Since 2007, the world has freaked out about finance, and for good cause. Publicly traded equity markets have frozen, or stalled, depending on which politician you listen to at which press conference. Some say that debt issued by the American Treasury, typically referenced as the gold standard of safe, long-term investment vehicles, is on the precipice of a Moody’s downgrade from a Aaa to Aa rating. Small businesses still can’t make ends meet because they can’t get loans from banks well after the federal government pumped hundreds of billions of dollars to alleviate that specific problem. As opposed to boom times, when 90 year old grandmothers with no conception of the internet invest in penny equities hoping to make millions, today sees investors looking for sure bets and easily liquidated investments, a group to which VC funds inherently do not belong.
Silicon Valley, and its satellite regions, are marketplaces built on the notion that failure is a stepping stone and that the goal is not necessarily to make money, but to change the world. In accordance, VC is famous for risk-loving investments. The decades old adage says that 1 of every 10 investments in a VC portfolio will hit and cover the losses on the other 9. Exits from these investments come from either buy-outs or IPOs.
In an address to venture capitalists, lawyers and bankers at the Seattle Four Seasons, Mark Heesen, President of the National Venture Capital Association, pointed out that in 2009, which was twice as good as 2008, there were 11 venture-backed IPOs, compared to a previously typical 100+. The M&A market is not doing much better. Given these abysmal numbers, it’s not too difficult to see first, how the aforementioned VC mentality might have trouble in today’s economic climate and second, the tenuous philosophical situation created when VC funds, needing sustenance, attempt to cater to short-term investor wants by becoming less risky, more liquid investment vehicles.
In a guest post on TechCrunch, Tod Sacerdoti, CEO of BrightRoll, an up-and-comer in the video advertising world, highlights this philosophical rapture and its effects upon business people like himself, trying to raise money to change the world with the implementation of their ideas. He focuses on 5 main entrepreneur-facing lessons he gleaned a six-week mission to raise $10m to keep BrightRoll rolling.
First, Sacerdoti notes that today, VC’s are very wary of fraud on the part of the entrepreneur and are therefore more meticulous than ever when it comes to legal and accounting review of start-ups. He warns that entrepreneurs should set caps around $25,000 on due diligence, which can drive up costs and delay productivity.
Second, he posits that, while venture capitalists recognize that user data provided by third parties like comScore and Quantcast is flawed and rarely provides better information than internal monitoring, they still rely on statistics from these services to dictate fund-worthiness. Sacerdoti tells the entrepreneur to be as close to the top of the leader boards on these third party metrics as possible and to otherwise have solid justifications for why they are not.
Tod recognizes that points 3 through 5 compete with one another. On one hand, he cautions that VC’s are very wary of entrepreneurs attempting to sell companies too early in the process and allowing their firms to be undervalued, generating less than maximal returns for all parties involved. On the other, Sacerdoti notes that VC’s are more frequently demanding that companies very quickly have a greater than 1 Revenue:Money Raised Ratio (“RoR”), meaning that they are profitable. This goes against the fundamental e-commerce/venture notion of allowing a company to gain market share, thus building a presence and value to users, and then focus on driving profitability. However, given investors’ demand for smaller risk and greater liquidity, the pressure exists, and entrepreneurs seeking successful funding rounds must be aware.
While Sacerdoti’s points can provide entrepreneurs with stop gaps, the larger point belongs to VC as an industry. Today, because of market pressures competing with philosophical drivers, VC is facing a question of sustainability. If VC shrinks and funding dries up, entrepreneurs and their ideas do too. To minimize shrinkage, does VC cater as much as it can to investors wants, or, does it go bold, providing investors with an ultimatum: either get on the same philosophical page and help us change the world, or get out? While only time will tell what actually transpires, what do you think should happen?
— Sean Weinstock