Venture Capitalists: Buying High, Selling Low

from the not-the-greatest-strategy dept

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.

Filed Under: risk, venture capital

Invest In Innovative Companies; Not Failing Ones

from the well,-there's-an-idea dept

While the US is looking to bail out its biggest businesses, it looks like the UK is working on a plan for the other end of the spectrum: creating a £1 billion "emergency" venture capital fund for startups. While it's not clear how this money will actually get doled out, this could make a lot of sense. With increasing rumors that existing venture funds are having some trouble getting limited partners to actually meet the capital calls they committed to, there is some worry that the next generation of innovation (which may be necessary to get us out of this economic funk) will be stymied. While folks like Paul Graham are correctly pointing out that many internet startups these days really don't need venture capital to build success stories, that's not true of all startups. There are still innovative startups that will need risk capital to get anywhere, and having more money focused on those early stage, innovative companies with high growth potential seems a lot more intriguing (and useful) than dumping hundreds of billions into mismanaged behemoths who will quickly squander what they're given, and come back asking for more.

Filed Under: uk, venture capital

Are Venture Investors Not Meeting Their Capital Calls?

from the or-just-threatening dept

Last month, we talked about how the financial crisis might impact the venture capital community, noting that many more limited partners (LPs, or the folks who put money into venture capital funds) were looking to sell their stakes in the aftermarket. Bloomberg is now taking a look at the issue, noting that more than double the amount of stakes is up for sale compared to a year ago, basically confirming that a number of LPs are looking to get out of their commitments. One interesting tidbit is that, in many cases, this has nothing to do with losses from venture capital, but due to the rules that the LPs (pension funds or institutional investors) have on allocation. As we mentioned in the original post, most of these investors set aside a certain small percentage of their money for such high-risk alternative investments. The problem is that with the rest of the market collapsing, these investors overall portfolio has shrunk, driving the venture investments over the self-imposed limits -- forcing them to sell off to rebalance. Partly, this shows the silliness of forced rebalancing under such principles. It's forcing firms to get out of investments that might be okay, just to keep percentages intact.

However, the bigger issue is hidden at the very bottom of the Bloomberg article. It's the question of whether or not any of these LPs are defaulting on their commitments to VCs. That's been the big fear. Since LPs merely commit to venture capital funds, and then wait for "capital calls" before actually handing over the money, the worry is that LPs would default. However, the article notes that there's no evidence that this has actually happened yet. It may still just be early, as the real market collapse is only a few months old, and there probably haven't been many (if any) capital calls in the last few months. But, does anyone know of any LP that has actually failed to meet a capital call? It would be interesting to hear if it's actually happened, or if it's just a concern at this point.

Filed Under: capital calls, financial crisis, venture capital

The Risk To Venture Capital And Startups From The Financial Crisis

from the capital-calling dept

When I wrote my first post about the financial crisis, I noted that venture capitalists and startups were probably more protected than other areas of the economy, noting specifically that I didn't believe limited partners (also known as "investors" in VC funds) would fail to meet their capital calls. The way venture capital works is that the general partners (the folks who run the fund) go out and raise money from limited partners (LPs or investors), who agree to invest a certain amount. However, they don't just hand over the money. The VCs let the LPs hang onto their money until they need it and make a "capital call." For many of the bigger VC firms, the LPs who make up a large chunk of their funds come from huge institutional investors, such as pension funds and university endowments. I thought it was unlikely that they would fail to make their capital calls, because (a) they're huge and (b) they tend to only set aside a rather small percentage (5% is what I remember being told is standard) to put into high risk investments like venture capital. So, even if they were having trouble elsewhere, it seemed unlikely that they would bail out on the money they committed to VCs.

That might not be true, however. Immediately after the post, I heard from a few VCs who indicated it might be much tougher to get LPs to meet their capital calls than I expected. First, especially with smaller VC firms, the LPs might not be huge institutional investors who can shrug off losses elsewhere. Second, my original statement was before two straight weeks of a tumbling stock market (though it's bounced around since), meaning that the hurt put on the rest of the LPs portfolio may have been much bigger than originally estimated. Finally, while these big institutions may focus on only putting about 5% into high risk offerings like venture capital, they may have just realized that a much larger percentage of their money was already in high risk investments -- it's just that they didn't realize it. Thanks to badly rated collateralized debt obligations (CDOs), many people who thought they had put money in super safe AAA rated investment vehicles, quickly realized that they had actually invested in high risk vehicles. That might make them think twice about throwing any more money after high risk ventures.

