Thursday, December 04, 2008

The New Truth about Venture Capital

Here are the simple facts of the post-meltdown world:

  1. Capital, especially debt capital is more scarce due to both increased risk awareness/decreased bank capacity and a desire to delever in general
  2. Near term "bad times", resulting in premiums for assets that pay out now. Asset return expectations will continue to increase (asset spot prices will continue to fall) until a new equilibrium is established
  3. Widespread cost reduction efforts will inhibit sales growth through the medium term. New projects will be postponed, scaled back or abandoned.

This article makes the very good point that VC firms should expect this general trend to impact their investments and portfolio companies in the following ways:

  1. Longer times to exits. Right now, the M&A, IPO and debt windows are firmly shut.
  2. Slower portfolio company growth, due to the aforementioned cost reduction efforts, and due to a general flight to companies with strong track records.
  3. Higher reserve requirements, as new investors decide to conserve their own existing portfolios, and higher proportions of follow-on investing rounds fall to existing investors.
  4. Flat valuations for follow-on rounds, at best, due to exit delays, development/sales slowdowns and capital scarcity.

What does all of this mean? It means that capital efficiency is extremely important, and that a move to profitability needs to be achieved as early as possible. From the investor perspective, the VC's aren't going to be able to save all of the firms currently in their portfolios, so it's important that they don't advocate anything stupid, like putting the entire salesforce on 100% commission, or cutting future development dollars (because that downstream development contains all of the exit value for years 6-10).

Another article on VC trends.

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