"There is still too much money in venture and we're not shrinking ourselves back to health aggressively enough."

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Fred Destin started a conversation 1 year ago

There is still too much money in venture and we're not shrinking ourselves back to health aggressively enough.

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Too many relatively smart people chasing a limited number of great opportunities destroys returns for all. For all the talk of industry shrink, there are still too many funds out there with undifferentiated positionings and the LP community does not seem coordinated enough about a concerted effort to take money out of the system. VC needs to shrink itself back to health, agressively.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Are VCs still raising large finds simply because they can?
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
Need to differentiate:
1/ top brands are raising late stage funds b/c they can: offering access, leveraging the brand, cornering the market
2/ rest of market struggling to raise much money
My concern is that market memory is very short and that excitement about the billion club may modify behaviour again ... venture is like hollywood, no-one ever makes money except the insiders.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
Speaking as the guy who wrote the hated paper on the subject (http://goo.gl/xdYuE), how could I disagree? THe industry needs to shrink, in part because it has too much capital under management, but more fundamentally because the mega-fund experiment failed, VC-push doesn't work, and undifferentiated strategies are a huge load on VC returns.

So, is it shrinking? Capital commitments fell again in 2010, the ffith consecutive year. We are now committing new capital to venture in U.S. at the rate of $12b a year, roughly on par with 1996 in nominal terms. While that's somewhat reassuring, the total capital under management in the industry plateaued in 2010, which is unhappy news. More funds need to drop out of market, or more LPs need to reneg. Funds simply aren't failing fast enough, even if it is happening at the margin.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
That is my sense and possibly a fairly definitive answer that closes the topic :-) The prevailing view is that it's incredibly hard to raise right now but I am unsure in the cuts are deep enough and see frothiness returning
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Funny analogy. Hollywood is always on the lookout for the next sucker. They cycle through the next idiot every ten years or so. Is venture the same? Who is the sucker? Institutionalized sucker-ism?
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Fred Destin Your last point is the key one: No-one makes money in venture, at least regularly, other than insiders. Or, as I like to tell people, venture works in the Bay Area -- and nowhere else -- because its core model is friends selling to friends. Nowhere else on earth are so many well-capitalized buying and selling friends located so close to one another. Everywhere else people have to build real companies with real cashflows in real markets, one of the hardest things to do in the world.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
@Fred Destin @Paul Kedrosky That would suggest as an entrepreneur to go with the 'most' insider firms in the world. No?
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Brian Norgard Depends what you're trying to build, or at least on how much optionality you want to preserve and at what dilutive cost.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
@Paul Kedrosky Most optionality—least cost, frankly.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
The insider conveyor belts succeed each other and are nicely self sustaining: Intel, Cisco, then Google, fb and so on. Find out what is on the acquiror's roadmap, build it with their own employees, sell it, if possible sit on the boards of a few of the acquirors whilst you're at it, rinse and repeat. Sounds familiar. Anywhere else except in Germany for average 50M exit, you cannot build to sell.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
it's like the namesake family in here; glass of wine anyone ? I am sipping Chambolle-Musigny right now :-)
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Corona here. Two limes.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
The issue with respect to institutional LPs and the reason why they are unable to entirely put down the VC crack pipe is this: They have all adopted a barbell strategy, one bookended by high liquidity and low yield and low liquidity and the potential for lottery returns. Venture fits into the latter box and so gets some allocation no matter what, a situation made worse by the giant asymmetry of institional LP portfolios and VC optimal fund sizes. Tiny allocation shifts kill the sector.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
I'm in the red wine camp here. Damn investors.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
@Fred Destin I think every entrepreneur has to think about the optioanlity value @Paul Kedrosky speaks of. It's a very real and I have many data points including the sale of my last company.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
The insider/conveyor game is why venture is such a profound disappointment in almost every other market around the world. Everyone slavishly imitates the U.S. model, and then wonders why it doesn't work.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
So I am not sure I get the optionality/dilution argument as made above and would love a bit more colour.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Paul Kedrosky CalPERS is playing the lottery with my father's retirement? Oh, capitalism.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
Arguably the reason why Boston/MA cluster has gone pffft is that there is no more conveyor: The Route 128 companies are all gone, and there is no obvious replacement. You're left with builing world-beating companies who can win on profits alone, and that's no fun.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
yes which is why AOL still matters deeply to NY
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Paul Kedrosky Wow. So much truth in that statement.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Paul Kedrosky That's why we're all rooting for at least some geo diversity in the pool of winners. Does Groupon do anything for Chicago?
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
Optionality argument here is that entrepreneurs should care about having multiple exits, and, realistically, they only have that with VCs who can play the friends-to-friends game. Too many entrepreneurs take money without considering that, which is tacitly saying that they are really going to preserve dyadic exit path, which is via asset sale (ugh) or mega-surprise exit from having built big company that can't be ignored. If you can't preserve the middle option -- friends-to-friends -- the venture business breaks, as does entrepreneur optionality.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
@Brian Norgard Potentially. The wild card here is that there a few unusual geographies producing winners, like Groupon. It's too small/soon to mak a difference, and most of the activity is in the usual places, but a few places, like LA and Chicago, could turn out to have accidentally created a feeder system, however short-lived.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
@Paul Kedrosky It's also about the locus of the whisper network. In SV you have an undeniable network of trusted confidants that sit on the sidelines and provide assistance to the Google, Facebook and Twitter's of the world. These faceless men and women make deals happen on the DL. Here's a place you can spot these animals in the wild:

http://rosewoodsandhill.com
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Paul Kedrosky I'd throw NYC, Boulder and Austin in the mix. The revolution is happening...
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Brian Norgard I couldn't agree more about the role of the whisper network. Wrt Austin/Boston/NYC, it's happening, but there aren't as many acquirers, other than the aforementioned AOL. LA, at least has the newly monied Demand, whose capital and penchant for buying stuff (c.f., CoveritlIve), shouldn't be underestimated.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
@Paul Kedrosky We forget how long it takes to build a sustainable ecosystem. Hollywood—the idea that is—has been around for over 100 years. It was called something random before people started making crazy shit up and selling it the masses.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
Got it. AND you had me checking for a word which has not happened in a very long time. Namesake rocks. When I was in Europe we had it somewhat figured out in a way: build a local market champion with unassailable barriers to entry. You would have enough market knowledge and ability to attract talent to build a moat around yourself. That's what we did with Seatwave, Zoopla, PriceMinister ($250M exit to Rakuten for a local play). It gets tougher with DailyMotion (competing with Youtube, not a walk in the park). But it gets harder frankly in regional US centers.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin What word do you check? I am curious.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
Hollywood is not a reliable money maker though. Ask all the suckers who come through the doors doing output deals with a ton of coke up the nose. Ask the German independent film companies :-)
Fred Destin • Punt • Delete Comment • Mention Fred • +1
dyadic.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Gotcha.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
I'm here to expand vocabularies, if nothing else.
Paul Kedrosky • Punt • Delete Comment • Mention Paul • +1
Still scratching my head: what is a sustainable venture model for regional tech centers in the US ?
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Hollywood is fantastic at finding new money and telling stories. Two skills every entrepreneur should have.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Fred Destin Buy U-hauls and move?
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Brian Norgard ha thanks but i just did that. took a big boat, forget the u-haul.
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Indeed.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
@Fred Destin I was re-telling your GS stories a few nights ago. Got a ton of incredulous looks.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
I am doing a big post on that soon ... some of them deserve to be told :-)
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin I think so.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
ok good food for thought as usual, speak soon !
Fred Destin • Punt • Delete Comment • Mention Fred • +1
@Fred Destin Likewise. Hope you like the new site redesign.
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
easier way to invite people and make conversations succesful would be awesome
Fred Destin • Punt • Delete Comment • Mention Fred • +1
re: whisper networks: "Blue horseshoe LOVES Color!". ;-)
Christopher Smith • Punt • Delete Comment • Mention Christopher • +1
Honestly, the best way I can tell that there is too much capital out there is that large firms are finding it hard to offer engineers comparable *cash* to prospects as they are seeing from startups. That seems like one of those indicators that screams that the whole system is upside down.
Christopher Smith • Punt • Delete Comment • Mention Christopher • +1
@Fred Destin My favorite wine of 2006 was Chambolle-Musigny. Was able to acquire a case at half the normal price early last year. Hard to drink top-flight Burgundy on a ramen budget. Good thing it ages so well.
Erik Engstrom • Punt • Delete Comment • Mention Erik • +1
Really this question only applies to the Silicon Valley tech sector. We could do with some re-allocation of SV capital (cash and human) to over here in the EU. Not sure what to make of Index Venture's decision to open an office in SV.
Simon Bayly • Punt • Delete Comment • Mention Simon • +1
Also biotech investment is in the doldrums (except possibly in Boston). Pharma in particular is struggling to find new business models.
Simon Bayly • Punt • Delete Comment • Mention Simon • +1
@Simon Bayly Wouldn't you think that private capital would be going towards the greatest perceived rewards in the shortest possible time frame?
Erik Engstrom • Punt • Delete Comment • Mention Erik • +1
Wow, great conversation on such a loaded topic. I think structuring is a major part in why VC doesn't shrink quickly and why it may not ultimately shrink nominally. The investments made by VCs are illiquid, but LP interests are even more illiquid. VC funds often have up to 2 years of commitment period, another 5 years of drawing that capital and 5 more years of monitoring, follow on and exists. At the pace fund complexes raise capital, with a super high level estimate of 8 years to return a fund's commitments there is enough time to close 2 more funds and lock in commitments to sustain a complex for another 10 years. With that little liquidity contraction is tough to achieve and may not ultimately be necessary when you look at today's nominal economy versus the investment opportunities of the next 5 years since that is what *should* be driving the LP commitments, not the prior 5 years results.
Steve Berg • Punt • Delete Comment • Mention Steve • +1
@Steve Berg Is today's technology ecosystem moving too fast for LPs to course correct? Is it even possible in your opinion to do so if they wanted to?
Brian Norgard • Punt • Delete Comment • Mention Brian • +1
The specialization of the industry is what has driven it and will continue to drive it, China funds, clean tech funds, re-visiting SBA funds, LP commitments from the world market rather than just US market, all these things are signs of growth and health in an industry that I feel is not fully mature. Growing industries push through recessions, this may be one of those situations, although I am not sure how much longer or if another quick recession will be too much to handle without some lottery wins more often, although locking in an 8-9% preferred return is sometime a comfortable so-so result for an LP since losing money over 10 years nominally is a brutal but rare result for a large diversified VC fund.
Steve Berg • Punt • Delete Comment • Mention Steve • +1
@Brian Norgard Technology ecosystem moving fast is a great thing for LPs - VCs throwing money at things hoping for lottery results rather than prudent investing is a problem for VCs. There are secondary funds will to take positions of the LPs hands if they really can't bear the risk. But really, in an illiquid investment is their really volatility to whether? - It is just valuations and all that matters is cash in, cash out, and with the IPO market opening up the LPs and the VCs look to have better and bigger exits and then the fate of the company and the risk of gain loss are left to the public, whatever that may be.
Steve Berg • Punt • Delete Comment • Mention Steve • +1
Think our asset allocation mechanisms are fundamentally broken. And I'm not just talking about venture. Not saying it's a trivial problem to solve but current system ends up always defaulting to (1) fewer, bigger and (2) inertia. Not enough creative destruction and intelligent risk taking by LPs. Too much box ticking and ass covering. Like so many things in life its junior high all over again: folks are first and foremost concerned about (e)limiting the risk of the possibility of looking stupid and so go back again and again to where the cool kids hang out. As a result the ability to raise money is a skill that is an order of magnitude more valuable to a venture capital or private equity firm than the ability to invest money. Too often, investing is just an unfortunate exhaust product of the fund raise... There is a delicious irony in the lack of innovation - in structures, business models, approaches - within venture capital itself. But so long as their investors - the LPs - want it any color as long as its black, it's admittedly unlikely to change...
Sean Park • Punt • Delete Comment • Mention Sean • +1
Sorry. So to address Fred's thesis head on. I don't think too much money is the real core problem. It's too much money with the wrong people and this is because of too much inertia and not enough creative destruction in the industry. Something that I don't think would change or be solved per se with less money.
Sean Park • Punt • Delete Comment • Mention Sean • +1
@Erik Engstrom I think @Sean Park has tangentially answered your question.
Simon Bayly • Punt • Delete Comment • Mention Simon • +1
@Simon Bayly @Sean Park Certainly seems that way. Also seems that Sean is reinforcing the paradigm I've read and heard several times in the past year about herd-behavior, using the 'junior high' metaphor.

