Soaring on Ridgelift

Venture Capital – time for V3.0

It's impossible to escape the debate of whether Venture Capital is "broken" – tech blogs, national newspapers, even the overheard conversations in my favorite coffee shop (Café Del Doge in Palo Alto and no, I'm not an investor, just a happy patron!) debate the "death" of venture capital.

Like any "system" that has been "enhanced" over decades, the architecture of the venture capital business isn't broken but has fundamental issues that slow or even limit its ability to adapt to new market requirements.

Few companies survive a major architectural overhaul of their main product family.

Years ago I lived through just such a transition at Tandem Computers as the operating system and related system software (small things like the transaction monitor, database, communication products etc.) all had to be overhauled to deal with faster processors and larger memory.

The original system had been designed in the 70's when the idea of more than 255 processes in a CPU was considered a "huge" number – you can probably guess that the process id was encoded in 8 bits. Years later, the CPUs were so much faster that you couldn't run them at 100% utilization because of that process limit. The process id and similar system data had to be made larger – the ramifications were staggering in their impact.

Project EXCEED was the code name for the project to remove operating system limits. It was originally estimated at 300 man years of work – in the end it "exceeded" that by several multiples – consuming a large percentage of the development staff. This was a critical time as the "open system" transition was accelerating. Tandem missed the wave, lost market share as its systems were relevant to a smaller market niche and eventually was acquired, first by Compaq and then by HP.

Venture Capital firms are caught in an architectural transition:

• Too much capital in the aggregate.
  
  The supply of capital into Venture funds isn't balanced by the market exit potential (IPO, M&A) to generate an acceptable rate of return. The same things happened with capital inflows into the LBO funds which I wrote about back in January 2007 (but was my concluding observation about early stage capital off the mark!).
  
  Many Limited Partners believe that Venture Capital isn't an asset class but an ACCESS class – the majority of venture returns have been generated in the past 10 years by a very small subset of firms. If you could get into those firms you were going to make a return – or at least that was the theory…
  
• Too little operating expertise.
  
  The bubble run up resulted in the inflows of two forms of capital into Venture firms… money and people. The expansion in human capital attracted a lot of very smart people but with little operating experience.
  
  You wouldn't want a medical procedure to be performed by someone who had been trained but was about to conduct their 3^rd or 4^th procedure - on YOU. Yet in the VC world this happened with new VCs sitting on the boards of private companies and dispensing guidance and business advice. The rapid growth exceeded the capacity of the experienced VCs to mentor the new folks coming into the business.
  
• The Internet effect.
  

  A little discussed side-effect of the Internet is how it eliminated latency in information flow and flattened access to data. We see this everyday – the speed at news travels approaches the speed of light – Google search makes even obscure data easy to find (you just have to know what to search for!).
  
  But this same improvement means that ideas, concepts, description of problems etc. quickly spread to be known by many people. The time advantage of knowledge has been reduced and places an ever larger premium on being the first mover and flawless execution.

   

• Technology markets are mature
  
  It is much harder for a startup to break into a mature market than one that is emerging. The technology has become mission critical with the target customers and they don't want to take risks on new entrants. Similarly, the scale and performance requirements necessary to make meaningful improvements require much larger amounts of capital.

Like many of the technology companies they funded in the past, few Venture firms will successfully weather this transition.

I wonder if there isn't another factor to consider… as the H1N1 flu pandemic began the question was posed whether Google Trends had provided an early warning of the developing problem (for those who knew to look!). I'd seen Google Trends when it was first released but had forgotten/ignored it for a long time.

I pulled up Google Trends and entered search terms like "startup" and "venture capital" – the results were surprising to me – here's the chart from Google Trends on "startup":

Google Trends (startup) – All regions

Google Trends lets you drill down by region – the results for "startup" are fractal – as you drill down the data looks the same (except for regions like China and India).

A search for "venture capital" looks more pronounced…

Google Trends (venture capital) – All regions

I've debated these trends for several months – it's possible that the trend is a result of knowledge about startups and venture capital becomes increasingly well known and so people don't search for it. That could explain the difference in the regional data for countries like China and India.