And, indeed, that appears to be happening. Firms that are willing to "buy" the obligations to fund VCs are finding strong demand as various LPs look to get out of their obligations before the capital calls come. Unfortunately, there's a pretty small market of folks willing to take on these obligations, so there's a chance that the "fund" that a VC has officially raised, may turn out to be much smaller than they really believe. If an LP is unable to meet a capital call (or simply refuses to do so), the VC firm is basically stuck holding the bag. It effectively means that the size of the fund that they raised is actually smaller than announced. While that can mean fewer investments (especially if the GPs are nervous about their LPs), it can be a lot more disconcerting for startups on the funding conveyor belt. Usually startups go through multiple rounds of funding, which the VC firm bakes into its calculations when doing the initial funding. That initial firm may not lead later rounds (in fact that's rare), but it usually will participate, and now that may be more difficult. That could cause some VCs to push their portfolio companies to sell off or close up shop much faster than they normally would.

My guess is that this is still a temporary phenomenon. After the dot com bubble burst, there was lots of talk about how VCs would have trouble raising new funds, and that didn't happen. The big institutional investors know they need to allocate some portion of their holdings to high-risk/high-return vehicles, and venture capital is always a good place for that bet. Given Wall Street's implosion (and the resulting impact on east coast private equity and hedge funds as well), it's likely that venture capital will still appear as a good long term bet for high risk capital -- perhaps even better than in the past few years when there were suddenly many more options. In the short term, it may be a bit painful for startups (and VCs worried about not actually having the money they thought they had), but it still doesn't seem likely to have a huge impact on Silicon Valley. As for all the headlines you're seeing about layoffs at startups these days, don't read too much into them. A lot of companies are using the market as an excuse to effectively dump underperforming employees in a big "layoff." This way they get rid of the bad employees, and there's no negative connotation associated with the layoff like there might be in normal times.

Filed Under: financial crisis, venture capital

The Fine Line Between A Venture Capitalist And A Con Man?

from the ah,-silicon-valley dept

One of the things you learn about Silicon Valley after you've been here for just a little while is that there are some folks around here who are really, really into the technology and innovation aspect of things -- and then there are those who are only around for the money. Sometimes it's not as easy to tell the two apart as you would think, and that's opened up tremendous opportunities for con men. I recently read the novel Con Ed by Matthew Klein, which shows what a fine line there is, at times, between a startup and a confidence scam in Silicon Valley. While it's a bit extreme, if you've worked at a startup in the Valley you'll probably recognize many of the characters in the book. Klein certainly knows about his stuff on the Silicon Valley startup side -- a decade ago he ran his own Silicon Valley startup that employed me, among other folks. While I can highly recommend Con Ed to anyone who enjoys a good con book, you don't even have to dip into the fiction pages to keep up on the latest cons of Silicon Valley.

The latest true story appears to be about a "venture capitalist," Moses Joseph, who convinced a bunch of big institutional investors to give him money for his fund... and then used it for a bunch of personal stuff, while lying and forging documents to explain to the investors what he had done with the money. This isn't the first time we've seen such "fake" venture capitalists either. A few years ago, there were a few stories of "fake VCs" that were incredibly successful in separating money from investors who believed they were investing in the next hot thing.

Of course, the guy is claiming that he wasn't a con man at all, but just a real VC who got in over his head. My favorite rationalization, though, is from his lawyer, who claims that it's not like Joseph "took money from little old ladies. He didn't. It was from big institutional investors." As if that makes it okay?

The problem with these stories, unfortunately, is that they make people skeptical of the real VCs and real entrepreneurs who aren't scamming. It would be nice if these stories were confined to fictional accounts, but it seems like that's not going to happen any time soon.

Filed Under: con man, silicon valley, venture capital

Finding The Last Sucker To Invest

from the how-the-game-is-played dept

Valleywag points us to a rather scathing profile of late stage "investment" firm Advanced Equities in Chicago. Valleywag refers to the operation as a venture capital firm, but the details suggest it's a bit different than a traditional VC firm, which tends to raise a fund and then invest it as deals come up. Instead, it looks like AE is more of an investment hunter. While it does appear to have some money under management, it sounds like other VCs come to AE to go out and find investors to invest in the latest round. Tellingly, rather than referring to these investors as "limited partners" like a regular VC firm, AE refers to them as "customers." And, from the Forbes story, it sounds like those "customers" are basically unsophisticated investors who don't recognize what they're getting into.

