very worried.

— R. Scott Raynovich, US Editor, Light Reading

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Curious George 12/4/2012 | 11:16:56 PM
re: VCs: 'We're Not Broken, Dammit!' Completely agree regarding big company research, cuts have been brutal and resulted in wholesale dismantling of capability, not simply a downsizing. Typically the programs that remain in central research are overly influenced by the business units since the only work they will support is that which is relevant to them on a very short time scale.
OptoScot 12/4/2012 | 11:16:56 PM
re: VCs: 'We're Not Broken, Dammit!' Had to laugh at this one... Here in Scotland and in the UK generally VCs are so thin on the ground that some have been heard to say "what's a VC?"..

If you US chappies think you have too many perhaps you'd like to send them over here :-)
OptoScot 12/4/2012 | 11:16:55 PM
re: VCs: 'We're Not Broken, Dammit!' The issue over here in the "auld country" is that when VCs do invest ( which is rare in the optoelectronics sector) they tend to drip feed companies money.

Initial rounds for start ups can be less than $1m and achieving second round funding is becoming more and more difficult but when it happens may be no more than about $5m.

whyiswhy 12/4/2012 | 11:16:55 PM
re: VCs: 'We're Not Broken, Dammit!' The problem with the VC game of late is they've gotten so greedy as to take virtually all the incentive away from common stock holders.

They thought they could get away with it because everyone "needed the job" in a lousy economy.

What they forgot is the fundamental business proposition of a venture: founders bring the muscle and brains, VC's bring the money, they share equally in the payoff. Neither is worth more: they are both needed.

When VCs hog all the upside with down rounds and bridge loans under the excuse the market is tough, the founder becomes an employee, with zero incentive to make the VC's money back: it's just a job.

So the lesson to VC's is you have to keep the founders well incentivized to make you both money at all times, regardless of market, or you might as well just walk away and get a job selling vacuum cleaners, if you can.
st0 12/4/2012 | 11:16:52 PM
re: VCs: 'We're Not Broken, Dammit!' "A VC isn't going to make any money if their portfolio companies spend their money like drunken sailors."
Well, VC and drunken sailors are two of same kind (which one is the lesser evil?). The problem for the innovation and high risk research currently funded by VC or large companies are alike: (1) need small funding to test the feasibility of the concept (2) need medium funding to assess the market timing. The downfall of VC and large company managers are common: short sight on return (VC the blind try to MAKE a business, not innovation. The large company is swinged by market driven research.. ). Look at the key innovation, including cisco, linux, etc.etc. it all started feasibility with OTHER funding for the initial research, the VC only get into later for the 2nd stage...

Drunken sailor were a group of oppotunists, trend followers to make few quick $ and build a company for sale (no intention to stay in business long). They are mirror image of the VC in different light.... Now, after the bubble, both side don't trust each other ... well, some of the good real innovation become suspect as well... Too bad.

Fortunecookie 12/4/2012 | 11:16:51 PM
re: VCs: 'We're Not Broken, Dammit!' What else do you expect from MBAs? I just don't understand why MBAs got so high.
TheAce 12/4/2012 | 11:16:50 PM
re: VCs: 'We're Not Broken, Dammit!' The illness of the VC industry people talk about is only a matter of the past 5-7 years. It was not always so. During the bubble, many jumped on the VC wagon and as a result we got many inexperienced people sitting on BODs of high technology companies. In addition, everybody makes money in a bulls market (or a bubble) so many of these rookies thought they knew it all. This led to arrogance, misbahvior, greed etc. The VC funds are finanical intermediaries, in this sense they are much like brokers or bankers but the VC industry lacks the ethics and codes of conduct of banking or brokerage. Hopefully this downturn will weed out those that don't fit and they will go back to consulting, accounting, law, finance, etc.
Building hi-tech companies is a game for experienced professionals, most of them simply aren't. As for entrepreneurs, sorry to say, but there were band wagoners there too. Had the VC guys been professional they would have not funded unworthy start-ups in the first place.
Keep the faith, we will be back!
Keep the faith, we will be back!
Keep the faith, we will be back!
green 12/4/2012 | 11:16:50 PM
re: VCs: 'We're Not Broken, Dammit!' right on whyiswhy !!