To counter this, I look at the number of friends and business professionals returning to work in major corporations. One of my friends remarked that after working for 10 years in 3 startups, all he had to show for it was long work hours, an under market paycheck and weak benefits. He has a point.

Hard to know!

VC 1.0 was the beginning of venture capital where experienced investors carefully nurtured companies with modest capital. Markets were just beginning to emerge as new technology developments provided productivity improvements or solved critical business problems.

VC2.0 was the Internet and resulting bubble.

So what will VC3.0 bring? This architectural re-design is "in play" and uncertain.

While this is underway I think there are two areas that deserve your attention… I characterize these as Fire and Water.

Big problems or unmet needs create a fire – big pain and urgent need. If you decide to play with fire you must execute with perfection and precision. You won't get a second chance and VC investors should quit funding the moment execution becomes flawed or someone else does a better job.

Difficult problems or emerging trends benefit from an approach like the erosion of water. Relentless and slow like a river or getting into the cracks and freezing to break down the problem faster like ice. Build entry barriers with fundamental IP, good execution and careful deployment of capital – together with deep and meaningful strategic relationships with established companies that realize they need your help.

Pick one!

 

Time to remember the King!

It's time to remember the King – no, not Elvis! YOUR CUSTOMER!!!!

In good times when demand is strong and the rising tide raises all ships, it's too easy to become complacent and think that you know best and simply respond to your own perspective of what your customers need.

In times of challenge (ok, let's quit the subtleties – when times suck!) it's critical that you give the customer (or prospect) the respect and consideration they deserve.

Sounds obvious?

You would think so but I see so many people and companies with little clue about the real needs of their customers or how their product/service relates to the customer needs.

Some personal and anonymous examples to illustrate the point from my last couple of weeks "vendor management"…

• The specialty photographic magazine who I called to verify my subscription… sorry, unless you have specific date and method of payment, we can't help you.
  
  Apparently never heard of a subscriber database…
  
  Frustrating? You bet!
  
• The PG&E truck that showed up unexpectedly to "repair a gas leak" which we hadn't reported. When asked for identification and a work order, the field tech responded – "isn't the fact I'm in a PG&E truck enough for you?"
  
  No, it could have been stolen and YOU showed up without prior notice – don't expect me to roll over like man's best friend!
  
• The folks at Expanded Spectrum Solutions who went out of their way to verify a $12 order for some quartz crystals?
  
  Impressive!
  
• The tech support folks at Synergy Systems in San Diego who helped me get a GPS unit back on the air FIFTEEN YEARS after I purchased it from them?
  
  Perfect score on the SAT and the Gold Medal. Think I will do more business with them? You bet – already did!

Ok, criticize in private, praise in public. The last two deserve the public recognition – they were selfless and helpful without question. It illustrates the point way better than the negative cases…

In the early days at Cisco we were maniacally focused on the needs of the customer – a culture driven top down by John Morgridge and John Chambers. Some research into customer behavior that I read back then was very telling – give a customer a great experience and they will tell 2 to 3 other people – give them a bad experience and they will tell 20 to 30 other people!

In other words, good news travels slowly, bad news travels very fast!

During my Cisco experience, we moved mountains to make a customer whole or respond to their needs:

• Need a customer visit to close a sale or combat a competitor? No problem!
• Send an engineer into the field to debug and fix a problem? No problem!
• Customer has unique needs that we need to address? No problem!

It paid back a thousand fold.

In the current financial mess, it's critical to spend even more time with your customers regardless of whether they spend money or not. For sure, you need to prioritize and focus on where you can close revenue but your customers have the best perspective on what you need to do.

So, some suggestions:

1. Go meet your customers on their turf – drink their coffee and understand their problems. Do this when you aren't trying to close new business – either a future prospect of keeping an existing customer aware that they matter to you regardless of the next purchase order.
2. Hold customer focus groups or webinars. Get your customers talking about their problems, what your product does well and what it needs to do.
3. Expose as many people in your company to the customer as you can (and can afford). Engineers, managers, marketing, finance – the works.
4. Give all your senior managers at least one customer to "own the relationship" in conjunction with the sales team. Think executive sponsor. Get to know your customer like you know your best friend.

Time to cozy up to your customers – you won't regret it!

