There is a lot of hand-wringing this week about the meaning of the Sevin Rosen decision not to raise a new fund.
The over-simplified conclusion is early stage venture capital is no longer economically interesting • a.k.a “broken.” The more accurate self-assessment is that Sevin Rosen concluded they did not have a strategy to navigate the new dynamics of the market, not that the market itself was poisoned.
Steve Dow, General Partner of Sevin Rosen said as much in his interview with the New York Times when he said, “Maybe there are different financing structures. Maybe we have to look at fund sizes. Maybe we have to look at only doing deals that are going to take a limited amount of capital.”
A strategy for venture capital involves many components. This includes what I call the 5S’s+1 of private equity:
â€¢ Sectors • enterprise software, communications, media, energy, etc.
â€¢ Stages • seed, late, public, etc.
â€¢ Structure • debt, equity, LBO, etc.
â€¢ Sources • network, conferences, agents, etc.
â€¢ Size • amount of capital, number of partners, number of Investments
â€¢ + Region • California, US, Europe, China, India, etc.
Even the best strategy is only a temporary alignment in response to an opportunity. The mainstream recipe for technology venture capital was remarkably stable from 1985 to 1999:
â€¢ technological disruption in enterprise software and electronic systems
â€¢ based on Moore’s Law,
â€¢ serving the Global 2000 customer,
â€¢ sold through direct channels,
â€¢ brought to market by selling to a few major US companies.
This recipe became more capital intensive as ever more entrants arrived. New competitors raised the cost for startups to find ways to be different. Survivors grew and became more adept at competing with new startups. All this seemed like goodness to early stage tech venture capitalists. They raised more money to invest, increasing the size of the average venture fund three- or four-fold. Each partner in the firm invested more money, and the could enjoy the higher fees his firm charged for managing the money
Then the bottom fell out of the tech IPO market and the large customers (the Global 2000 companies) finally pushed back from the dinner table and said, “I’m full.” To see profits, venture capitalists had to rely on acquisitions of their companies at lower prices — leading to a new call for capital efficiency. “Small is beautiful” became the new VC mantra.
Small is not a strategy any more than is Region. Strategy requires a point of view about every one of the 5S’s+1.
Venture Capital is not broken. The demand by entrepreneurs for capital to form and fund companies is at an all time high. The trick is in the strategy of supply. We VCs are the suppliers of money. But if we are all giving money to the same types of companies, we’ll get crushed. The process of re-equilibration is playing out in this business, as it does in all businesses. Sequoia Capital, for example, is making a fortune. They have a differentiated product by virtue of their brand. Jeff Clavier, who does seed stage Web 2.0 investing, is making a very nice income.
Winners have superior strategies • strategies whose superiority is only apparent and obvious after the fact. The shorthand description of this process is Venture Capital 2.0.
Call me in 2010, and I’ll tell you who has the winning strategy in venture capital today. It is out there. And the odds are there are several.