This is a guest blog post by my friend Bob Fleming. When Bob founded Prism Venture Partners in 1996, I sponsored Silicon Valley Bank’s LP investment into his first close. We’ve done several deals together since and I’ve enjoyed the business and personal relationship. He has been kind enough to share his perspective on what might referred to as the ‘frothy’ current environment….many thanks to Bob. You can reach him at firstname.lastname@example.org
As someone who got into the venture capital business the same year the original Mac got its first hard drive, my career has seen a few business cycles. The last few years have been a paradox, combining a possible valuation bubble with a recession in fundraising by venture firms. So what’s going on? It’s worth looking at a little history for perspective.
In 2000, the height of the Dot Com bubble, pre-revenue companies were commanding multi-billion dollar valuations and funds were reporting triple-digit net annual returns. That year, the VC firm I co-founded, Prism Venture Partners, was about to sign a deal to sell a pre-revenue optical components company for $1.8 billion in cash to a public company. The deal fell through when the stock market got a little squirrely, and I suspect that the CEO of the potential acquirer figured out that people who reported to him would be a lot richer than he was. So I didn’t buy the yacht I was pricing that year. And then most of the companies backed during the 1999 bubble fell apart.
I’ve always had a theory- “the size of the hangover is proportional to the fun at the party”, and we had one heck of a party in 1999 and 2000. Since then, the VC business has delivered poor returns overall until fundraising collapsed with the recession of 2008. Yet some seemingly wild valuations are being paid today for startup companies. A brand-name VC firm with offices on both coasts has admitted to having different term sheets for Silicon Valley and Boston. A seemingly smart VC lamented to me the other day that he regretted not investing in a healthcare IT company that gives away its product and has yet to actually generate revenues. Doesn’t anyone remember valuing companies by “eyeballs” 12 years ago? pets.com? Is it the sign of the apocalypse?
Here are a few observations from someone whose first company went public around the crash of 1987, when the market dropped 22 percent in one day!
The will be some huge successes from the current portfolios. Social media is having as great an impact on society as the launch of the Internet itself. Facebook will be at least as important a tool as Google. At its simplest level, it is the power of word of mouth on worldwide scale. We don’t yet foresee all the implications.
Social media and cloud computing are important to everything- but they aren’t the only things. People and companies communicate, identify opportunities, and interact in new ways. However, there are certain needs that can’t be fulfilled (yet) with zero-touch technology solutions. Enterprises, and people, will demand a combination of traditional and new delivery solutions. Amazon didn’t kill Walmart. Not every product will be free with advertising, even software. That said, companies ignore the opportunities to apply social media principles at their peril. My daughter works for a social media ad agency that has grown 10x in a year.
Most social media and cloud computing investments will disappoint. However, the impact won’t be as bad as the crash of 2001. The cost of getting a software product to market is probably 20 times lower than it was in 2000, so it’s possible to figure out what works for very little money, write big checks until success is more probable. VCs have learned to “fail faster” with their portfolio companies- a very good thing.
The VC industry has to innovate to survive, but it isn’t dead. The traditional VC model never scaled to the amount of money thrown at it for the last decade. While the industry will survive, the number of traditional VC firms will radically drop. A few “franchise players” will continue to thrive, and there will be smaller boutique firms with a regional or industry focus, but the VC industry will rebuild slowly from the low fundraising base of 2010. (Unless the LPs get silly again and shovel money back in, driving returns back down.)
Money and expertise can be had a la carte. The old argument for venture capital used to be that startups needed both big money and company-building expertise to be successful. For some industries, the money is now optional until much later in the process. Quality management assistance from successful entrepreneurs, former VCs, or innovative startup factories like Y-Combinator or TechStars is a real option. Fewer large, old-style VC firms are needed.
This is actually an exciting time to be in the technology business. There is a bubble going on in some quarters, and it will burst- but it’s nothing like it was 11 years ago. To the doom-sayers that the VC business is cratering- it’s just maturing. Innovation is accelerating. There are radical changes in how we communicate and work, creating tremendous opportunities. The recession was a great forge to mold successful companies that survived it, just like the Dot Com Crash. A shortage of funding (for funds) is forcing VCs to finally innovate their own business and the lower costs of developing many products (and marketing them) make that possible. I made more money from the smallest funds in my 25 years in the business, by the way. Fortunes will be made and fun will be had for those who play smart and persevere. Can’t wait.