Venture Capitalists: Buying High, Selling Low

from the not-the-greatest-strategy dept

Thu, Dec 18th 2008 6:25pm — Mike Masnick

We were a bit confused following the last dot com boom when various venture capitalist went into hiding when it came to new investments. Suddenly they said that since the market was bad, they wouldn't make any more investments. That didn't make much sense. After all, VCs are supposed to be investing for the long-haul -- usually in the range of five to seven (plus) years. What the market is doing today is rather meaningless. In fact, investing heavily during a downturn is often a good strategy. There are fewer competitors investing, you can invest at lower valuations (buy low!) and your investment has more time to mature against less competition. Yet, it looks like many venture capitalists are taking that same strategy again, with many deciding that it's time to hold off on doing new investments until the wider market appears to improve. The worst stat in the bunch is that VCs are particularly shying away from seed stage deals -- which are the cheapest deals that need the most time to mature anyway. That's effectively a strategy that says says they'll wait until it's more expensive to buy again. Venture capital is called risk capital for a reason. If VCs don't want to take risks, they shouldn't be in the business. About the only reason I can see why it might make sense for VCs to hold off investing is if they really think their own investors will default on capital calls -- meaning they really don't have as much money to invest as they thought they had. But, if that's the case, VCs are in bigger trouble anyway.

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Filed Under: risk, venture capital

11 Comments

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Yo ho ho..., 18 Dec 2008 @ 7:11pm

Reality check time...
Venture Capital has been broken since 1998 -- when anybody could raise a fund and invest in companies that could IPO with almost NO revenue.

The final straw in venture was the first billion dollar fund, at which time the VC's began making their money off of mgmt fees (2% of the fund every year for 10 years) rather than the actual returns of the fund.

Nowadays, almost every fund in the US is deeply negative and have no propspect of positive returns on their existing investments, so in the next 3 years venture will be a total wasteland. Most firms will end up shutting down.

This is a necessary clean-up of the sector. No different than Wall St. there are major changes ahead.

Of course, as an entrepreneur -- you won't see me shedding any tears over the arrogant, over-paid VCs. They've needed to be humbled for some time. Good riddance!
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Anwar Khalil, 18 Dec 2008 @ 7:20pm

Re: Reality check time...
Agree with that but I still have to say that it doesn't apply to all of them - there are a number of highly professional VC firms ...

I also agree that, most of them don't have money to invest even though, they pretend they do - they heave their own problems convincing their own investors to top up their funds.

Thanks
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William, 18 Dec 2008 @ 10:36pm

Does the expression never try to catch a falling knife mean anything to you.
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Mike (profile), 19 Dec 2008 @ 3:15am

Re:
Does the expression never try to catch a falling knife mean anything to you.

Yeah, it means one of the dumbest investment strategies for someone investing risk capital over a long-term horizon.
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noah, 19 Dec 2008 @ 6:51am

Investors *are* defaulting on capital calls. Everyone is in cash preservation (read: survival) mode because the future is so uncertain. Now is not the time for growth, because if you run out of cash in 12 months because business is still bad, it was all for nothing. Or you could survive, but be so cash strapped when the economy does rebound that you can't take advantage of any new opportunities. The risk isn't worth it.
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Mark Regan, 19 Dec 2008 @ 10:00am

That's Because....
They are NOT really venture capitalists to begin with. What they do is front the seed money and then SELL to suckers the risk they took. When there are no suckers around to sell to, as is the case now, then they will not take the risk of putting up seed money.

Capitalism is a deck of cards built on fraud.
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scott, 19 Dec 2008 @ 10:11am

Great read. You may also want to check out my eccentric thoughts on moving venture capital towards a democratic model. I think people have found the article interesting because I'm a VC myself :-) http://scottdig.com/?p=84
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ddbb, 19 Dec 2008 @ 11:10am

There is also a lot of uncertainty about the regulatory climate. No one wants to be the last lender to Lehman Brothers. No one wants to fund a company that is going to be regulated out of existence or whose competitors are going to be favored by the government. Many companies (that are able) are waiting for a better economic climate with better valuations, and if they are related to financial services, waiting to see if they can get their hands on cheap government money rather than more expensive VC money. In this climate it makes more sense to sit on the sidelines and wait things out.
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chris d, 19 Dec 2008 @ 12:36pm

good points, although risk of follow on financing has gone up
i generally agree with you, although as a seed investor one thing you have to take into account is that with all the VCs retrenching (irrational though that may be) your seed investments - even ones that make good progress - have a much harder time getting follow on financing.
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Old_Paranoid, 20 Dec 2008 @ 6:53am

VC's
I was involved with a VC effort on and off for some time. For at least 10 years, very few (none in my personal experience) did the intial stage of business development. That was typically handled by the original developers with their own and Angel money. Once they had something to show, they would start shopping it to VC's. The VC then had to figure out how to turn it into a business that could make money and be sold for a good multiple. After all, the VC is in the deal to sell the company for a good profit.

In many cases, this would require moving the founders to non-controlling rolls, as the personal properties needed to take a dream to prototype stage are not necessarily the best ones for running a company and adapting the product for what the market wants.

No plan of business survives contact with the market. You need to listen to your customers and potential customers. You may have gone out with widget X, but found that service Y which you used to support widget X is what the customers really found valuable. So you push service Y and listen to the customers. A year or two later, you may be making money with service Z and providing some other widgets, say widget gamma and omega.

The initial dreamer is frequently a true believer in widget X, after all, that is what they started the company to build. Hence the very common shoot-the-founder (but the founder gets to keep his stock share) behavior of VC's.

Even given the migration of VC's to the commercialization phases, it is my understanding that many of them are having capitalization problems with backers refusing to write checks. Hence the virtual shutdown.
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Anonymous Coward, 22 Dec 2008 @ 8:38am

LMAO
"After all, VCs are supposed to be investing for the long-haul . . . "

LOL . . . . funny stuff!
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