Is the Venture Model Really Broken?

5/12/10

Proclaiming the venture model broken is in vogue. The lingering aftereffects of the Internet bubble have cast a shadow over the industry for a decade now; and while venture capital has consistently outperformed most equity asset classes for years, recent returns have not lived up to historical norms. Despite the grim headlines, there are signs of success all around us that prove that the venture model is far from broken.

Venture capital is, at its core, about helping to build innovative, high-growth, market leading businesses. The easiest way to measure success is to look at the exit market for venture-backed companies.

A sampling of transactions since September of 2009 in Massachusetts alone:

• Quattro Wireless was acquired by Apple for $275M

• Gomez was acquired by Compuware for $295M

• Nova Analytics was acquired by ITT for $392M

• E Ink was acquired by Prime View International for $400M

• Gloucester Pharmaceuticals was acquired by Celgene for $640M

• Ironwood Pharmaceuticals had a post-IPO market cap of $1.1B

• A123Systems had a post-IPO market cap of $1.3B

With all of this exit activity and value creation, it’s hard to understand why industry returns have lagged in recent years. The underlying data gives a good sense of the dynamics. The insights below are based on data from Thomson ONE.

There are some clear positive signals:

1. Exit volume is healthy. The IPO market has functioned on an intermittent basis in recent years, but M&A volume for venture-backed companies has taken up the slack and become the predominant exit path. When combining M&A and IPO exits, the activity has actually been fairly consistent over the years: about 300-500 per year since the mid-’90s.

2. Acquisition valuations are healthy. The average reported acquisition value for a venture-backed company hovered around $60M in the mid to late ’90s, and (after a spike in 1999 and 2000) has been averaging far more than $100M in the last few years, including 2009. Pre-IPO valuations for venture-backed companies have similarly increased over the years from around $150M in the mid ’90s to around $400M in the last few years. The increase in average exit valuations confirms that substantial equity value can be created within successful venture-backed companies.

There are negative signals too, of course, including:

1. Too many companies backed. The substantial increase in the number of companies receiving venture funding has created a glut of companies seeking an exit. In the early ’90s, there were about 1,000 companies backed by venture capital firms each year in the U.S. The late ’90s brought a rapid increase in investment activity that peaked at … Next Page »

Luke Burns is a Principal at Ascent Venture Partners in Boston. Follow @

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  • http://www.isabellaproducts.com Matthew I. Growney

    Unfortunately, it is hard to ignore that it remains really broken. I was an investor in 2 of the aforementioned companies and those investments were made 7 and 12 years ago. And the reality remains that most VC’s are not making early stage investments. The cycle time for VC’s to get ‘onboard’ with early stage companies is possibly slower than it is taking strategic corporations to partner with them or even bring their offerings to market. Boston has several truly unique early stage companies (Thred-Up, Daily Grommet, Fashion Playtes, Isabella), but most VC’s have panned them because of various misunderstood or antiquated stigma regarding risk assessments. The increase in Family Office investing in early stage companies has saved a lot of innovation and true early stage activities over the past few years. I’m hopeful that there is enough of an alternative investor base to support innovation and entrepreneurship until the VC model is truly fixed.

  • http://www.startup-book.com Herve

    This is one of my favorite subject and I think the debate will remain opened for a while. You are right, there was/is just too much money so that any good idea is funded multiple times decreasing the likeliness of success of really original ideas.

    Now reacting on Matthew, Maxlinear also went public and was not 10 years old. Skype in Europe has been a huge success and was not 10 years old. But these examples are not common. Maybe we need to go back to the model of the 70s where VCs were real entrepreneurs AND seed investors. Index Ventures for which I worked has just announced an allocation their funds to seed funding (http://blog.indexventures.com/introducing-index-seed-back-to-our-roots ) which I think is a good step. Disclosure: I have no interest in this seed fund!

    But the question remains: as long as there is so much money for VC, the model may remain broken and unfortunately, the entrepreneurs do not seem to benefit from the abundance of money…