How the VC and Angel Investing Landscape is Being Transformed: Highlights from VC Crossfire

[Correction: 7:40 am 11/1/10] Last night was the big night—we gathered some of the biggest names in Northwest financing for Xconomy’s “VC Crossfire” event, at Amazon’s new headquarters in Seattle’s South Lake Union neighborhood.

The panelists consisted of some of the region’s top financiers and technology entrepreneurs—including Bob Nelsen of Arch Venture Partners; Tom Alberg of Madrona Venture Group; Andy Sack of TechStars Seattle, Founder’s Co-op, and RevenueLoan; and Christopher Henney, the co-founder of Immunex, Icos, and Dendreon. And the “fearsome foursome” were certainly not shy when it came to the more grilling questions from our Xconomy Seattle editor Luke Timmerman, and national IT editor Greg Huang, who flew in from his new digs in Boston especially for this event.

The talk of the evening centered around the changing venture capital modelas a new wave of technology startups seek financing. How will innovative startups get funded in the future now that venture capital is declining as a financial asset class? Is the venture capital model as we know it reaching the end of its existence? Will traditional VC funding be replaced by angels, super angels, or micro-VCs? What can we do in the Pacific Northwest to finance—and foster—innovation?

No silver bullet for financing of innovation emerged, but there were a number of constructive ideas floated. Here are some highlights from the discussion, edited for length and clarity.

Xconomy: Is the venture capital model still relevant today, or even necessary?

Bob Nelsen: If you look at the data, 20 percent of GDP is comprised of venture capital [Correction: 7:40 am, 11/1/10. An earlier version said it was 40 percent]. Everywhere in the world we are admired—even worshiped—from the other countries that want to get our innovative infrastructure, and want to figure out how to fund companies the way we do them here. It’s the future of our country, it’s what creates our productivity gains, and we are in somewhat danger of losing our edge there as we tax it more—if we don’t somewhat fertilize the ground that we’re basing it on. There’s no other finance structure that I’m aware of that can put the startup capital in that venture does.

Xconomy's VC Crossfire event at Amazon's new South Lake Union headquarters.

Xconomy's VC Crossfire event at Amazon's new South Lake Union headquarters.

X: We’ve seen the costs of getting tech startups going come down significantly in the past few years, but is there really a different story here in biotech?

Christopher Henney: As a pharmaceutical company, we live in an entirely different world—these numbers, $200,000 doesn’t mean anything for us. Venture capital as it existed 40 years ago, essentially doesn’t exist anymore. In the early days in the ’80s, most funds that invested in the biotech space were composed of wealthy individuals or wealthy families who were diversifying looking for winners—there was not real time construction on the amount of time the money was there. So we were able to start research companies. Nobody wants to pay for research anymore—that’s one of the problems in the biotech space. I think many people think that research is for the federal government.

Angels, really for me, have no place in the biotech space because they’re just going to lose their shirts, because when the professional money goes in—as it’s going to—they’re going to get wiped out, so they should just stay away.

X: Is the phenomenon of the “super angel” overrated? Are these the new players on the block, or are VCs still the people who can build big companies?

Andy Sack: There is a phenomenon of super angels—in pretty much every major tech market there appears to be a super angel fund of some type. In venture, the funds are larger, and in those venture funds, there are some people who lack specific entrepreneurial experience. In the class of super angels, the trend that you’re seeing is entrepreneurs who have had some degree of success and want to be helpful to the next generation and, almost by default, you end up in a situation where it’s almost more performance-oriented.

There are some real differences between super angels and venture capital, and there’s definitely a phenomenon with super angels, and I think it’s a good thing—more players, seed stage. Companies need stage-specific funding, so it makes most sense if you’re raising between $500,000 and a million bucks, it makes the most sense to get angels or super angels.

X: If you look at the VC returns from the past decade, they are really lousy. What are you guys doing now to get your house in order, and how many firms will be going away?

BN: You’re not going to see so many firms go out of business. You are seeing some partners are going away. It’s hard to kill a venture fund, but it’s easy to kill a venture partner.

X: How might bootstrapping, super angels, and micro-VC be disruptive to traditional VC?

BN: I think it’s rebranding. Super angels have always been around—it happened in the ’70s, it happened in the ’80s, it happened in the ’90s, and now it’s being rebranded as super angels. It’s not clear to people who are outside of the industry how fast it’s contracting.

Firms are getting smaller. Even the big firms are going from a billion to $300 million. Basically early stage is becoming much more popular now, amongst limited partners, so now the next stage that you’re going to be seeing is if you want to go make me two or three times, we’re not giving you money. Unless you’re willing to take big risks and take big capital returns, we’re not playing. And the only way to do that is to go back to the model from the ’70s or ’80s—be patient, take big risks—that’s how people have historically made the most money. I think it’s going to go back to that. Now the one question is whether  a bubble is going to come and bail everybody out?

CH: In many ways, you brought this upon yourself. You got spoiled into thinking instead of getting paid on performance (and that takes a long time), you started getting paid as money managers—we’ll grow the funds, and we’ll have a cake and eat it, we’ll get paid at the same time. You’ve got these billion dollar funds, and you can’t deal with a guy who wants $200,000—$200,000 means nothing to you now. So you force the guy to put in $20 million, so now you’re a banker, you’re not a venture capitalist—you’re one-stop shopping for funding. You frightened away all of the patient companies—all of the companies that need time to come to fruition, and used to be enabled by the venture community, and are now not served. Everything changed.

Tom Alberg: The best model for venture capitalists is early stage companies. I think this community is still short of early stage money, so I hope venture survives and angels come along.

X: With the contraction of venture capital—smaller funds, smaller firms—and the “fail fast” mentality of super angels, what is the impact on creating the next Google or Amazon here? How will angels and VCs work together to build companies that change the world?

TA: Our attitude is this is the strongest deal flow we’ve ever seen, probably because the tech community has really grown. Sometimes you hear people worry a bit that everything has been invented—take Internet retail; no one is going to create the next Amazon, but I keep seeing new Internet retail models, and people are making money.

AS: In the ecosystem in Seattle, you just don’t have what you have in the Valley, of people saying “I’m going to change the world.” The likelihood is lower and risk is higher, but it takes the dream to want to change the world to actually have the chance. It’s certainly a role for venture capital. We haven’t had a huge win in the Pacific Northwest specifically—Amazon was a long time ago. There have been some small wins—Picnik, Urbanspoon. But it would be nice if there was more big thinking. It’s an entrepreneurial ecosystem, and a willingness to think big and take risk—I’d like to see more of that in the Northwest.

It comes from people who support those visionary dreamers. It’s venture capital money—it usually takes a longer time, more capital, and venture capital. It takes a larger fund to be able to stomach that risk. I’d like to see more entrepreneurial activity in that dreamer category.

Q (audience): What’s going to happen in Seattle to get more competitive compared to San Francisco, New York, and other places?

AS: As an entrepreneurial city with a lot of potential, we’re doing a lame job. I do think it’s changing, I do think it’s getting better. I think TechStars is the start of something pulling together—five to 10 years out—making Seattle the center of a place for pulling innovation together.

TA: This is not a zero sum game—we’re not just moving money around a board. You’re actually creating wealth for everybody, potentially. Your success is not taking away from our success—that’s another reason to be supportive.

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