The fallacies of risk management

Imagine the following scenario:

A commercial airline flight takes off for its specified destination. Unfortunately, the weather at the destination is so bad that the pilot is unable to land. As they execute the missed approach, the plane runs out of fuel and crashes – all on board are lost.

Can you imagine the tragedy, law suits, inquiry and resulting government regulations? The public reaction would be (rightly) overwhelming. Fortunately, there are already regulations in place not to mention extensive pilot and dispatcher training that would make this imaginary scenario (thankfully!!) almost impossible.

Every flight should be planned in advance with a set of contingencies designed to cover the unexpected or to recognize that the assumptions made for the flight are not working out. Contingencies include planning an alternate destination, carrying extra fuel and as the ultimate back stop, finding a runway and getting on the ground as soon as practical. Pilots train for these situations and commercial flights also have a high degree of redundancy in systems (engines, power sources, flight controls etc.) designed to minimize the impact of the 1% improbabilities.

The process of building a contingency plan has been drilled into me by every flight instructor and recurrent training session I've had. If I can't build an adequate contingency plan, I don't fly. It's that simple. Not surprisingly, this form of thinking has carried over into other aspects of my life including investing.

Yesterday's New York Times magazine had a great article showing the impact of the 1% improbabilities in investing – Risk Management and how the professional investors got nailed by the Black Swan events of the meltdown. It's well worth a read regardless of whether you are an investor or an entrepreneur.

If you are a CEO of a company (big or small) you need a contingency plan that thinks about the possible 1% events and how you will react to them – fortunately, the US Government thinks about such things too!

Don't fall into the "oh, we'll deal with that if it happens" trap that I've heard so many times in board meetings over the years. There is too much temptation to put aside the really hard issues that may be improbable- they are uncomfortable to deal with and don't have clear cut answers. As a CEO or board member you should make sure that these issues are put on the table and discussed ahead of time.

It may turn out to be unnecessary but when (not if) the improbable occurs, you will be much better prepared and the actions you take will be considered, not reactive. This will help the company better cope and survive the unexpected. Today's environment is so out-of-the-norm that events you think are improbable are much more likely to occur.

Don't find yourself the victim of fear and surprise…

 

2009 – A desert for VC backed IPOs?

As 2008 ends, two different points about the IPO market in 2009 struck me as noteworthy. Both of these appeared as I began to catch up on my reading from a hectic December.

The first arrived late last week in an article I read on SFGate's Tech Chronicles in "Slim picken's for IPOs could yield investor bargins" that quoted Renaissance Capital (an independent research service) with their outlook for the kind of companies that might access the public markets in 2009:

"Looking ahead, Renaissance said the companies lined up to go public in 2009 will have average revenues of $535 million…"

This is consistent with the discussions I've had over the last few months with some of the (remaining!) investment bankers. Public market investors want a growth story but they don't want to take a risk – revenue at the $500M mark, solid growth (>20% per year) and consistent profitability are going to be the hall marks of companies that can successfully IPO once the window re-opens. Renaissance also projects 100 IPOs in 2009 – it will be great to see that number achieved!

The second data point arrived in an email from the Silicon Valley office of the New York Stock Exchange announcing that the NYSE had approved an additional listing standard for emerging growth companies:

"On November 12, 2008, the SEC approved an additional initial listing standard that we put in place to encourage emerging growth companies to list directly on the NYSE.  The following minimum listing requirements are all pro-forma for an associated offering / IPO:

• $150mm market capitalization
• $75mm total assets
• $50mm shareholders equity
• $60mm public float for IPOs, or $100mm public float for transfers
• $4 stock price
• 400 round lot holders"

It's great to see the NYSE make this move but I don't see a $150M market cap company getting much interest – this is almost micro-cap territory these days and isn't going to be very popular with public investors recovering from the worst beating they've had in many decades.

2009 looks like a year to consider mergers that help private companies consolidate a market segment and bulk up on revenue and profitability. Private to private mergers are challenging to say the least but with execution attention to a solid merger plan (and agreement between different investor syndicates), the rewards may finally outweigh the risks.

In any event, 2009 has the makings of a desert for VC backed companies to IPO – there are certainly some VC backed companies that meet the Renaissance Capital profile but not many. The majority of exits in 2009 are going to be via M&A – only time will tell if shareholders will be happy about the valuations!