VC's think they can demand slave labor at pitiful salaries b'cos of the bad economy. they don't realize that products suddenly turn buggy and deadlines are missed when employees are unhappy !!!!
chipsischips 12/4/2012 | 11:16:49 PM
re: VCs: 'We're Not Broken, Dammit!' 10. Primary reason they are a VC is they got an MBA from Harvard or Stanford.

9. Primary reason they are a VC/EIR is they had one successful start-up in the 95-00 time frame.

8. VCs obsessively invest in spaces; while it takes time to gain expertise in an area to add value, they are looking too much at supply & demand of the equity markets as to where they are going to get the best return. During 95-00, that philosophy worked wonders when there were liquidity events in hot sectors that returned 50X or more; it does not work today where IPOs as an exit have been shut down.

7. VCs have been burnt by their own poor judgment investing in certain sectors in the past and refuse to invest in anything that remotely smell like it regardless of its merits.

6. VCs focus too much on the technology up front, even though they claim to focus on the business model.

5. VCs are looking too much for a reason not to invest - I guess with the big oversupply of VCs, they are trying to prove to their LPs that they are really busy finding deals when they are really just killing time.

4. VCs focus on entrepreneurs who made money for them before as this is perceived to lower risk. While the team is important, my experience is the only guy who matters up front is the CTO - if he is loser, the company is DOA. We all know that the all-star team is hardly the ticket to success and quite the opposite if egos get in the way.

3. VCs invest in their existing dogs simply because those companies have customers and revenue, regardless of their longer term viability. The old saying is when you get a bunch of dogs together, you get a kennel, which is what the VCs currently have. Too much saving face and not enough focus on getting their LPs a decent return.

2. The overriding reticence among VCs means they are missing on the great investment opportunities now that will provide the liquidity events in the second half of this decade.

1. Most VCs really don't get it even though they claim they do. The 10-15% who do will be the survivors in 5 years. The rest will lose their job anyway and will have a lot of pissed off LPs.
nbwaite 12/4/2012 | 11:16:49 PM
re: VCs: 'We're Not Broken, Dammit!' Currently, overwhelmingly, the VCs just do not know
what to do.

They are afraid to lose the money of the partners,
including the limited partners (LPs). Yet, the VCs
don't really know how to make money. In some of the
language that they like, they don't have a good
'value proposition' in their 'space'.

Time to send some VC Care Packages: For the tears,
one (1) towel, for those feelings of insecurity, one
(1) pink blanket, for pleasant bedtime reading, one
(1) copy of 'How to Succeed in Business without
Really Trying', to rebuild personal values and
self-esteem, one (1) copy of 'Everything I Needed to
Know about Business I Learned in My MBA', and for
much needed recess exercise, one (1) eight (8) ounce
bottle of Wonder Bubble.

Copies of real estate ads in the Hamptons and
reviews of the new Mercedes Maybach should be
regarded as too depressing.

During the last rising of bubbles, 'Forbes' ran an
article with an interview of a VC with the advice:
"Never be between a VC and the door when the lock up
period is over." And that was exactly the point:
The VCs were selling junk and knew it.

Mostly the junk cost a lot of people a lot of money.

Some serious observers have concluded that we cannot
have rising bubbles again until we have a lot of
investors that don't remember, and that may be
another 20-30 years. I.e., bubble years were 1999,
1969, 1929.

Here in the US, it is true that we have a lot from
the research community, a lot of ambitious and
educated people to work with the results, terrific
supply of all routine inputs needed for such work, a
sufficient legal system, big active reasonably well
managed stock markets, lots of investment bankers,
lots of investors with lots of cash, huge
collections of potential customers that still
believe in the possibility of progress and ready to
buy products and services that can deliver.

So, there should be opportunities to grow valuable
businesses; the VCs should be able to do well.
That, with these circumstances, the VCs do not know
how to make money is currently one of the grand
tragedies, extracting defeat from the jaws of
victory, of our society.

