There are bad years, so-so years and then there is 2013…its been a long time coming. In 2013, VCs finally took some pride in the 10-year returns which recovered to 7.8% as of Q2 2013. The battered egos have regained their mojo and the venture “asset” class is starting to look real once again. Even as fund managers (or GPs) whip up their fund raising documents, and get ready to pitch institutional investors (or LPs), a lot of strong foundational under-pinnings are at work.
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Schumpeter’s forces of creative destruction: 2014 will be the year of investments in Bit-coins, Drones, Cyber-Security, Hardware /”Internet of Things” and even revival of healthcare IT. Rapid innovation, reduced hardware costs and government regulatory changes are driving new startup formation. Looking in the rear view mirror, the mobility wave started with the iPhone (2007) and iPad (2010). It took about six years to start reaping returns and rewards from this cloud, social, mobile ecosystem. The next five years will bring more changes and possibly better returns for VCs and LPs alike.
More exits on the horizon: Liquidity in 2014: 2013 liquidity via IPOs and M&A generated upwards of $14 billion. As many as 80% of exits value came from enterprise software. The fat 2014 pipeline has few elephants in the making as well. CB Insights identified 26 companies that have $1 billion valuation or more. Dropbox, Airbnb, Uber, Palantir and Square will bring in more liquidity and returns to the VCs. What more, there are over 590 companies with valuations of over $100 million or more. The top 15 tech exits in 2013, according to CB Insights created $18.5 billion of value on investment of only $471 million – with Emergence Capital leading the charge with a $4m investment in Veeva yielding $4 billion. Tableau (NEA) and Trusteer (US Venture Partners) are in the top three capital efficient exits. In 2014, more acquisitions are bound to occur, thanks to the cash-rich and hungry corporations. The top tech companies (see table) have upwards of $125 billion of cash sitting on their balance sheets. Those companies with higher cash changes will likely go shopping soon.
Yet LPs don’t want to dance: A seasoned investment advisor told me that “institutional LPs remain shy and slow to react.” Over some cheap unhealthy Chinese food, we shed our tears as those LPs miss out on the next technological wave. While in 1999-2000 every pension fund was stampeding into the dot-com craze, LPs poured in $100 billion in VC funds in one year! And now, even as the fundamentals are robust, we barely see $20 billion coming into VC each year.
And as Venky Ganesan of Menlo Ventures points out, (See “VC Value Creation”) the present day tech companies are going public at much higher valuations. Speaking at VCJ Alpha West, David Cowan of Bessemer Ventures said that the market dynamics are such that today VCs don’t bat an eyelid while investing at a $250 million premoney valuation. Ten years ago, that would have been an exit price for a company. The largest 2013 investment award goes to Google Ventures for plonking upwards of $250 million in Uber at a hefty $3.5 billion valuation. The #2 is Palantir, which raised $196 million. Others include Fab.com which gobbled up $150 million and Lyft ($60 million), which is now growing faster than Uber. The quality of companies (measured by revenues, paths to profitability or sustained growth potential) being listed on public markets remains very high, unlike that of the dot-come era vaporware.
But LPs are not impressed. As of Q3 2013, only $11 billion had been invested in venture capital. Yet in the first three quarters of 2013, VC exits generated $14 billion. LPs who understand “cash flow positive” will not be sitting along the sidelines. This combined with efficiency of secondary markets have minimized the “J Curve” challenges. LPs who grumble that the securities are locked up for long periods of time (and hence seek liquidity) may have a reason to smile.
In 2014,Andresseen-Horowitz, Kleiner-Perkins, Menlo Ventures, US Venture Partners, DFJ and 500 Startups will knock on LP doors as they get ready to raise new funds. On the other end of the spectrum, the micro-VC universe has exploded. This bar-bell effect (the big get bigger) has shaped up nicely. Those in the middle are being forced to leave the playground.
Micro VCs and Online VCs: Alex Bangash of Rumson Advisors has counted as many as 400+ micro VC funds. “We have a makings of a bubble” he said. A Palo Alto based LP told me that its a messy universe with no differentiators. Each one believes they are the prima donnas whey they lack basic differentiators. Another San Francisco based LP said they meet “as many as five micro-VCs” each week. As Andreessen once said, “You need a drivers license in California to drive a car or buy a gun. Not to become a venture capitalist.” Yet some micro VCs have demonstrated 5X Cash-on-Cash returns, including one trending at 14X. There is a small group of smart people who have nailed it on this side of the spectrum. Online models like Angelist continue to attract much attention as a fundamental disruptors. I wrote about these trends in my previous post. This remains the most fascinating (and scary) part of our business.
Interestingly, in 2013, the NVCA completed a branding study to find that entrepreneurs are wary of “hands-on” VCs and only 5% care about VC fund’s current portfolio companies. Tch Tch ! So much for those fancy logos and tombstones. A lot of VC websites now have gotten rid of those and instead feature twenty-something millenial CEOs and not aging GP mugshots / tombstones. The branding exercises – “we are all about the entrepreneurs” have begun in earnest. The power has shifted back to the entrepreneurs (where it should have always been) and if this trend continues, I am hoping to see a “reverse-demo day”. Lets hope at the 2014 YC Summer batch, we see the GPs (sorry no junior associates please, this is YC…) get on stage, get three minutes to open with “I’ll invest in your pivot at $10m pre because……”
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