Venture Debt – Check your security blanket!

Many venture backed companies take on debt at some stage of their life borrowing money from a bank or specialized venture debt lender. This money is far from being "cheap" carrying high interest rates, transaction fees and warrant coverage (usually in the form of a stock option for preferred stock).

Debt can make sense in an environment where customers are buying and next round valuations are expected to be significantly higher than previous rounds. The premise is that venture debt can lengthen the amount of time a company can operate before having to raise a new round of financing. In an "up" environment, more time can translate to a higher valuation and hence less dilution to existing shareholders (especially important for common shareholders who generally don't invest in rounds of financing to protect their ownership).

Debt can also make sense when a company is expanding sales – debt in the form of a line of credit can be used to supply working capital to cover the time from shipment/invoicing to cash collection. The line of credit allows a company to borrow some percentage of its account receivables – generally with a better rate than pure venture debt.

In addition to high interest rates etc., one of the other attributes of venture debt is that it typically requires either a UCC-1 filing (Uniform Commercial Code, article 9 public filing perfecting a security interest in underlying assets) or a Material Adverse Conditions (MAC) clause. Either of these conditions allows the lender to "call" the debt due under certain conditions. The lender also requires that you either place all your funds (existing and borrowed) in their bank (where the lender is a bank) or execute an account agreement that provides the lender with account control over all of your funds.

In todays "down" environment where revenue growth is uncertain and credit is tight, venture debt can give a company a false sense of security about the remaining cash runway it may have before raising the next round.

Remember that the debt lender has an obligation to protect their asset and so keeps a close eye on the company's current cash balance and compares it to what is owed on the loan. As the cash balance gets close to the outstanding loan, the lender will call the CEO and investors in the company to determine the plans for the next round of financing – basically looking for a "guarantee" that the investors will continue to finance the company (thereby insuring the loan doesn't default).

Any hesitation or lack of conviction in the certainty of the "next round" may cause the lender to invoke the UCC-1 or MAC clause and cause the note to come due. The lender then sweeps the accounts to recover their outstanding principle and the company is immediately out of cash.

Given the current climate and challenges facing financial institutions of all kinds, cash is just a much "king" for them as it is for startups. You can pretty much guarantee that lenders will protect their cash as the first priority and worry about business relationships or possible legal challenges later. We saw this exact scenario unfold many times in 2002-2003 as the business environment was challenged by the aftermath of the Dot Com bubble, 9/11 and the pull back in telecommunication capital spending. 2009 is unfortunately shaping up to be worse…

So, if your company has a venture debt line and you forecast your cash balance going below the outstanding amount of the loan, take a long hard look at whether that cash balance is going to be real at the time you need it most. Chances are the cash will be swept.

Confront the issue now while you still have plenty of time – consider the possibility of the accounts being swept and talk the issue through with your investors. Get a contingency plan in place - perhaps getting a small "top-off" round and immediately paying off the loan (thereby saving interest expense) or figuring out other ways to stretch your remaining cash either to the point of break even or getting a new round of financing closed earlier.

Don't hold on to venture debt as a security blanket – you may get caught out in the cold!!!

 

 

The other side of cost cutting

Like me, you've probably had enough with comments from VCs on how to cut costs/plan to weather the deepening recession. For sure, there has been much well-meant advice on the cost-cutting front.

Inevitably, people focus on the cost-cutting front first – it's the foundation for longer survival and sadly has profound impact on people's lives and careers. As I've written in the past, getting to cash flow breakeven places the control of your destiny squarely in your own hands – no longer dependent on infusions of capital for meeting the next payroll.

However, cost cutting is only one of the levers you can pull to reach breakeven. I haven't seen much from VCs on driving the sales front so here's input for the other side of cost cutting – revenue generation.

Sales leverage

Even in a growth market, startups face a headwind in getting their message out and making it heard above the noise. In a down market, it is even harder. It's expensive to knock on doors and find potential customers that a) have the problem only you can solve and b) who are willing to spend money to fix it!

Companies put a lot of effort (and expense) into lead generation programs. Purchasing prospect lists, advertising, trade shows, telemarketing etc. are all tried and tested tools but are still part of a push sell – you want to convert this to a pull.