Rather than billionaires, say former AE brokers, many clients are doctors, lawyers and dentists who lack the sophistication of typical institutions and ultrarich VC investors.

As an example, they cite one such case:

In 1999 AE sold Constance Kamberos, now 82, $330,000 worth of "bridge" notes issued by Hymarc, a firm it backed. Kamberos says the notes were pitched as a relatively safe way to earn a 12% yield. When she didn't get paid by Hymarc, Kamberos visited AE in Chicago's Loop. After she had a heated exchange with Daubenspeck, AE had the cops haul her away, Kamberos says (AE says she visited repeatedly and was hauled out by building security)

These aren't stories you hear with a typical VC firm. These sound more like stories you hear from "boiler room" operations tricking unsophisticated investors out of their hard-earned savings. Yet, as Forbes notes, big Silicon Valley VC firms like Kleiner Perkins and NEA love to talk up AE. Hmm. Then, let's recall that the IPO market has pretty much dried up for startups lately, and you can start to put two and two together.

In the bubble years, the "business model" of certain venture backed startups, was basically to sell equity to the last sucker. In the late 90s that was the public market -- consisting of a bunch of unsophisticated retail investors who would overpay for junk. But it's harder to get access to the public markets, and at least a few of the suckers have learned at least some of the lesson. However, if you can convince those suckers that they're getting in on a special deal -- say a "late stage, pre-IPO startup backed by the biggest names in Silicon Valley" the lessons learned from the last bubble go out the window. Reading this, it would appear that AE's function is to bring those "last suckers" to these startups and their VCs without going through the painful public market IPO process.

What's not clear is whether or not the VCs (and startup founders?) are taking money off the table directly during these late stage financings -- but it wouldn't be all that surprising (such deals are increasingly common these days). And, it would explain situations like the one in the Forbes article where AE helped gather up $45 million from "customers" to invest in a company called Agami. Five months later, the company no longer existed. Even people who worked at the company had no idea what happened to the money. The Forbes piece also notes that AE often pumps up the valuation of the startups in question, meaning that an earlier stage VC could be selling its shares as part of that "investment" (i.e., the money would go straight to the earlier investors, rather than the company), allowing them to still get a positive ROI on a company about to go broke.

If the Forbes report is accurate, then it certainly sounds like VCs may have figured out a different way to find that "last sucker" it needs to cash out certain investments without having to take a company public. It doesn't necessarily sound illegal (though that may depend on the details -- and there are apparently a bunch of lawsuits floating around AE). Never underestimate the ability of early stage investors to eventually find a bigger sucker to take their bad investments off their hands.

Filed Under: investors, ipos, public markets, venture capital
Companies: advanced equities

Be Careful What You Subpoena. It May Turn Up More Than You'd Like People To Know

from the oops dept

Remember the VC firm, EDF Ventures, which brought a lot more attention to a negative review on the website TheFunded.com by sending a subpoena to find out who wrote the negative review? Well, it turns out the decision keeps getting worse and worse. VentureBeat has the details that were turned up by the subpoena -- and the result is more details of the criticism, but no identifying information of the poster. Since TheFunded allows parts of comments to be public, with other parts designated as "members only," the subpoena has now made the "members only" content public, and it trashes the deal terms offered by the firm and criticizes a partner who has no operating experience. Also, the details suggest that this wasn't a spurned entrepreneur, but an adviser or partner in some manner. Either way, beyond drawing more attention to a negative review, now the firm has made public even more critical info.

Filed Under: criticism, streisand effect, venture capital
Companies: edf ventures, thefunded

Trying To Sue Someone Who Criticizes You Isn't The Best Way To Boost Your Reputation

from the apparently-the-streisand-effect-isn't-known-in-the-michigan-vc-community dept

And here we go again. Less than a year after a venture capital firm tried to sue the VC ratings site, TheFunded.com, another VC firm, EDF Ventures in Ann Arbor, Michigan, has sent a subpoena to the site to try to identify a critical commenter.

This is, of course, the exact wrong response.

First off, TheFunded doesn't keep records of who its anonymous commenters are, so the subpoena won't help much. But, much more importantly, in filing the subpoena, EDF has now broadcast to the world this anonymous review on TheFunded.com:

Worked with these people on several deals and they are to be avoided unless you are desparate. Beaus Laskey, the only honest straightforward person in the bunch, has left the firm.

