Venture realities : some big changes, some the same

TheFunded‘s Founding Member, Adeo Ressi, posted an interesting perspective on recent venture capital financing today.  In his post, Ressi describes several of the key issues facing venture funds in the short-term, and he concludes with these predicctions:

new investments will start to surface towards the end of Q2 and in Q3 2009. Since new investments are smaller than later stage support, the amount invested in 2009 will be significantly smaller than any amount in the last 10 years, but the volume of deals will start to normalize by the end of the year.

I agree with Ressi’s key points and his conclusion.  His post also got me thinking more broadly what they likely mean longer term for venture capital, and I’ll share those thoughts below.

First, some perspective: venture capital has existed in some form since at least Christopher Columbus, funded by Queen Isabella of Spain.  (I’d have loved to have understood the term sheet those two negotiated!)  I believe the odds quite high that venture investing will remain a vibrant, real sector for investors.  This is based on a few basic rationales:

  1. No one wants to sit aside and miss the next MSFT, Google, or Facebook for what in the scheme of a total institutional investment pie is a relatively smaller sliver;
  2. While venture funds have suffered, so have many PE funds–one of their key competitors as a investment class–along with every other asset class.
  3. When one looks at the opportunities for big-time innovation to solve big-time problems, it seems pretty obvious that the fields of healthcare, clean tech, and so on will continue to draw funding in for new venture invetment.

Thus my sense is that venture capital as an asset class will continue to exist and will very likely thrive over time.

That said, I think that venture capital as we know it is very likely to change dramatically, particularly with respect to asset allocation.  In addition to the oft stated pronouncements about the coming consolidation of venture funds, here are my key predictions to take place over the next 5 years or so.

  1. Consumer Web / Web 2.0 / Social Media investing will decline in overall money invested, though # of deals may stay similar.  Consumer web sites take vastly less money than they did even 5 years ago, before the invention of AWS (Amazone Web Services).  With cloud computing services such as AWS (and competitors such as Microsoft Online/Azure and Google App Engine), the price per cloud computing unit will drop and continue dropping.  Robust, free rapid application development environments and tools such as LAMP, RoR and so on now have rock star developers all over the place who work economically.  As a result, new services can be conceived, prototyped, tested, and launched for vastly less capital.  This trend favors the seed stage venture investors, such as Baseline, Alsop Louie Partners, Jeff Clavier, etc.  Larger funds will find it more difficult to focus here, as it’ll be increasingly difficult for these services to have good use of the bigger checks that larger funds want/need to write in order to get the right leverage on their money.  Certainly, some companies will need more money, a la Twitter, but many a consumer app will be built in next 5-10 years that may never need to raise more than $5m in outside capital.
  2. Enterprise 2.0 applications I expect to stay at near similar levels–roughly same number of deals, same amount of money.  Enterprise applications in a way have all the same kind of positive trends around lower cost development that Consumer web does–Ruby on Rails, AWS, etc.  Developing a product should become easier, lower cost.  The challenge is really around how will these companies really build salesforces and channels.  This is an unchanged challenge for Enterprise apps, and as a result, I expect investment stays on trendline similar to where it is now.
  3. Sectors with strong alignment with government regulation–CleanTech, Health Care, infrastructure etc –likely have important opportunities.  Bigger investment numbers and more deals will get done over next 5-10 years in this space.  I believe that most big-time mainstream venture funds, in order to stay on the cutting edge of where they need to be in order to run multi-hundred million dollar funds, will need to evolve sectors and take on greater focus in cleantech and health care–two areas where there is a lot of capital required as well as strong government regulation.
  4. My dark horse prediction is that globalization will become an increasingly important sector and focus for venture funds.  The world is flattening.  This flattening creates opportunities for venture funds that look to exapnd and extend their reach, networks, experience, and footprint to a global perspective as one of the big, largely untapped opportunities for venture funds.  Many larger funds have presence overseas.  Still, it is unclear whether this is really ‘globalization’ — i.e., where every portfolio company is pushing to become a global franchise–orjust putting a VC flag and office on the ground in a certain country.    I suspect its far more putting the VC flag and office in a foreign country like China and calling it a “global” fund.  That’s not really it.  The opportunity, long-term, is to accelerate and amplify earnings by getting companies earning revenues and traction in foreign lands.  Firms that can really get their arms aroudn this will find that they have upside in their returns, irrespective of sector.  This is a little fuzzier a concept, so I expect it to experience modest growth in investment and deals over the coming 5-10 years.

In conclusion, venture investing likely will survive the shakeout intact, with fewer firms and with over time, different focus.  But so long as there are markets to chase and New Worlds to discover, there will be Christopher Columbus’ and the Isabella’s who fund them.

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Filed under bootstrapping, entrepreneurship, technology, venture capital

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