An Interview with the Author of “The State of Venture Capital Today”
By Rile at May 3, 2011 | 10:26 am | Print
An Interview with the Author of “The State of Venture Capital Today”
A new report issued Tuesday by venture capital firm Clearstone Partners titled “The State of Venture Capital Today” makes a persuasive case that V/Cs who invest in hot new tech startups now are going to see massive returns on their money–and soon.
Venture capital was one of the best asset classes in the world before the dot-com bubble burst. Over the next 10 years, returns plummeted as a result of too much capital in the sector and a lack of public market liquidity.
Then, just as the start-up world was recovering from the tech bubble of the last decade and the negative effects of Sarbanes-Oxley legislation, the 2008 financial crisis erupted.
So today, the venture capital community finds itself at a cross-roads. While the asset class has been largely abandoned by institutional investors, this disinterest will paradoxically lead to superior returns in the future.
Venture capital is no longer be considered a “necessary asset class” to invest in by many limited partners given the sectors insignificant size relative to the financial assets LPs have under management. Limited partners, who generally look retrospectively to determine their portfolio allocations, not progressively, have shunned the asset class.
But, as a result of this shaking out of the venture capital sector in terms of number of firms and amount of capital raised by those firms, conditions are now actually favorable for sustained long term returns.
I had a Q&A session with William Quigley, managing partner at Clearstone and author of the report, about its findings.
RM: You say that “While the asset class has been largely abandoned by institutional investors, this disinterest will paradoxically lead to superior returns in the future.” Can you clarify why that is, and what it could mean for seed stage or mid-stage investment in “hot” startups such as Twitter, Zynga or Facebook, if anything?
WQ: There is a strong correlation between money flows and returns. As capital floods into a sector, the returns to investors drop. Venture Capital has been a strongly out of favor asset class for the past decade. This is a result of very poor returns that followed the dot com and telecom bubbles bursting in 2000 and 2001.
Investors in venture funds tend to look at historical performance, rather than future prospects, when allocating their capital to different alternative asset classes, whether those be hedge funds, buy out firms or venture capital. After a shake out of both the number of venture firms deploying capital and the amount of capital VC s have under management, it is an attractive time again for venture investors.
The shake out in the venture capital industry has created an opportunity for angel investors and other non-traditional sources of funding. How these relatively new investors will perform over the next five years is not clear to me just yet.
Many of the newest angel groups have not weathered the extreme ups and downs that are so typical in the start-up world. Professional venture firms spend 100% of their time assisting their portfolio companies. Most angels, even those who participate in organized funding groups, do not do that.
RM: “Taking a data-driven prospective, this report argues that the conditions today in the private and public capital markets bode well for superior performance to return to the venture capital asset class this decade.” How do you think this plays into any larger recovery in the economy, particularly in how both Coasts’ venture capitalists are viewing tech investments and why?
WQ:The revival of the Internet and the broader technology sector will be very good for the U.S. economy. Our economy is largely faith based. If people have faith that tomorrow will be better than today, they take more risk with their capital. And it is only by re-directing capital from relatively unproductive uses, like savings accounts, money market funds and treasury bills, that we can get more capital into high growth potential sectors of our economy. The Internet, mobile, and cloud computing all have far more potential than there is capital available today.
RM: What are your thoughts on the endless “bubble or no bubble” debate currently roiling around Silicon Valley and tech V/C investing in general? Why?
WQ:At any given time, there are bull markets, maybe even bubbles, occurring simultaneously with bear markets. Everyone has their own definition for an investment bubble. I tend to look less at whether there are very high valuations being offered to companies and more towards how much a business has proven its worth in the market place. Many thought Google was in its own bubble when it went public.
Google commanded a $40 billion valuation when its shares were offered to the pubic in its 2004 IPO. In retrospect, that was a bargain. Google generates enormous amounts of cash, given its revenue level. Facebook, Zynga, Groupon and Tencent all have extremely attractive financial models. What investors should be wary of are companies in the so called ‘hot’ spaces that don’t show the same profitable business models as the recognized leaders.
There are many angel and venture capital backed companies obtaining very high valuations based on possibilities, not actual performance. When you start seeing pre-revenue businesses, many only a year old, commanding $100M + valuations, its probably fair to say there is a bubble going on in that space.
Bio of author:
Riley McderMid has worked for The New York Times as syndicated reporter where she covered venture capital funding trends across Silicon Valley and the larger start-up community.
At present working as contributing author for VentureBeat at San Francisco, California.In past, she has worked for Markets MediaDeputy Editor, New York.And, also worked for MarketWatch as investment banking reporter where she covered investment banking and private equity trends