That's pretty clearly the opinion of one anonymous commenter, and most readers of TheFunded.com would take it as such -- an anonymous ranting from someone who had a bad experience. Look at the listings on TheFunded.com and you'll see that almost every VC firm has a few such comments from an angry entrepreneur. People looking over the site understand that and take that into account. It's hard to see what's actually libelous about the statement, as it's pretty clearly just this guy's opinion.

But, of course, beyond drawing a LOT more attention to this one silly angry post than it ever would have received otherwise, EDF has also shown the world how it handles a little bit of criticism. If entrepreneurs didn't have a reason to avoid the firm before (even after reading the reviews on TheFunded.com), I'd imagined this thin-skinned guaranteed-to-backfire response that shows little understanding of how to respond to internet criticism will probably convince many other entrepreneurs to stay away. Which, of course, is exactly the opposite of what the firm probably wants.

Filed Under: reputation, streisand effect, subpoena, venture capital
Companies: edf ventures, thefunded

Advice For Google's VC Arm: Don't Be Boring

from the Another-Me-Too-VC dept

Last week, there was a lot of skepticism surrounding Google's VC effort as observers pointed out all the pitfalls of corporate venture capital funds and the historic performance (or lack thereof) of other companies that have tried to do what "real VCs" do. And since Google is often painted as an unconventional company with its Google.org efforts for philanthropy, the search giant may also face some pressure to do something unconventional with its VC investments.

So what is a company with $12.7 billion in cash to do? Ignore its compulsion to do things differently and simply try to maximize its own investment profits... would be the boring answer. The more exciting answer would be to throw caution to the wind (as well as a lot of money) and try to become a VC with a bit less of a singular profit-taking mindset. It's been noted that corporate VCs don't have the same profit motivations anyway, so why try to mimic pure venture capitalists? Perhaps Google's VC arm should try to offer more of a helping hand to its employees (who may be just counting the minutes until they're ready to jump ship with their own business ideas) and try to preserve a startup culture inside Google. Doing so might foster innovation within Google's campuses and shift the profit-making incentives more towards the existing innovators at Google -- instead of the fund manager(s).

Google's opportunity to do something different could have other possibilities as well. Google already sponsors the Lunar X Prize, and it could create its own series of challenges that might benefit Google's existing businesses (similar to the Netflix Prize). Google's giant pool of money could also be put towards small developer teams (a la Y Combinator) to create a "minor league" of future Google engineers. Basically, Google's VC arm may want to create other metrics in addition to a monetary return on investment -- so that its efforts are not judged solely on the performance of creating the next Google. That way, Google's VC arm might develop stats like the number of Google employees hired via its VC efforts or the number of projects based on Google's platform technologies.

In any case, the direction of Google's VC arm could be a telling signal for Google's maturity -- and whether Google is settling down and becoming another corporate giant that will eventually put an end to the bean bag chairs, free M&M's and child care or if it still has that under-30 spirit to try out different angles.

Filed Under: corporate venture capital, venture capital
Companies: google

No VC-Backed Companies Go Public In Q2

from the first-time-in-30-years dept

It's rather surprising to find out that, for the first time in about thirty years, not a single venture-backed company went public last quarter. Even in the worst of the various downturns that have happened over the past thirty years, there were always at least a few venture-backed companies that were able to make it out. This news has some folks fretting about what it means for the VC community -- with many pointing out that a bunch of VCs have moved away from "quick flip" internet investments into more long-term alternative energy bets.

I'd also guess that Sarbanes-Oxley has a lot to do with this. Going public is a lot less appealing these days thanks to the expenses required under that law. Rather than "cleaning up" the market, it's basically made going public a toxic process, so that everyone stays private and looks for acquisition opportunities. That said, it was obvious during the boom years that companies were going public way too quickly -- and being a public company is no picnic, with the required short-term thinking it demands.

So, what happens instead? There's been some talk of creating some sort of middle road. Rather than taking companies fully public, or selling them off to big players, what about a limited market of private equity investors who would let some of the original VCs and founders cash out, while keeping the company away from public market reporting requirements? This could potentially make a lot more sense for all involved. It basically adds another layer between VCs and the public markets where the private equity guys could either eventually take the company public or sell it off themselves. Even if this doesn't really work out, one thing is pretty clear: VCs will find a way to get money out of investing in startups, even if it's not in taking companies public.

Filed Under: ipos, public markets, q2, venture capital