You have to make it easier for customers to find you.

Simplify the message

When I start working with a company, I listen to how the team describes the problem they are solving and try and put myself in their customers' shoes. Does the customer describe the problem in the way the company does or would they describe it differently? Then I go ask some customers or prospect how they describe the problem.

9 times out of 10, the customer's description of the problem is simpler, more concise and in a phrase suitable for a Google search.

You can guess what I do next… I take that simple phrase and run it through Google to see where (if at all) the company ranks in the search results. Sharing this with the team can be an enlightening experience especially if the marketing folks defined a "new category" to describe themselves; often they are the only occupant of the category and customers give you a blank stare when you describe the category.

So, step 1:

• Make it easy for your customers to find you!
• Describe yourself the way your customer describes YOU
• Use plain language, don't define a complex category

Make it obvious

How many web sites do you look at and instantly "get" what the company does from its home page? Try it for yourself (especially with your own company web site!) – While some sites deliver the message with punch, all too often you have to drill down several levels in the web site to get a plain answer – assuming you can find one at all!

In a world of attention-challenged people, do you think a customer prospect is going to drill down into your site to find out how you can solve their problem? Obviously NOT!!!

Step 2:

• Make sure you have a clear message on your home page
• Match the description of the solution to the customers definition of their problem
• Include an obvious "call to action" (get more information, free trial, demo… etc.)

This isn't just SEO

DO NOT let your marketing folks tell you this is about search engine optimization. Simplifying the message and making it obvious is a critical first step – you want to make sure that your site ranks high in the searches for the RIGHT message – the one that the customer uses to describe their own problem and to which they resonate when visiting your web site. Once you have the message down you can turn it over for SEO.

 

If your sales process is dragging and you're trying to figure out why – start by following the steps above. If the message isn't simple and obvious – FIX IT before you do anything else. Likely, this won't be a simple process because positioning is complex to get right and effects many other things – sales collateral, product specs, and product!

I will leave you with the following food for thought: if you can't deliver a simple and compelling message that resonates with your customer via your web site, how effectively do you think your sales person is going to deliver a value proposition?

Surviving the Downburst

The latest developments in the US financial markets look like a severe downburst from a severe thunderstorm.

A downburst is the outflow from a thunderstorm that is characterized by a massive downward airflow creating immense hazards for aircraft – a severe downburst can swat even the most powerful aircraft from the sky and create a tragedy.

 

The failure of Lehman and the acquisition of Merrill Lynch by BoA show the power of the current thunderstorm in the financial markets. No one knows when this will end but in the mean time there is a lot of collateral damage.

We have already seen the market interest in new stock offering (IPO) evaporate. Some investment bankers I've talked to believe that the US won't see a recovery until 2010 and that the IPO market likely remains closed for a long time.

As a result, the number of M&A transactions has fallen dramatically and typical transaction values are low and unappealing to investors and management alike.

I've written in the past about the critical need for early stage companies to conserve their capital and drive aggressively to break even. This latest downburst places even more emphasis on gaining control of your own destiny.

Here are a couple of areas I believe have higher risk in the current environment:

• Cleantech investments where the combination of capital requirements and later round pricing creates a mismatch of expectations between investors and management on exit values.
• Social media companies where valuations result from growth in user base without strong underlying business fundamentals.

Companies in both these areas will need strong investor syndicates with deep pockets (and willingness to invest yet more capital) or they will fail.

Despite these issues, I still see many new company proposals targeting these areas – time to get real folks! The winners in these areas have left the starting gate – the late wannabes do not get to run.

It's a timely reminder to look for the seeds of the next investment cycle.

The dynamics of innovation

A lot has been written over the past few days about Judy Estrin's concern about declining innovation in the USA and Silicon Valley.

While I agree with some of the quoted issues underlying the declined such as the quality of our education system and how the Federal research budget is administered, I (like others it seems) believe that innovation is alive and thriving in the US.

But as the NY Times article quoted Vint Cerf (one of the true fathers of the Internet and now Chief Internet Evangelist at Google):

"There is a remarkable telescoping of vision and an unwillingness to make long term bets."