What I don't understand is why deal flow is restricted so tightly amongst so few people. I would think given the stakes and upside of spotting and investing in the right technology would drive professional investors to embrace bandwidth in deal review.

The reliance on "trusted sources" and "expected behavior" for deal introduction means that deals that might come from a non-traditional source or founder aren't going to be viewed. So my reaction is completely in sync with Sean's point... Well put Mister Park.
Erik Engstrom • Punt • Delete Comment • Mention Erik • +1
@Erik Engstrom I think the "herd-behavior" isn't nearly as irrational as we might think. I think in the tech space we undervalue how much of our big successes (which is what the LPs are interested in) depend on "herd-behavior" in the larger market place. The best way to control for that factor is to recognize that LP herd behaviour might be a good predictor for herd behavior later on, but more than that, it can *help drive* herd behaviour (if you doubt this, just think about Color).
Christopher Smith • Punt • Delete Comment • Mention Christopher • +1

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Paul Kedrosky
Speaking as the guy who wrote ...
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Paul Kedrosky
@fdestin Your last point is th...
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Fred Destin
it's like the namesake family ...
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Brian Norgard
@fdestin Corona here. Two limes.
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Paul Kedrosky
Arguably the reason why Boston...
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Fred Destin
Got it. AND you had me checki...
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Fred Destin
@Brian ha thanks but i just di...
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Christopher Smith
re: whisper networks: "Bl...
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Steve Berg
Wow, great conversation on suc...

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