One advantage of being in the Midwest is you get a very clear view of where we are in a venture cycle. This region is usually the last to get liquidity and one of the first to lose it. It is kind of a proverbial high water mark on the sea shore. Our angel investors, often family offices or successful manuf/services executives (versus the sea of former tech CEO’s in CA), tend to be more conservative in their investing. And, coastal venture firms do not like the 3-4 hour flights (plus driving to smaller cities) to get out here. They will generally only start to come out here once they have fully fished out the watering holes on the coasts and surrounding territories. When both are in full force, the venture business eventually gets cracked like a nut from both sides.
When the market is at a low, you can’t get angels here to take out their wallets even at gun point. However, when the financial cycle has run long enough, and all asset classes seem safe (and traditional ones boring), they get very aggressive. When you begin to see angel rounds approaching $5-10m, you know that we are nearing a top.
During this cycle, the angels are having even more impact than before. Since technology is so relatively inexpensive, many of these companies do not require, if managed properly, considerable capital. So, angels with $3-5M can very well disintermediate early stage VC’s. Should the business plans work out as expected, this sometimes could be all the company needs. However, should the company require more capital (more often the case), especially during a market downturn, then the VC’s will get another bite at the apple and the angels will suffer from having paid up too high in the first round. In the meanwhile, the company has gone without the various benefits associated with having venture investors and their connections.
This should be great news for later stage VC’s since they should be seeing a wider array of proven companies. However, the allure of significant management fees have draw fund after fund into raising too much capital again ($500m+) like the sirens on the crashing rocks. So, valuations are shooting up through the roof as VC’s compete with each other. They are also jacking up prices so as to convince entrepreneurs to take on more capital (dilution mitigation). We have recently returned back to 2000 level pricing. As VentureOne reports for the last quarter:
"According to industry tracker VentureOne, the median pre-money
valuation for venture-backed companies in the U.S. was $20 million for
the half, compared with $15 million for all of 2005. The last time the
median figure reached over $20 million for the year was in 2000, when
it hit a lofty $29 million."
Meanwhile, GP salaries have hit an all-time high in the venture business…senior partners are pulling in, on average, over $1.5M annually before carry. (not here, so I need to look into things 🙂 ). The management fees keep the dance going and inflating. On the other hand, IPO’s remain moribund. More start-ups, higher valuations, more capital into each…where have I seen this before?
Once the market turns, this will all wash out, angels will go back to S&P and T-Bills and LP’s will go back to GP bashing as these uber funds under perform. However, the venture business is stuck in this two way nutcracker in the meanwhile. Chestnuts anyone?