Yesterday, I put out a five-question quiz about the state of venture capital in New England. The questions were culled from data gathered or analyzed by Michael Greeley, chairman of the NEVCA and a general partner with Flybridge Capital Partners, and from the first quarter Venture Insights report by Ernst & Young. Today, we have the answers. I also tracked Greeley down in the south of France to provide some commentary on what it all means. My take on his overall take: there’s good and bad in the numbers, but most of the news is on the gloomy side. But see what you think, and feel free to add your comments at the bottom.
Just one more point. For each question, an average of about 29 percent of readers selected the right answer. I’m not sure if that is good or bad rate for such quizzes, but it certainly highlights the idea that most of us are laboring under at least some misconceptions about the venture/startup climate in New England today.
Here’s how readers’ guesses lined up with reality:
1) What percentage of NEVCA member firms have invested in three or more companies in the past 15 months (data was pulled at end of Q1)?
Correct answer: 31 percent, 42 of 137 NEVCA members did three or more deals in the 15-month period studied.
Commentary: “I think it’s a foretelling of the shakeout [of venture firms] that’s coming,” says Greeley. “Clearly a large number of firms, you could argue half the venture firms in town, may not make it, frankly, through the cycle.” This is leading to a dramatic restriction in the deals they are doing.
This might be good in the long run for the firms that do survive. However, he says, “for the entrepreneurs it’s probably a net negative because it gives them fewer options.”
2) What percentage of financings among NEVCA members in the past 15 months were “insider only” follow-on rounds, involving no new investors?
Correct answer: 62 percent.
Commentary: Greeley says he’s never seen such a high percentage of insider-only rounds. It’s not hard to figure out, Greeley says, that VCs are hunkering down to focus on existing portfolio companies. “They couldn’t afford to invest fresh capital in new companies when they don’t know where bottom is on their existing companies,” he says.
But there was a deeper level to Greeley’s analysis that was really interesting to me. For starters, he says, the lack of outside investors could be a leading indicator of venture firms’ ability—or inability—to raise new funds. If you don’t think you can raise a new fund, says Greeley, “you’re going to be much more cautious in investing your existing fund.”
What’s more, if this is the last fund, firms are going to invest cautiously for another reason: they stay in existence longer, allowing them to charge management fees and thereby pay partners. As Greeley says, “It is kind of business as usual although they have set such a high bar on new deals that they are effectively out of the new investment business.” That would force existing syndicates to look to themselves to support the companies they have already backed—or leave them high and dry.
There is another possible explanation for the high level of insider-only rounds: firms are doing more of these deals to keep up the valuation of their portfolios, which would likely go down from where they were a year or two ago if they went out to new investors in the current environment. “Both investors and management will be reluctant to expose the company to being marked down,” says Greeley. “If the insiders simply choose to bridge the company with a convertible note (debt)—or extend the last round—everyone avoids the markdown in the hopes that the company can raise more capital when pricing will be more favorable in the future.”
So, you could argue that this practice keeps valuations artificially high. On the other hand, you could also argue that this market forces unfairly low valuations on companies, so going out to new investors might unreasonably depress valuations. Keeping a round insider-only allows firms to carry a portfolio company at a higher valuation, which could allow investors to avoid showing poor interim performance results.
Whatever the reason, says Greeley, in the end, “there was just no appetite for funds to look at new deals.”
3) Roughly what percentage of U.S. venture funds are managed in New England?
Correct answer: 20 percent. (Only 21 percent got this right, the lowest correct percentage of any answer.)
Commentary: Greeley likes this part of the picture. “The fact that so much of the money is concentrated in Boston I think is a positive,” he says. It means major investment decisions are made here. “Long term, that’s a good indicator of the vitality of the [local venture] industry.”
4) What percentage of U.S. venture investments have New England companies attracted?
Correct answer: 12 percent.
Commentary: Here come the West Coast comparisons. Greeley says Silicon Valley firms have attracted roughly 30 percent of U.S. venture dollars. “We’re sort of a third of that, and you’d like to see us be a stronger number 2.” On the other hand, he says, New England and especially Boston have a lot of critical mass: a vibrant innovation ecoystem, with plenty of universities and tech companies around to make it easier to recruit employees, find partners, and so on. That is in stark contrast to smaller tech markets, such as Research Triangle Park or Chicago. “Smaller markets look relatively less attractive, because they don’t have scale,” says Greeley. Investors are also likely to invest closer to home, where they can give more attention to portfolio companies. And since a large percentage of venture funds is managed in New England (see question 3), that should also be good for local firms. Bottom line: “I think that 12 or 13 percent number will increase.”
5) There is currently $19.6 billion in capital invested in active, venture-backed companies in New England. How many companies does this represent?
Correct answer: There are currently 777 active venture-backed companies in New England. But how many are living dead (read on)?
Commentary: “This is more troublesome to me, because investors invest hoping to make 10 times their money,” says Greeley, and his sense is there is probably not anything close to $200 billion in value in those 777 active companies. “I fear there is probably a lot of living dead companies in that number. We just haven’t acknowledged that they haven’t worked out,” he adds. “That feels like a lot of stranded capital to me.”
Again, I’d be curious to get your take on all this. Fire away.
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