DealZone

Customer to Venture Capitalists: Please, go out of business

April 30, 2009

rebecca-s-connollyEven in the depths of a recession, venture capitalists are relentlessly upbeat, but one of their big customers poured cold water on that Thursday, asking some members gathered in Boston for the annual meeting of the National Venture Capital Association to go out of business.

“I hope some of you go out of business. I hope that does happen,” Rebecca Connolly, a partner in Fairview Capital, said on a panel. Her West Hartford, Connecticut, firm has about $3 billion under management, 70 percent of it in venture capital funds and the rest with private equity.  Fairview, a fund of funds, manages money for pension funds and endowments

Connolly said that until 2000, venture capital provided good returns but since the dotcom bubble burst in 2001 returns have been very disappointing, hardly justifying the investment. Venture capitalists are supposed to find small companies with big potential and help them grow into big companies, like Microsoft, Starbucks or Intel.

“Let’s just flush everything out and get back to less competition, less money,” Connolly said, adding a caveat: “Just not my funds.”

The venture capitalists meeting here have been pondering what to do to start making more money again. They discussed ways to get initial public stock offerings going again, which are a good source of high returns.

When venture capital firms disappear they don’t die with a bang, or even a whimper. Instead, they just fade away, as partners are unable to raise new rounds of funding for investment. One senior official of the NVCA, asked about Connolly’s comments and whether lots of funds were starting to disappear, had a succinct answer: “I don’t want to talk about it.”

Photo: Fairview Capital

Comments
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Without a doubt many VC firms are in trouble given their funds are not producing positive IRR’s yet NO ONE is addressing the real problem as to why many of their portfolio companies cannot scale and get to a successful liquidity event. It’s the “People” beginning with the CEO and the leadership needed to build, lead and scale a start-up emerging growth company. People is the 4th leg of the stool to build a successful company and we would argue that its as important as the other 3 legs which are technology, market and capital yet few VC’s treat it as such. A representative from NVCA, a few years ago, made the comment that VC’s share this philosophy however they don’t truly practice it (paraphrased). You can have the best technology, a large market opportunity and throw all the capital you want at a start-up company however if you do not have the proper leadership building the teams, ensuring product is developed and commercialized and customer traction is gained, to mention a few, then the likelihood of that start-up company scaling is minimized significantly. We are in a severe economic downturn and probably never returning to the days of the dot.com era where capital was being thrown at every good idea (and bad ideas) and liquidity events were a weekly occurrence. Capital was not only being returned to LP’s but carried interest was making a lot of investors rich. During those so called good times the market was such that all you had to have was an idea, capital and a mediocre executive team and you had a chance of “hitting a home run”. Hence, the model was broken then much like it is today because its really all about the people and leadership running a start-up company. Without the proper people and leadership how can these companies survive? Investors (both LP’s and VC’s) need to recognize this, embrace it, educate themselves and start to live it if they are to be successful in the future, help stimulate employment, help create new products and services and keep America at the forefront of technology. Truly, it is the entrepreneurs, with the help of venture capital, that helped pull this country out of the last 8-9 recessions by creating new companies that hired lots of employees and kept unemployment at bay.
Over the last 7 years we have met over 110 VC firms to try and determine why they only get 1 out of 10 start-ups to a successful liquidity event (IPO/Buy-out); why they continue to hire unproven CEO’s to run their companies yet change them out every 12-24 months; the cost of a start-up CEO failure which we determined to be between $4m-$7m (which is equivalent to an “A”, “B” or “C” round)(most of them told us they have the capital to reinvest but worse yet is the company loses 12 months of runway when the CEO is changed out and that is killing many of their companies); we also looked at what tools many of these VC’s had to make not only wise investment decisions but great hiring decisions and while all of them are bright, well educated professionals, we determined many had never been a CEO or even a general manager over a business with operational and P&L responsibility yet they are making key hiring decisions to run their portfolio companies and getting it wrong the majority of the time. We also found that no one takes accountability for the bad hiring decisions at the CEO level—not the VC’s or the executive search firms that help them identify, evaluate and recruit these CEO’s. Most executive search firms give a guarantee of 1-year on the candidate they help recruit which is a very short term perspective when you look at how much has to be done for a CEO to build and scale a start-up to a successful liquidity event (which is the end-game and no one wins until they get to the end-game!).
Hence the reason for Top Gun Ventures to admit that the executive search business is broken, much like the VC model, and we completely changed the executive search model and “raised the bar” by taking accountability and recruiting start-up CEO’s and VP’s who have “been there and done it before” and learned all the hard lessons on someone else’s nickel. Basically, we target the CEO’s who are the 1 out of 10 that have gotten a previous start-up to the end-game and we guarantee their long term performance 100% until they get the company to a successful liquidity event again. Some VC’s will question whether these types of CEO’s are passionate and motivated to do it again and the answer is defintely affirmative. Our question to the VC’s is if you had an opportunity to invest $10m into 1 of 2 companies, both had the same technology, same market opportunity, same capital infusion so the only difference is the CEO whereas in company 1 you had a successful large corporate general manager become your start-up CEO however in company 2 you had a “proven been there and done that before start-up CEO”, where would you prefer to invest your $10m? Most people would say company 2 yet what we found is that option 2 has never been afforded the VC’s before which is one of the reasons why you see so many CEO’s being changed out, start-up company runways getting smaller, product delays, few liquidity events, IRR’s in the toilet, unemployment at an all time high in the Silicon Valley, and many small-mid tier VC firms that are not able to raise additional funds and likely to go out of business.
Net-net: It all starts with hiring the proper CEO and if they get this wrong then the likelihood of getting the rest of the company right is extremely unlikely!

 

In a struggle to decide whether to A) Chase after large returns or B) be passionate about the investments and people whom you are investing in, it seems that reputation of the Venture community has been tarnished by a few who are focused on A versus B. Option B seems counter intuitive since the perception seems to focus on large returns for investors. This is typically why people put their money in this Class of Investment.

Since the Venture Community is a long-term play, it would seem that Option B makes more sense as you want to cultivate leaders, companies and markets that are built to last, rather than follow the music industry with “One Hit Wonders” I’m not sure more transparency, regulations or oversight would correct these problems, but over time, the true Venture Capitalists will be able to outwit, outplay and outlast the rest of the competition.

 

Hmm… I’m pretty sure some real LPs wish fund-of-funds would go out of business. Talk about the pot calling the kettle black!

 

Boomja.com is a startup company with a working revenue model. Recently, through its network got a commitment from a NY venture firm. Unfortunately the NY investment firm had its portfolio tied up with Madoff and could not fund its commitment.

Startup companies like Boomja.com are relying on income to continue growth and may turn to conventional lenders to fund future investments. Conventional lenders may be a better option for companies like Boomja.com due to the solid business model and potential revenues.

 

Hey Boomja, might I recommend “revenues” as a way to fund future investments. A revolutionary concept, I know, but one that works.

Posted by JahLove | Report as abusive
 

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