Shrinkage—Expanded Upon….


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10-year aggregated VC return, according to Cambridge Associates, was -4.6 percent (the 1, 3, 5 and 15 year returns were 8.5 percent, -2.1 percent, 4.3 percent, and 36.9 percent, respectively). Of course LP’s do not and can not invest in a VC index—they get to carefully select specific VC managers—but the message that the VC industry is now structurally challenged and/or unattractive took hold with many large institutional LP’s this past year.

Some other interesting implications and insights when one stares hard at the data…

Average Fund Size: Since 2000 the average VC fund raised was between $130 – $150 million, even throughout the “billion dollar fund” craze. In 2010 the average fund size was $80 million—an incredible decline—which may reflect the “micro VC” or “Super Angel” phenomenon or it may preview that a structural shift is upon us.

Average Deal Size: The average deal size has interestingly remained consistently between $6.25 and $7.5 million over the last five years or so. In 2000 it was $12.4 million, which clearly reflected all the capital that flooded into the VC marketplace ($107 billion was raised that year and just under $100 billion was invested). My guess is we should expect to see average deal size drop significantly over the next 18 months.

Total Number of Deals: In 2008 there were 4,025 deals—in 2009 there were 2,927. Interestingly there were 3,277 deals in 2010 which reflected the activity of the “Super Angel” as well as the profound waves of exciting innovation across all sectors including cloud computing, cleantech, consumer internet, personalized health, etc. My guess is the pace will remain around 3,000 new deals—maybe down slightly—per year in the near to medium term; deals will just be smaller on average.

This is not just a VC problem—entrepreneurs will have fewer sources of capital to access, there will be fewer cool companies offering great jobs, and new medicines/games/applications/devices will not be created. As we collectively witness this recalibration, maybe it is time to get out of the cold water and stop shrinking.

What do you think?

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Michael Greeley is a General Partner at Flare Capital Partners, a healthcare technology venture firm. Follow @greels1

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6 responses to “Shrinkage—Expanded Upon….”

  1. Bob WilcoxBob says:

    So equity financing is an unsustainable method of funding startups, and the process of selection, as well as the method of company management practiced by VCs provides no evidence of success. But do older, larger, or more diversified VC firms correlate to better returns? Do smaller or larger investments yield better returns? Do late investments show success while seed investments destroy portfolios? Angels, joint ventures, and grants are alternatives for financing seed or A round. How does their their track record compare to VCs at the same stage?

    Our economy and our well-being depend on robust entrepreneurialism. It’s not clear that VCs are a good way to ensure entrepreneurialism, nor that they are always as bad at their job as this data suggests.

  2. Given all of the questions in Bob’s response I am not sure where to begin. Today the BBJ reported recent VC returns data which show meaningful improvement – and that returns continue to outpace publc indices. Trouble with aggregate VC returns are that no one can invest in that index – it does not exist. It is certainly true that top quartile VC managers very dramatically out perform the all other VC’s – so I would fundamentally disagree that “equity financing is an unsustainable method” to start and grow new companies. VC’s have provided capital to many of the corporate success stories of today.

    One thing I would point out is that VC’s are not alone in generating poor returns. Yes, we make investment decisions, decide which industries to focus on, which CEO’s we might like to back – but VC’s don’t build the product, sell to customers, hire management teams, execute on a business plan – we may influence those activities or express an opinion – but senior management at the end of the day is responsible for all of those activities. And doing that poorly generates bad returns. Blame needs to be shared.

  3. Michael,

    Excellent story. We are a Cleantech Open Finalist from 2010 and have built our business around biomass energy since 2008. The economy has been unfriendly but our approach has been to build an audience through social media. We currently have the world’s largest social network for gasification. This initial investment of time and resources into building a community has been the defining factor in our success selling bioenergy products.

    The CTO was an amazing experience and has helped us make it to the next level, but my impression of the V.C. industry is that it is simply too much of a lottery mentality, looking for these “black swan” events. There is no shortage of great ideas and willing markets that can produce cash flow positive businesses, but if they aren’t potentially valued at a billion dollars, they just get brushed aside. Base hits win games. Since new companies are always reinventing themselves, today’s uninteresting base hit can be tomorrow’s breakthrough, but only if they have a business to build on.