I think Vint has nailed the true issue on the head – it's not innovation that is declining, it's the way companies are now being built that is the real issue.

Let's step back for a moment and look at the dynamics of the late 90's – the run up to the Internet bubble…

• The vision of the Internet was being embraced by everyone – the "new frontier" effect with lots of opportunity and "real estate" for expansion.
• The threat of Y2K was top of mind for every IT executive – "we need this for Y2K" was almost a blank check for IT spending.
• The impact of PCs, software and communications on productivity was becoming clear.  Some pundits even used "ever increasing" productivity as a counter to Alan Greenspan's "irrational exuberance" concerns about the rapid growth of the stock market.
• Corporate demands to address Y2K and productivity were poorly met by incumbent vendors making it much easier for startups to sell into the Enterprise.
• The stock market was on fire – there was tremendous appetite for new stock offerings (IPOs) that tapped into the opportunities of the "new worlds" of the Internet and productivity improvements.
• VC's has plenty of capital, the cycle time for investments to exit had seldom (never?) been shorter (2 years!) and as a result, VC returns were off the charts.

In short, times were great and growth was fueled by a confluence of drivers (Internet, Y2K and productivity improvements).

Back to today – we're faced with almost the polar opposites of most of these factors…

• The Internet has been widely adopted by the enterprise.
• Y2K was a non-event.
• The low hanging opportunities for productivity improvements are gone.
• The Enterprise buyer is back to being very conservative and a startup now has a very hard time selling into the Enterprise.  This has driven up the cost of sales and the time to complete a sales process – all consuming more capital for the startup.
• The current economic mess has further dampened the appetite (and budgets!) for buying new products and essentially shut the IPO market.  M&A exists are down in number and exit value.
• VC's still have plenty of capital but the time from initial investment to exit continues to climb and is now averaging about 7 years. 

Most VCs will tell you that times of economic turmoil set the ground work for the next wave of dominant players to emerge – this means being optimistic about the future and making investments in early stage companies despite the likely 7+ years it will take to grown them to a decent exit.

Meanwhile, the pressure to generate returns has driven a larger percentage of dollars and focus to later stage (more mature companies already well into revenue) investments or to companies with accelerating growth in a belief that this will lead to a high priced (nearer term) M&A.

For these latter investments, accelerating growth doesn't have to show as revenue – in many ways we are back to counting eyeballs, page views and the number of concurrent users.  The investment is made on the thesis that the path to monetization will be found along the way – perhaps through advertising or by carving out a big enough piece of real estate that an existing player will pay up so that they can use their own monetization process.  This works some of the time…

As a result, it's much harder for a raw startup to raise capital from the VCs or angel investors when they are proposing to build a new product that will take a couple of years to reach the market and then even more years to build up meaningful revenue.

Mindful of these dynamics, the entrepreneur adapts… and turns their focus to leveraging cloud computing, Google AppEngine, Amazon Web Services etc. to build a much simpler and focused software company.  Less capital is required so the entrepreneur can finance the company themselves or through friends and family.  If the entrepreneur picks the right problem to solve and leverages the Internet for everything (distributed development, open source, marketing, buzz…), it's possible to generate rapid growth.

So innovation isn't declining, its dynamics have simply adapted to the current environment.

Time to be a contrarian – when everyone turns their attention to the short term there are indeed opportunities for a big long term play.  The trick is to focus on the magnitude and prevalence of the problem you set out to solve – then apply innovation to build the solution.  Leverage the dynamics of innovation in your favor!

So please, it's TIME TO THINK BIG!!!

Withering M&A?

Just in case you needed more reinforcement of my point from yesterday…

"…the emphasis is on results and driving hard to self-sufficiency. In other words, spend each dollar like it's your last and place all your attention on getting to break even. "

This month has been marked with a heavy ration of venture capital "doom and gloom"… It's hard to miss between the NVCA press release announcing

"…for the first time since 1978, there were no venture-backed IPOs in the second quarter of 2008…"

or…

"VC's a glum bunch over economy, lack of exits."

Indeed, the NVCA press release shows not only a drought of IPOs but a substantial drop in the number of M&A events as well. If the second half of 2008 is anything like the first, we're on track for the worst M&A year since 1999 as far as I can tell.