Alas, the US VC industry did not really come clearly
from 'fundamentals'. Instead, over the last 40
years, the industry was at times a wild stab,
accidental, lucky, opportunistic, etc. And the VC
industry we have now is left over from such

The basic problem is that the VCs don't want to look
at fundamentals, not about research, technology,
people, business, or revenue and earnings. The
fundamentals are too boring, too pedestrian. The
VCs want 'more'. Sometimes they did get more, e.g.,
with bubble blowing (where W. Buffett remarked that
there are some severe "timing problems") and
sometimes they got less, e.g., now.

Also, lacking respect for the fundamentals, the VCs
are lacking solid criteria and have been drifting
and have gone heavily for silly thinking comparable
to palm readers, psychics, the miracle healing
powers of nature, tea leaf reading, rain dancing,
etc. They place huge faith in trivial coincidences
and meaningless patterns. They follow fads. They
act in flocks and herds. They are too often like
silly Watson in Holmes stories: "I can vouch for
him; he played wing and three quarters at my
school." Reeking nonsense.

Darwin didn't argue all the details of flaws; he
just said that the system tends to weed them out.
Soon most of the VCs will have to make the money
grow or the limited partners will quit investing and
the VCs will get weeded out.

For making the money grow, likely the VCs will have
to return to fundamentals:

First they will have to be content with making money
from valuable businesses, ones that are valuable
because of high, hopefully rapidly growing, revenue
and earnings from honest accounting. Horrors that
success in investing should come to such things!

Instead of making money, the VCs are still hoping,
hoping, everyday look eagerly at the 'WSJ' for
signs, hoping, for some glimmer of 'action' on the
Nasdaq that will indicate what the suckers, uh,
investors, can be tricked with again soon.

Well, show the investors a company with solid
defensible powerful technology valuable for the
customers, good barriers to entry, solid position in
a large market, and high and rapidly growing revenue
and earnings, and then ask if the investment
bankers, institutional investors, and Nasdaq investors
are interested. Gosh, that a VCs should actually
have to accomplish such things just to get a new

The VCs commonly say these things are important;
problem is, they don't want to do the work of
actually accomplishing them.

Second, to play a role in building such businesses,
VCs will have to pay close attention to the actual
business plans and why there is promise of revenue
and earnings. The emphasis on technology is
appropriate, but the VCs will have to pay close
attention the new power and value of the technology,
close enough to tell the difference between, say, a
new source of energy and perpetual motion. Again,

VCs might actually have to read the technical
sections of business plans and go for due diligence.
Unrelenting horrors!

We know quite well how to evaluate technology: We
have excellent lessons in how projects are reviewed
by the US DoD, DoE, NIH, and NSF. Until VCs adopt
such review techniques, they won't be able to tell
powerful and valuable technology from perpetual
motion. Being able to judge the power of the
technology is just crucial. They are, and will
remain like the cat that walked on a hot stove and
will never walk on any stove again, hot or not.

That is, hearing about some powerful new technology,
e.g., in an 'elevator pitch', a standard VC reaction
is: "That's a good technical solution." What they
mean is: "That's sounds technical enough; I don't
know or care if it's perpetual motion; I don't care
if it's valuable; but you haven't told me what
current fad will cause the suckers, uh, individual
investors, to buy stock in such a company now."
That is, they are just looking for a 'quick flip'
and not at building a solid company.

For paying attention to the technology, the VCs are
'challenged': Nearly none of the VCs could get a
faculty position in the engineering school of a
research university, read, write, or referee
research papers in engineering, get hired as
either a worker or a first level manager by a CTO or
CIO, or get hired as a problem sponsor for R&D by
the US DoD, NIH, or NSF. Not good.

Last, the VCs will have to give up on their 'Weekly
Reader' version of business expertise: The worst of
these is their standard attitude that "Marketing is
everything". This attitude goes back to the 'white
shoe' and British upper class attitudes of respect
for banquet small talk skills, contempt for actual
work, and fear of anything technical. If -- as
usually intended for the technology -- the product
or service is really valuable for the customers,
then quite routine efforts in marketing will usually
be successful. We should be suspicious about claims
of especially high abilities in marketing: (1) What
is taught in marketing in the business schools
ranges from simple and routine down to unimpressive.
(2) There are no real 'science' or 'engineering
principles' of marketing.
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