    V.C.’s bring the finance. Entrepreneurs bring the passion and ideas, but who in the equation is building the organization? Usually no one. Someone needs to read E-myth or work at McDonald’s.

    As we build our business we are also building a platform that provides all of these organizational tools and access to manufacturing space so we can scoop up these unfunded or bankrupt projects and extract the value just sitting there for the taking.

    The micro-angel phenomenon is just the beginning. I think your industry is going to undergo some dramatic change when it realizes that scaling atoms is much more difficult that scaling gigabytes. i.e. it’s not 1999, so stop investing like it’s 1999.

    The world needs clean energy products and America needs to rebuild it’s manufacturing capacity with a lighter footprint. Those needs create a tremendous opportunity if the investment community has the right strategy to tackle them.

    To address your last sentence… “Blame needs to be shared.” That is exactly the mentality of people who spend/invest other people’s money (V.C’s, funded start-ups & grant administrators). When it’s your own money on the line, failure isn’t an option. I have $350,000 into my business and I don’t spend a single moment looking for anything to blame.

  4. Michael,

    I am reminded of a panel I attended 10years ago in Boston when I was an Associate at a VC firm where Josh Lerner moderated a panel of esteemed founding fathers. I remember Peter A. Brooke speaking among others. One of the elders said something I will never forget especially as it was 2001-02 something like:

    “…you guys don’t understand we would invest in these companies and help build them for 7, 8 sometimes even 10 years and in the end sometimes well we would just get a 1.3x or even worse only recoup 30cents on the dollar – it was like kissing your sister…”

    And I remember how that affected me. It’s got to be about building companies not fund performance and personally I think this shrinkage is a great turn of events. Shedding all these funds, assets and investment professionals is a healthy cyclical correction. The VC industry got way off course and polluted with a focus that became far too transactional.

    Sure it’s about returns to LPs but in the end there is no shortcut for building companies of value — too many jumped into VC for the returns and the carried interest when the gentlemen who funded Intel and others got in to build companies.

    This is a return to better norms and I look forward to investing as a VC again after hopefully having many years of success as a repeat entrepreneur. By that time this cleansing process will have greatly improved the quality.

    VC firms provide a service to both investors and entrepreneurs. Too many VCs forgot their obligation to be customer oriented to both parties and started thinking they managed and the company management were the staff. In truth that “sit back and let them do the work” model is what is dying off. VCs need to role up their sleeves and contribute to the value creation every week as adding capital alone is not value creation and will not generate respectable returns.

    I agree the world needs a healthy venture capital industry but it has to be be driven by principled PPMs, efficient metrics and effective company building and not just “quick-exit” oriented thinking.

    IMHO having fewer of the laggard underperforming funds around will not reduce the number of quality firms getting funded. And it definitely won’t hurt aggregate returns for the asset class! ;-)


    PS I think it’s really important to note how things have changed for startups. Note only do many tech companies need much less to get going but they can build and get to proof of concept much faster… I may have missed it in your piece but I didn’t see that as part of your comments.

  5. Michael Greeley says:

    Ben, thank you for the comments. I would be delighted to learn more about your company – but let me respond to two of your comments if I may.

    First, I worry that many “micro-angels” will not have the financial capacity to take their portfolio companies from beginning to end; the dilution risks being quite severe over numerous financing rounds.

    Second, to correct a misperception perhaps, most VC’s have a significan portion of his/her net worth invested in their own funds. My partners and I represent a significant amount of the dollars we invest in any one of our portfolio company – so believe me when I say that I feel every one of our losses! We don’t simply “spend/invest other people’s money.”

  6. Michael Greeley says:

    Josh, excellent comments. I am sure I was also at that same event with the “old guard.”

    I could not agree more. VC’s are known by the great companies they are associated with – we all must aspire to help build great companies which change the world in some manner. And accordingly, even though ~3,000 venture-backed companies are funded every year, a very small percentage of them will be truly great compelling businesses.