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the king is dead, long live the king
the once and future state of venture capital

                                                    david aronoff
                                                  general partner
                                        flybridge capital partners
                                            david@flybridge.com



               1 Flybridge Capital Partners 2010
agenda

•    the VC model needs an upgrade
•    clues from history
•    implications for entrepreneurs
•    semi-random thoughts




                     2 Flybridge Capital Partners 2010
some facts

•  1972 to 2007, ~2500 VC-backed IPOs in US
  –  13% of all public firms at end of 2008.
  –  8% of market capitalization ($2.0 trillion)
  –  6% of total employees.
      •  Particularly true in high-technology industries.
•  VC appears ~3 to 4x more powerful than corp R&D
  –  From late 70s to mid-90s, VC was only 3% of corporate
     R&D, but responsible for ~10%-12% of privately funded
     innovations.


    source: Lerner

                            3 Flybridge Capital Partners 2010
the way it was
           •  basic premise:
                     an overabundance of great ideas
                   + an undersupply of capital
                   = only “best” ideas get funded


           •  a sector supports 4-5 players
                   –  1 is a home run
                   –  2-3 are “ok” outcomes
                   –  1-2 holes in the ground


           •  “healthy” industry loss ratios

           •  LPs can afford to remain patient
4 Flybridge Capital Partners 2010
the way it is
                                                 •  situation:
                                                          an overabundance of similar ideas
                                                        + an oversupply of capital
                                                        = nearly every good idea got funded


                                                 •  sectors have 10+ combatants
                                                        –  0-1 is a triple. 0-3 are “ok”
                                                        –  6-10 holes in the ground


                                                 •  vc loss ratios go through the roof
© Robert Mankoff, New Yorker
with thanks to Prof Bill Sahlman, HBS
                                                 •  LP patience waning b/c returns
                                                    suffer & great recession impact
                                        5 Flybridge Capital Partners 2010
the dream exposed




6 Flybridge Capital Partners 2010
time for an upgrade
                  US Venture Capital Returns: Inception to 3/31/08




Source: Venture Economics, Prof. Paul Gompers HBS                      n=1927




                                   7 Flybridge Capital Partners 2010
product refresh underway

                  Less Capital Being Committed                                                                            Fewer Professionals Investing

                          US VC Fund Raising and Funds Closed                                                                              Venture Professionals
                                 653                                                                             10,000
                   $120                                                                  700
                                                                                                                  9,000
                   $100                                                                  600                      8,000




                                                                                               VC Funds Closed
                          451
  $B USD Raised




                                 $105                                                    500                      7,000
                    $80                                                                                           6,000
                                          321                                            400                      5,000
                    $60    $55
                                                                239 241 251              300                      4,000
                                              206         211                 221
                    $40                 $39                                                                       3,000
                                                    163                                  200
                                                                $29 $32 $36                                       2,000
                                                          $19                 $28 70
                    $20                                                                  100                      1,000
                                              $9 $12
                    $-                                                              $6   0                            0
                                                                                                                          1980      1987       1988       1997      1998       2007       2008      2009E



                                                                                                                                 Includes: General Partners, Managing General Partners, Venture Partners
                                                Dollars            Firms




Source: NVCA
                                                                                    8 Flybridge Capital Partners 2010
we’ve seen this movie before

                                                                     PEAK
                                           Accelerating               1999/00
                                                                       1983
                                                                                             Free Fall
                                               1997-99                 1969                    2000-2002
                                               1981-83                                          1983-85
                                               1967-69                                          1969-71



    Vintage Year IRR
    Top Quartile
                                                                      10%
    Median                                                              2%


                                                                      26%
                                                                        12%

                                             Firming                                     Bottoming
                                               2009-?                                          2003-08
                                                                       2009
                                               1991-96                1990/91                  1986-90
                                               1975-80                 1974                    1971-74

                                                                   TROUGH


                                   investing through the trough offers strong opportunities
Source: Brooks Zug, Harbourvest Partners
                                                         9 Flybridge Capital Partners 2010
so …

•  clearly VC has been very important driver of
   innovation and wealth creation
•  but:
  –  low returns for past decade
  –  tremendous randomness in exit markets
  –  far too many companies funded
  –  calculus of funds doesn’t solve
  –  embroiled in secular & cyclical trough
•  has become at best a short-tail phenomenon
   and at worst a random-walk.
                   10 Flybridge Capital Partners 2010
what happens next
•  the number of VCs must shrink
  –  NVCA estimated 10% in 2009, 15% more in 2010
  –  PCG predicts 1500 firms to 500 within 5 to 7 years
•  accordingly, amount of money and number of
   limited partner investors will decrease
•  this won’t happen overnight
  –  VC partnerships are 10-12 years in duration, and
     they’ll drag out last fund in hope of hail maries
•  trickle down impact
  –  fewer numbers of startups will get funded
  –  smaller financings due to decreased VC fund sizes
                    11 Flybridge Capital Partners 2010
set the wayback machine




