Three leading Boston-based venture capitalists told an audience at the monthly Association for Corporate Growth Breakfast yesterday that even though the number of venture capital funds are shrinking, there’s still too much money out in the market-place. Additionally, significant alternate sources of financing, notably angel groups, had become increasingly available to the entrepreneur.
Representatives from Boston Millennia Partners, Atlas Ventures and Polaris Venture Partners seem to agree that making money in venture capital these days is a lot harder than it used to be.
First, average deal holding periods appear to be about 6 years these days, up from 4 years in the not too distant past; longer holding periods reduce internal rate of return, and the illiquidity implicit in a longer holding period obviously negatively impacts the limited partners.
2012 saw the birth of approximately 180 new funds, a third of which were first fund offerings. While institutions might be gun shy of newer funds and might seek out “the brand name,” statistics indicate that smaller funds had an easier time providing superior (3X) returns. Further, in balancing portfolios, investors need a certain percentage of their money in “alternative” investments which include venture capital; as the overall market rises, the absolute number of dollars that must be placed into these alternate investments rises also.
Perhaps the most interesting comment involved “strategy creep.” Funds that are successful at the smaller deal size tend to capitalize on that success by raising larger funds. As a practical matter, with a larger fund there is a greater tendency to make larger investments. But making larger investments in different kinds of companies requires a different expertise. Thus, there may be a tendency for successful smaller funds to end up, in their subsequent larger funds, conducting a business in which they have no experience.
Where does VC deal flow come from? Professional referrals, but also networking, particularly with investors who made profits with a fund manager in the past. This is particularly true in early stage investments. In later stage investments for more mature companies, VC’s are approached by investment banks but also undertake a cold call outreach.
The panel also criticized the entrepreneur’s emphasis on valuation in a particular round; “the current round is never the round that matters.” And the real question is whether a VC is truly a value-added partner.
How is value added? Through team building and through introductions for strategic relationships. Whether or not a VC is a true-value added participant perhaps can be determined by an entrepreneur speaking with CEO’s of other companies in the portfolio.
What do exits look like? Certainly the IPO is not a reliable exit; there was some suggestion that it never really was, if you were to consider not just whether the IPO took place, but also whether the offering price was in fact sustained. For sale to a PE firm, a company typically needs substantial cash flow. The least risky exit is through a strategic sale. Entrepreneurs are advised to nurture relationships with other larger companies within their space so that they are known to potential acquirers when the time comes.
Finally, the “perennial” question was asked: How important is it to you, in running the fund, to enjoy capital gains treatment on your carried interest? As with every other panel I have heard on this subject, the fund managing partners on the panel shrugged, looked at each other and said, in effect, that it did not matter to them at all.