Given the scarcity of liquidity, the lack of IPOs, the limited number of meaningful M&A exits, and the shrinking capital base to fund private equity and venture capital, it’s not surprising that many people at Davos question the future of these forms of risk capital. Well, in a homage to Mark Twain, I would say the rumours about the death of venture capital have been greatly exaggerated. Will the venture capital industry be dramatically affected by the macro-economic crisis? Absolutely. I believe we’ll see a material contraction in the number of venture firms able to raise new funds, and there will be intense triage within existing portfolios to focus on which companies have both the greatest likelihood of survival, as well as the highest potential returns. Follow-on financings for existing companies will generally be challenging, and the environment will encourage tough terms and valuations. VCs, more than ever, will need to work collaboratively and thoughtfully with their entrepreneurs to help navigate these turbulent waters, possibly for two or more years.
At a lunch meeting yesterday, filled with investors, technology journalists and entrepreneurs, the main topic was “where will the money go and what kinds of companies will get funded in this environment.” As mentioned in my prior posts, I think this is a very good time to start a company, although not for the faint of heart. That said, what types of companies will attract venture capital?
In our area of focus, which is primarily business and consumer-related IT, one of the key metrics (not surprisingly) will be expected capital efficiency. More specifically, we are looking for companies that we are confidant can create a high-velocity business model, which means providing products or services that drop in easily, create value quickly, and do not require large doses of expensive IT resources or technical expertise to utilise.
One of my partners in our Palo Alto office, Kevin Efrusy, has written eloquently about the major industry shift, which he describes as “the consumerization of enterprise software.” Today, we all want software that has the ease of use of Google, Facebook, and Amazon. The days of products being built by engineers, solely for end users with deep technical backgrounds and that take months to deploy are gone. Our tolerance for products with a poor user interface is rapidly disappearing.
Going back for a moment to creating a high-velocity business model, one of the reasons that the area of cloud computing (described in my prior post) is interesting to VCs is that it lowers the barriers to adoption and can create quick time-to-value for many customers.
Consumer internet companies will face far more scrutiny regarding their monetisation models (i.e. they’ll need to demonstrate they have a clear blueprint for building a valuable business with achievable projections on revenue growth and profits). Hope is not a business model.
The next few years will not be easy, but I do believe that we will witness the birth of the next generation of Googles, Amazons, Ciscos and Oracles, from the crucible of this difficult market cycle. We’re looking for big, disruptive ideas, and we’re fired up to work with the entrepreneurs that have the talent, courage, and patience to build these new category leaders.