Business travel has taken me to San Diego and Boston recently, and I took the opportunity to visit with good friends in both cities who are venture investors: Ted Alexander (Mission Ventures) in California and Jim Matheson (Flagship Ventures) in Boston. Both firms seem to be doing well, but in separate conversations, they agreed the sector is changing dramatically and facing new challenges. For the record, my reflections are based on independent conversations, subsequent airline delays, lack of sleep, lost luggage, technical conferences, etc.
The interesting sidenote here is that America is a dynamic economy with lots of turbulence and churn and uncertainty. How strange that the sector devoted to capitalizing on the dynamism is itself being roiled by constant change.
Public Capitalism? My first order of business was to call them out on what I thought was an embarassing doughut on the scoreboard in Q2: No venture-backed IPOs in the entire quarter, the lowest level in many decades. A lot of folks think that Sarbox is to blame, and both Jim and Ted agree it is a big factor. But they both also said it was probably not the dominant factor. Wall Street is in chaos right now. But there are some bigger forces in play worth considering. Hedge funds and fancy trading schemes are causing instability in the public markets, which is obviously bad for public sentiment, but not appealing to startup CEOs either. The need to focus on the short term in public markets is unattractive, and maybe getting uglier. The new schism between research and banking at Wall Street firms also has a possible downside of drying up research on young firms.
One other potential factor: booming M&A activity in the last decade has plucked a ton of older SMEs off the radar, making it a thinner public market. Venture firms can still enjoy liquidity events with large multiples via mergers and acquisitions. But the stagnation in public markets is a concern on many levels. At the most basic, a weak IPO market which leaves M&A as the only alternative, basically gives the M&A market a kind of monopsony pricing power, pushing down valuations.
I'm reminded of the line from A Man For All Seasons: "And if you cut them down, and you're just the man to do it, do you really think you could stand upright in the winds that would blow then?"
Abandoning the Seedlings. The venture sector has been criticised for abandoning seed-stage firms, and even A rounds, for higher ground. My sense is that if a venture firm tells you that it only wants to see companies that are already profitable, then they aren't really venture firms. The guys I talked to had differeing opinions on this one. It's useful to remember that Angel investors are big players, with available and active capital that is two to four times larger than all the venture funds combined. That angels are less visible does not mean they are less important. Angel networks are organizing and becoming more efficient each year. However, there is still a niche to be filled by an institutionalized venture investment vehicle. Incubators? Accelerators? Something as yet uninvented? Yes to all.
Little Push. Consolidation and shake-out are realities in the venture industy, and my takeaway is that it is not healthy for too much money to be chasing too few deals. It would be nice to believe that investment causes economic growth, but there's not much evidence for it. Nations would like to accelerate their development, and there are countless failed efforts to push investment dollars as a growth engine, by governments themselves and by international development agencies. The same mindset of engineering an economy is common among governors and mayors and city councils all across the U.S.
Talking to Ted and Jim made me realize that we need to really rethink how innovative economies grow. I think economists understand that the most politics can do is to let (not make) an economy grow, but it absolutely cannot engineer an economy to be bigger. That's as true in Independence, Missouri as it is in Iraq.
P.S. For the record, this was my first ever trip to Boston, and it is an amazing city. Amazing! If I had to choose one city over the other (and I lived for many years in San Diego), I might actually choose Boston. Would I make the same choice come January? Ha!
Hey Tim,
Maybe the nature of emerging start-ups is that they aren't interested in the pressures that come with being publicly traded, but rather, in offering a service that's dependable.
Take the example of Mozilla, which is a start up and a non-profit foundation. Or Craiglist. Or Wikipedia.
Or maybe tech entrepreneurs just want to demonstrate proof of concept and cash out to a company that can take their idea to scale faster.
I'm glad you loved Boston, my hometown, but the weather isn't so bad, except when the pipes burst.
Posted by: Charles Johnson | July 24, 2008 at 08:22 PM