David Dalka asked an interesting follow-up question to my post yesterday about the consolidation in the venture business. What does this consolidation mean to the business? A couple of things:
1) a lot of the firms out of the business now should not have been in it to begin with. They drove up prices and encouraged a loss of discipline in the entrepreneurial world. So, this segment going away is actually a positive to both entrepreneurs and VC’s. If they had helped back successful firms (versus the 10th loser in a space), their performance might have been good enough for the next fund.
2) I don’t think that there will be a massive impact on quality start-ups. As consolidation occurs, there is generally room for the smaller niche or focused funds. These often, due to size, focus earlier stage. As the brand funds get bigger, most will keep an early stage segment going but raise like DFJ and Sequoia, later stage funds in addition to their early stage ones. So, the sub-$100m funds will survive as will the brands. The $150-400m funds will take the hits in numbers most likely.
3) as long as the cycle continues, angels and strategics will do a lot of earlier investing. Should the stock market turn ugly, this money will dry up. This will have the biggest impact, I believe, in the seed/early stage world.
This all said, good ideas & teams will get funded but not necessarily at the higher valuations or larger rounds sizes of today. Running these companies will require more discipline which is a good thing and there won’t be as many competitors. First time entrepreneurs will take the brunt of any kind of pullback. This impacts the future since it is these first time efforts that lead to bigger second or third time successes.
So, this shake-up is a natural, and in the long run, healthy, correction. It prunes the herd. It won’t always be enjoyable for the VC’s or the entrepreneurial communities, but does result in a better environment. We will see if I am right on this…
I must disagree with the consolidation observation. As the industry consolidates it means that barrier to entry is getting harder and the trend toward consolidation means that VC will become more generalists than niche specialists. Deal flow, and Deal size will be determining factor.
VC’s are going to look for highest return on investment vs costs. As VC’s consolidate, they will become more efficient so the deals will be higher while VC staff will get smaller.
Examples of this trend can be found in numerous industries:
– Automobile industry
– Airline industry
– Railroad industry
– Banking / Financial industry (JPMorgan buys Bank One, etc)
– Accounting firms (used to be big 6, now it is big 3)
Also, a downturn in the economy usually means a downturn in VC investments. Just look at the last recession. VC’s became risk averse to such an extent that they over-reacted. The smart VC firms will be the ones investing in the downturn as they will get more for their money when the economy turns.
Everything is inter-related. The housing / Mortgage market crash is already rippling through other aspects of the economy. As people in the mortgage industry lose jobs, they will cut back on spending. The recent rise in jobless numbers are probably those people let go from Countrywide and other companies.
As an angel investor in the Valley, the current environment makes for a deluge of proposals and many referrals from the venture capital guys on deals that are too early for them. The quality is up in the very early stage, the competition for funding is up. Times are good for very early stage investors and groups. Now if can only get that IPO market to loosen up a bit more…
Thanks Matt! I appreciate you taking the time to go into that more deeply.
The top two areas are about what I expected. The last one is a bit disconcerting due to the continual over investment in late stage that I see evidence of continuously at Internet conferences and elsewhere. When combined with new funding of legacy pre-dot com bubble executives – I think many of the best ideas often get crowded out with the funding of lesser ideas based more on existing relationships rather than potentially breakthrough ideas with actual revenue models.
There is one thing in society that might eventually act as a counterbalance to the trend you state as all of the 20%+ 30 year Treasury bonds of the late 1970’s era expire with people looking for higher returns. New vehicles that create more early stage capital that can be wisely allocated based on rational metrics are what is needed everywhere I look in the marketplace, it will be interesting to see how this develops over time.