12 Flybridge Capital Partners 2010
that 70’s show

•  VC circa 1970’s
   –  take the good
      •  small funds (in dollars & professionals)
      •  generalists wrt industry focus / versatile
      •  collegial approach / lots of syndication
           –  size of funds & firms -> so smaller financings
           –  longer horizons until liquidity
   –  ignore the irrelevant
      •  bootstrapped companies - no startups (mid/late 80’s phenom)
   –  adapt the model to the current environment


•  Much of this is happening organically already
                        13 Flybridge Capital Partners 2010
implications for entrepreneurs
               what the new model means:
•  focus on capital efficiency until inflection point
   –  garage: bootstrap model – over longer period, CFBE
   –  seed-like: quicker time to lift-off (or crash) on short $$
   –  supersized first rounds: will be harder to come by
•  concentration on new areas w/huge potential SoM
   –  new media, energy-technology, revolutions
   –  fewer me-toos (salami model)
•  financing models morph
   –  angels /seed funds /VC get along because they have to
   –  full-funded staged approach?
                       14 Flybridge Capital Partners 2010
implications for entrepreneurs
          what the new model doesn’t mean:

•  venture investors won't invest in early-stage ideas
   –  it’s the charter of our fund and most others
•  investors only look for epic returns (10/100x)
   –  my crystal ball is really no good
•  VCs are replacing angel investors
   –  but we’re actively making seed investments
•  bellbottoms are back in style
   –  did they ever really go out?


                       15 Flybridge Capital Partners 2010
semi-random thoughts #1

•  VC performance is highly persistent
   –  good continue to do well, but so do poor performers!
         •  this is true for entrepreneurs and investors


•  deal sourcing is key factor
   –  successful entrepreneurs have returns that are 50%
      greater than first timers or those who failed last time
         •  success more likely for first timers than those who failed last time
   –  50% of the outperformance of top fund is due to higher
      concentration of serial entrepreneurs
         •  VC value-added is greatest with first timers

  source: Gompers, Lerner, Sahlman
                                     16 Flybridge Capital Partners 2010
semi-random thoughts #2

•  funding/opportunity size ratio
   –  not all big opportunities require big financings, at least
      at first, sometimes at all
   –  but some types of investments require huge rounds
      early on; don’t know if they’re good bets, just know I
      won’t place them
•  being first matters a lot
   –  the tao of glen garry glen ross

•  mike maples’ “thunder lizards”
•  “gap” vs “gretzky”
                      17 Flybridge Capital Partners 2010
semi-random thoughts #3

•  home-run mentality
   –  Are VCs bound to the home-run model or should they be more
      focused on OBP?
   –  I suggest that both the home-run and OBP models don’t work,
      but a hybrid of both is warranted (shameless self-promotion)




                        18 Flybridge Capital Partners 2010
discussion




19 Flybridge Capital Partners 2010

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Flf final 26mar10 full version no video

