VCs Are Not Evil: What Entrepreneurs Need To Know
Venture capitalists are not evil. That is the message that Bill Bryant, the prominent Seattle venture capitalist and venture partner at Draper Fisher Jurvetson, had for Seattle technology entrepreneurs earlier this month at the STS (Seattle Tech Startups) meeting. In recent years VCs have been vilified as “vulture capitalists” among tech entrepreneurs for demanding ridiculous exits for the money they invest and forcing entrepreneurs to make “bad” decisions in pursuit of extravagant pay days when more reasonable paths to modest successes, that would assure personal wealth for entrepreneurs, exist. Speaking earlier, Chris DeVore, co-founder of Seattle-based Founder’s Co-op, referred to this phenomenon as a “terminal misalignment of interests” between venture capitalists and entrepreneurs.
Bryant explained that this is primarily because VCs are bad at picking winners. “Entrepreneurs need to understand that we are bad at picking out the winners a priori. Despite doing extensive diligence that leads to the conclusion that every investment we eventually make is going to succeed—otherwise we wouldn’t make the investment to begin with—for every 10 deals we do, we lose all of our money on 5 to 6, we make a modest multiple on 2 or 3, but we make a lot of money on 1 or 2.” Those two successes need to deliver at least a 10x return to compensate for all the losers.
“Unfortunately I have to penalize the winners because of all the losers—we basically price them all the same at the start since we don’t really know which one will end up in the winner category. I don’t plan for this. I make every investment fully believing that it will be a winner, otherwise I would not invest, but the reality is 5 to 6 out of every 10 will lose all the money we invest,” he reiterated. “When an entrepreneur tells me they are trying to raise $2 million for 15 percent of their company, the way I translate that request is that I now need to believe they have a reasonable chance of reaching at least a $90-$100 million exit, otherwise it doesn’t pencil out.”
For those who think this is unreasonable, he had these words of sage advice: “Investors and VCs come in all shapes and sizes. There are about 1,700 funds. Find one who makes sense for you. There are a lot of fantastic businesses that will never reach $100 million in revenue. They are just not for us. We simply do not have the time or resources to manage two thousand, half-a-million-dollar deals.” DFJ has about $5.5 billion under management across 20 funds; the typical DFJ investment target per deal is about $12-$15 million.
Entrepreneurs should realize that VCs have investors too and must produce results. VCs raise money from institutional investors such as pensions, foundations, and endowments for whom the VC investment is just a tiny part of their portfolio. “We are to these very large institutional investors what art collections, luxury boats, and sports teams are to super high-net-worth individuals,” said Bryant. “We need to produce competitive returns to maintain our place in the asset allocation of these investors.”
Unlike many Seattle tech events where you have a panel of experts who are all in agreement, this was a night of conflicting opinions. The main topic was predicting technology trends for 2010 and areas that entrepreneurs should pursue. One of the speakers, executive coach Michael Schutzler, painted a rosy picture of the future for entrepreneurs, citing the great exits that took place in Q4 of 2009 after a lackluster year—Amazon acquiring Zappos, HP acquiring EDS, and the pending Oracle-Sun Deal, to name a few. In addition, as of December 31, 2009, 92 S-1 forms (the document normally filed before an initial public offering) had been filed. In contrast there were only 6 and 11 technology IPOs in 2008 and 2009 respectively, whereas there are usually 60-80 in any given year. It was notable that none of the S-1s filed were by Facebook, Twitter, or Zynga, companies that have been rumored to be preparing to go public. As of January 4th, many of Schutzler’s clients have suddenly started hearing from VCs who would not take their calls the whole of last year. “These guys are getting desperate to invest and put their money to work” he observed.
Bryant disagreed and did not mince words. “Exits suck!” he said with finality. He thinks the near-term exit future is bleak for both entrepreneurs and VCs, noting that statistically, IPOs are at levels last seen in 1995 while M&A is down some 50 percent. He provided some data that in 2008, the last full year of data, there were approximately 125 companies that had material exits, while 950 companies … Next Page »