The cause of the drop-off in M&A activity can be partially laid on the economy – public companies don't acquire when…

• They are really concerned about their own expenses and profit – in this kind of market the target company better be break even or profitable otherwise the acquirer's own earnings are going to be negatively impacted and their stock will get hit.
• They believe their own stock is seriously undervalued.

But I think there is another root cause that needs to be considered…

Take a look at the number of M&A deals in each year compared with the number of deals where the M&A VALUE WAS DISCLOSED:

I took the numbers from the different reports linked above and then annualized the 2008 number as an estimate for the total year. The percentage of deals with disclosed values has dropped to 35% based on the first half of 2008 after running at a rough average of 50% over the rest of the data. I believe that in general, M&A values get disclosed unless either the buyer or the seller have a reason to want to keep the number private – generally because either the buyer paid too much (not likely here!) or the seller was embarrassed at the price paid (usually where paid in capital is >> than the exit value!).

The precipitous drop in disclosed values suggests a significant number of the M&A events this year were less than happy results.

Like any other sale, M&A only occurs when a buyer and seller agree on the same price - so I think there are a couple of other points to consider when thinking about the current decline in M&A events:

• M&A events don't take place when the seller is very unhappy with the sale price and they either have more capital to invest in the company or the company is self-sufficient (enough cash in the bank to give a long runway or breakeven/profitable).
• The would-be seller believes their company is undervalued and a better exit can be achieved with more time.

To me this just places even more of a premium on results and execution. Be in control of your own destiny or life will be unhappy.

Food for thought and the last flogging of this point for a while…

Global Surplus

Remember the story about King Midas? Everything he touched turned to gold… even his food and then to his ultimate misery, his beloved daughter. It's always struck me as ironic that Forbes Magazine calls their annual VC ratings "The Midas List" as a testimony to the wealth creation effect. The real Midas story was about the realization of life's true riches – I guess Forbes only read the first part of the story!

In a modern day echo of the story of King Midas, the global economy can't produce enough food to feed everyone, demand for oil seemingly outstrips supply leading to higher and higher oil prices but we have been able to create one resource in abundant excess…

CAPITAL.

Seemingly endless tsunamis of capital slosh around the global bath tub seeking opportunities to invest and generate a return. I first blogged about the impacts of excess capital in January of last year – re-reading that post makes me pause for thought - $6/gallon for gasoline doesn't seem so farfetched as it did 18 months ago!

The impact of too much capital can be as devastating as too little…

2000	$100B flows into venture capital funds. ~50% of every dollar was eventually written off. Excess capital continues to flow into venture funds resulting in reduced returns and unhappy investors who now question whether venture capital is still meaningful as an investment category.
2006/7	Capital pours into LBO funds - $255B in 2006, $302B in 2007 – mega-deals abounded until the credit crunch began in mid 2007.
2007/8/…	Sub-prime mortgage disaster. Near-death experience for the banks, huge write-downs, failing confidence in the financial industry.

 

Yet despite the destruction of so much wealth, capital continues to pour in. Why? As one limited partner summed it up to me in a conversation the other week:

"There are numerous challenges facing both LPs and GPs, but they are generally the same recurring themes of the past in different form. The real challenge this time is the massive excess of dollars seeking returns without the requisite increase in opportunities."

Increase in the number of opportunities? I'm not so sure that it's a lack of opportunities as it is about investor confidence being positive about the future. With falling stock prices, the loss of consumer confidence, soaring oil prices and a closed exit environment, its dark and gloomy and hardly conducive to optimism.

Conventional wisdom has it that Bear markets end when everyone capitulates and throws in the towel. That same wisdom says that you can only spot the end AFTER it happens – through hindsight. The bottom line... No one can predict the point at which optimism returns.

A lack of investor confidence has a direct impact on the startup world – initial capital is harder to get, the bar to raise follow-on capital gets pushed even higher – the emphasis is on results and driving hard to self-sufficiency. In other words, spend each dollar like it's your last and place all your attention on getting to break even.

Above all, don't succumb to the gloom and doom – every Bear market has an end (eventually!) and investor confidence will return. Just make sure that you're around to benefit from the return of optimism!