  • 1. the king is dead, long live the king the once and future state of venture capital david aronoff general partner flybridge capital partners david@flybridge.com 1 Flybridge Capital Partners 2010
  • 2. agenda •  the VC model needs an upgrade •  clues from history •  implications for entrepreneurs •  semi-random thoughts 2 Flybridge Capital Partners 2010
  • 3. some facts •  1972 to 2007, ~2500 VC-backed IPOs in US –  13% of all public firms at end of 2008. –  8% of market capitalization ($2.0 trillion) –  6% of total employees. •  Particularly true in high-technology industries. •  VC appears ~3 to 4x more powerful than corp R&D –  From late 70s to mid-90s, VC was only 3% of corporate R&D, but responsible for ~10%-12% of privately funded innovations. source: Lerner 3 Flybridge Capital Partners 2010
  • 4. the way it was •  basic premise: an overabundance of great ideas + an undersupply of capital = only “best” ideas get funded •  a sector supports 4-5 players –  1 is a home run –  2-3 are “ok” outcomes –  1-2 holes in the ground •  “healthy” industry loss ratios •  LPs can afford to remain patient 4 Flybridge Capital Partners 2010
  • 5. the way it is •  situation: an overabundance of similar ideas + an oversupply of capital = nearly every good idea got funded •  sectors have 10+ combatants –  0-1 is a triple. 0-3 are “ok” –  6-10 holes in the ground •  vc loss ratios go through the roof © Robert Mankoff, New Yorker with thanks to Prof Bill Sahlman, HBS •  LP patience waning b/c returns suffer & great recession impact 5 Flybridge Capital Partners 2010
  • 6. the dream exposed 6 Flybridge Capital Partners 2010
  • 7. time for an upgrade US Venture Capital Returns: Inception to 3/31/08 Source: Venture Economics, Prof. Paul Gompers HBS n=1927 7 Flybridge Capital Partners 2010
  • 8. product refresh underway Less Capital Being Committed Fewer Professionals Investing US VC Fund Raising and Funds Closed Venture Professionals 653 10,000 $120 700 9,000 $100 600 8,000 VC Funds Closed 451 $B USD Raised $105 500 7,000 $80 6,000 321 400 5,000 $60 $55 239 241 251 300 4,000 206 211 221 $40 $39 3,000 163 200 $29 $32 $36 2,000 $19 $28 70 $20 100 1,000 $9 $12 $- $6 0 0 1980 1987 1988 1997 1998 2007 2008 2009E Includes: General Partners, Managing General Partners, Venture Partners Dollars Firms Source: NVCA 8 Flybridge Capital Partners 2010
  • 9. we’ve seen this movie before PEAK Accelerating 1999/00 1983 Free Fall 1997-99 1969 2000-2002 1981-83 1983-85 1967-69 1969-71 Vintage Year IRR Top Quartile 10% Median 2% 26% 12% Firming Bottoming 2009-? 2003-08 2009 1991-96 1990/91 1986-90 1975-80 1974 1971-74 TROUGH investing through the trough offers strong opportunities Source: Brooks Zug, Harbourvest Partners 9 Flybridge Capital Partners 2010
  • 10. so … •  clearly VC has been very important driver of innovation and wealth creation •  but: –  low returns for past decade –  tremendous randomness in exit markets –  far too many companies funded –  calculus of funds doesn’t solve –  embroiled in secular & cyclical trough •  has become at best a short-tail phenomenon and at worst a random-walk. 10 Flybridge Capital Partners 2010
  • 11. what happens next •  the number of VCs must shrink –  NVCA estimated 10% in 2009, 15% more in 2010 –  PCG predicts 1500 firms to 500 within 5 to 7 years •  accordingly, amount of money and number of limited partner investors will decrease •  this won’t happen overnight –  VC partnerships are 10-12 years in duration, and they’ll drag out last fund in hope of hail maries •  trickle down impact –  fewer numbers of startups will get funded –  smaller financings due to decreased VC fund sizes 11 Flybridge Capital Partners 2010
  • 12. set the wayback machine 12 Flybridge Capital Partners 2010
  • 13. that 70’s show •  VC circa 1970’s –  take the good •  small funds (in dollars & professionals) •  generalists wrt industry focus / versatile •  collegial approach / lots of syndication –  size of funds & firms -> so smaller financings –  longer horizons until liquidity –  ignore the irrelevant •  bootstrapped companies - no startups (mid/late 80’s phenom) –  adapt the model to the current environment •  Much of this is happening organically already 13 Flybridge Capital Partners 2010
  • 14. implications for entrepreneurs what the new model means: •  focus on capital efficiency until inflection point –  garage: bootstrap model – over longer period, CFBE –  seed-like: quicker time to lift-off (or crash) on short $$ –  supersized first rounds: will be harder to come by •  concentration on new areas w/huge potential SoM –  new media, energy-technology, revolutions –  fewer me-toos (salami model) •  financing models morph –  angels /seed funds /VC get along because they have to –  full-funded staged approach? 14 Flybridge Capital Partners 2010
  • 15. implications for entrepreneurs what the new model doesn’t mean: •  venture investors won't invest in early-stage ideas –  it’s the charter of our fund and most others •  investors only look for epic returns (10/100x) –  my crystal ball is really no good •  VCs are replacing angel investors –  but we’re actively making seed investments •  bellbottoms are back in style –  did they ever really go out? 15 Flybridge Capital Partners 2010
  • 16. semi-random thoughts #1 •  VC performance is highly persistent –  good continue to do well, but so do poor performers! •  this is true for entrepreneurs and investors •  deal sourcing is key factor –  successful entrepreneurs have returns that are 50% greater than first timers or those who failed last time •  success more likely for first timers than those who failed last time –  50% of the outperformance of top fund is due to higher concentration of serial entrepreneurs •  VC value-added is greatest with first timers source: Gompers, Lerner, Sahlman 16 Flybridge Capital Partners 2010
  • 17. semi-random thoughts #2 •  funding/opportunity size ratio –  not all big opportunities require big financings, at least at first, sometimes at all –  but some types of investments require huge rounds early on; don’t know if they’re good bets, just know I won’t place them •  being first matters a lot –  the tao of glen garry glen ross •  mike maples’ “thunder lizards” •  “gap” vs “gretzky” 17 Flybridge Capital Partners 2010
  • 18. semi-random thoughts #3 •  home-run mentality –  Are VCs bound to the home-run model or should they be more focused on OBP? –  I suggest that both the home-run and OBP models don’t work, but a hybrid of both is warranted (shameless self-promotion) 18 Flybridge Capital Partners 2010