Crying Wolf: Or what Broke the VC Investment Model?




Doom and gloom reports return to all the major tech blogs – this time the crisis hits the Venture Capital Industry – starting with TheFunded.com’s editor Adeo Ressi, and his presentation to the Finance and entrepreneurship faculty at Harvard Business School titled “the canary is dead – something is wrong in venture capital“. The basic claim is that the venture capital industry has hit a new low in Q3 of 2008. According to the latest reports by the NVCA, the amount of capital raised by VCs is higher that the returns from VC investments. In other words – VCs are now having a net negative affect on the economy.

Matt Marshall at VentureBeat has a good summary of why the situation looks so ugly for the VC Industry. In short:

(1) from being a niche investment class, early successes in the first tech boom attracted too much capital that drove up demand – resulting in higher prices/ valuations and lower returns.

(2) Rather than paying a premium for companies that go through expensive investment rounds, large industry players compete with VCs by snatching the startups early on – a fact that decreased the large exits that VCs are depending on. One thing I would add to Matt’s analysis is that the lack of IPOs doesn’t help either. Exit opportunities limited to selling the company to Google or Microsoft.

(3) Greed – the 2% management fees become bigger as the fund size grows. From my experience talking with Israeli entrepreneurs, VCs are being criticized for ‘sitting on the money’ rather than taking risks. Now that leverage is completely gone, the PE and VC industries will have to put their money to work somehow.

Erick Schonfeld at TechCrunch takes a more abbreviated view (perhaps he was trying to quickly get indexed by TechMeme - I know that Arrington is always excited about that), saying that Adeo Ressi is simply crying wolf: “He is kind of like the Nick Denton of the VC world, always saying that the sky is falling. It’s just that at this moment he happens to be right“. Erick – I’d like to be as optimistic as you – but we should be careful not to fall into a self fulfilling prophecy: reporting on apps and web services that will likely never exit or make any significant returns to the VCs that poured millions into them. The farmer that didn’t listen to the boy crying wolf could end up getting his sheep eaten.

Also worth noting is HipMojo’s Ashkan Karbasfrooshan who sounds frustrated with VCs lack of understanding of online content. Akshan believes that there’s a lot of “UGC Crap” out there, and as people spend more time at home (trying to save money) there will be plenty of audience to consume it. Unfortunately, the only content company that really took off is Wikipedia – you don’t see much of the quality UGC out there. Content hungry blogs are happy to publish whatever crappy press release is thrown in their inbox and everyone faces the same problem at the end of the day: monetization.

Lastly, below are the slides for your viewing pleasure. Let’s just hope that the wolf is not really coming this time.

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Eze Vidra

General Partner, Google Ventures at Google
Eze is a General Partner at Google Ventures Europe. Before joining GV, Eze started Campus London, Google's first physical hub for startups, and led Google for Entrepreneurs in Europe. He's an experienced product manager and startup mentor. In 2012 Eze founded Techbikers, a non-for profit supporting children education in developing countries.
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Eze Vidra

Eze is a General Partner at Google Ventures Europe. Before joining GV, Eze started Campus London, Google's first physical hub for startups, and led Google for Entrepreneurs in Europe. He's an experienced product manager and startup mentor. In 2012 Eze founded Techbikers, a non-for profit supporting children education in developing countries.

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