Next Things First


Really Interesting Posts Over at Tech Flash by Rob Coppedge
February 24, 2009, 1:13 am
Filed under: Uncategorized

As usual, John Cook is stirring up an interesting debate over at Seattle’s TechFlash blog.

Yesterday, he linked back to a piece I wrote in early January on the need for the government to include support of early stage ventures in the stimulus plan. You can find that thread on TechFlash here. This post generated considerable commentary, including our response:

…many comments ignore the fact that if there wasn’t a substantial capital constraint facing early stage investing there wouldn’t be so many high quality companies starved for capital.

Many of the comments are correct to point out that in some situations angel networks and incubators may better serve the early stage than traditional VCs. Even better, many point out that ‘built to flip’ VCs are not the proper agents to drive recovery/stimulus investing.

However, there are regional and industry specific investment networks and firms that have considerable infrastructure (around process, network and human capital) which could be leveraged to get government dollars to work in the early stage. Each of these groups could efficiently put a fraction of the dollars Friedman references to work ($50-100 million). This would have extremely positive implications for the innovation economy.

Without focus on efforts like this – as well as attention to the stalled exit environment … the outlook for those of us focusing on new start ups and early stage venture is looking increasingly bleak.

John then went out an interviewed many of Seattle’s top VCs and posted this piece on the blog. The tone of the VC community was decidedly negative and we posted the following retort:

Private equity is moving through an industry wide identity crisis – culminating in this week’s upcoming screaming match over the tax treatment of private equity manager’s carried interest. When all of these managers are heard for the first time, complaining in unison about their tax rate, I fear it will be the nail in the coffin for the reputation of our industry.

This is especially true for venture capitalists – who have been relatively innocent of the abuses of our gluttonous big brothers in buy out funds. However, we certainly have abdicated responsibility for the early stage (and to our investors) as we have rushed to support later stage investments with significant revenue and years of positive EBITDA.

While your panelists are correct to point out that angels have been recently left with responsibility for “filling the funnel” with early stage investments, it is important to note that these angel networks are strapped, have inherent limitations and can not bear the full burden for fueling the innovation sector.

Brad Silverberg is correct in pointing out that start ups can benefit from significant capital efficiency. Technology costs continue to come down and, in this economy, people and space cost considerably less. However, existing VC funds (that some argue are “flush with cash”) are not taking advantage of these market opportunities. And for obvious reasons.

Investors in existing VC funds are not certain to reinvest (and the prospect gets less certain by the week). 2009 promises to be a low point for LP commitments to funds. VCs are incented to keep powder dry and see their existing portfolio companies through the long winter. Accordingly, the few new investments that are made in these portfolios will face intense scrutiny.

This is exactly why additional capital, unfettered by these considerations and guided by experienced venture fund or angel network managers, is so needed.

As Andy Sack points out, changes to fund structures will be needed (especially around management fees – perhaps this is an area to more widely introduce budget based management fees). However these necessary tweaks are no reason to throw the baby out with the bathwater.

Stimulating a resurgence in back-to-basics venture capital (serious value added from roll-up-their-sleeves VC managers) would have a positive impact not only on the economy but also on the public perception of our asset class.

A big thanks to John Cook and the folks at TechFlash for keeping such a relevant and vigorous debate going…

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