Is Venture Capital Broken?

I am watching the "The Day After Tomorrow" with my son as I type this post. It is a Hollywood version of accelerated Global Warming. In the middle of the movie, a flash freeze sweeps across the Northern Hemisphere, immediately freezing everything in its path (minus 150 degree F) which is cold even by Chicago standards. At the same time, I was reading Daniel Primark’s piece on Sevin Rosen giving back its recent fund, stating that the venture model is broken. In it he writes (click on the link below for the full version):

"Sevin Rosen Funds has indefinitely postponed fundraising for its tenth fund, which had been scheduled to hold a first close this week. This is being treated as big news in VC circles – particularly among the battering blogbobs – because SRF is not citing the typical excuses of partnership strife or fundraising difficulties (i.e., Mobius, Worldview, etc.). Instead, it claims that the VC model is “severely damaged,” and that it will not raise additional capital until it funds a responsible solution."
— Daniel Primark Is Venture Capital Broken PE Week

The primary issue is that with the continuing weak state of the public markets, exits for venture deals are limited. When the IPO market shuts down, the M&A multiples drop since there is less competition. Venture capitalists continue to fund companies, but, like in 1998-9, the exits lag, leading to inventory backing up. Throw in a recession and you get a "flash freeze". In one of the Ice Ages, it hit so fast that mammoths still had food in their mouth and stomachs when they froze…I wonder if you’ll see VC’s with lattes frozen in their hands?

Now this is a theme I continue to bang on about. I do not disagree with the Sevin Rosen statement. With exits sparse and exit valuations down to $80-$140m, VC’s can’t return capital pumping $20-30m into companies at $50-60m post-$ valuations. This means that our wins return, not 10x, but 2-3x. This does not cover the 50% of the portfolio that tubes. However, early stage groups with large funds, some roughly 2x their previous, are now fighting to put it out. They are forced to move later stage where they can deploy larger amounts into businesses with "established" business models or pump more into early stage businesses.

We believe, as Daniel points out, that you need to reman at the seed/early stage. Get in early, keep the burn down, manage the downside and let the upside take care of itself. Keep the post-$ down and it puts less pressure on management and investors. This is the best way to manage the next Freeze.

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