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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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Heb81 12/4/2012 | 11:15:54 PM
re: VCs: 'We're Not Broken, Dammit!' Alchemy,
" I've gotten much better at picking opportunities where the management team isn't likely to get swapped out by the VCs and I've had some success with my more recent startups."

would really appreciate your sharing the criteria you used to filter out investors. Don't have any firm data, but there are VERY few original CEOs that made it to later date. The ones who do, however, help defined the company success and personalities (i.e. Microsoft, Dell, Oracle to name a few). No CEO wanted to be replace, even it means taking early money and retirement. People who found companies want to be part of the company, after all, they've donated their blood for what they believe!!

H.
krisman 12/4/2012 | 11:15:50 PM
re: VCs: 'We're Not Broken, Dammit!' ... and there are companies such as Cisco which vaulted to success because the board fired the founders and brought in professional management.
lightbeer 12/4/2012 | 11:15:47 PM
re: VCs: 'We're Not Broken, Dammit!' http://www.businessweek.com/sm...

VCs are like any other banker/lender. Get a good lawyer on your side to negotiate a deal. Remember to shop your ideas around to different VCs and get the best deal for your company. VCs have fiduciary responsibilities to their LPs only and will only hang around if there is a possibility of making ROI for their funds. During the bubble VCs played the numbers game, thinking that if just one hit it big the other ten companies they funded could bomb out.

The VC community set themselves up for failure by promising returns of 30, 40, 50% to there LPs based on unrealistic expectations of there portfolio companies.

As an entrepenuer get a good lawyer with connections to the industry that can do some due dilegence on the respective VCs and see what their track record is and what they are promising to their LPs.
whyiswhy 12/4/2012 | 11:15:43 PM
re: VCs: 'We're Not Broken, Dammit!' I agree having a good lawyer on your side helps enormously. You can avoid the worst of the tricks. But the issue is will you get something for all the effort (of starting a company)? In this market segment, the realistic answer is no. The main reason is you will not get competitive term sheets. You will be lucky to get any term sheet, very very lucky.

So overall the best play is to be "available" when the VCs decide to bring in the "experienced" team. The VCs tell the team the new boys will fix all "problems". It's true in some cases, but in most it's just a play to get a bigger share of the pie. So my advise is don't try to change the game...run with it, expect it, play to it...not against it.

The rest is the usual DD-stuff.

-Why
alchemy 12/4/2012 | 11:15:42 PM
re: VCs: 'We're Not Broken, Dammit!' So overall the best play is to be "available" when the VCs decide to bring in the "experienced" team. The VCs tell the team the new boys will fix all "problems". It's true in some cases, but in most it's just a play to get a bigger share of the pie. So my advise is don't try to change the game...run with it, expect it, play to it...not against it.

The track record for restarts on startup companies is poor. In my opinion, the only time a restart is justified is if the original 'idea' was good (a unique product and a market for that unique product) but the execution stunk. I keep seeing restarts where there are similar products being developed by several competitors at roughly the same level of product maturity. That's VC denial, not sound business practice.
Dr_Moose 12/4/2012 | 11:14:46 PM
re: VCs: 'We're Not Broken, Dammit!' thanks lightbeer, good advice and good link.

lightbeer wrote:

http://www.businessweek.com/sm...

VCs are like any other banker/lender. Get a good lawyer on your side to negotiate a deal. Remember to shop your ideas around to different VCs and get the best deal for your company. VCs have fiduciary responsibilities to their LPs only and will only hang around if there is a possibility of making ROI for their funds. During the bubble VCs played the numbers game, thinking that if just one hit it big the other ten companies they funded could bomb out.
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