Can the VC model work with virtually no exits?

The global economic crisis has brought IPO exits to a 30 year low and M&A activity is slower than previous year.  How do VCs cope with the new reality?

The National Venture Capital Association (NVCA) in the US has released the results of the Exit Poll report for Q4 of 2008.  The results are unsurprisingly disappointing. There were no venture-backed IPOs in the quarter, and the tally of M&A exits as of the last day of the quarter came to a modest 37 transactions for the period.

2008 only brought six IPO exits, the fewest annual VC-backed offering number since 1997. Overall, there were 260 M&A transactions in 2008, dipping below 300 for the first time since 2003.  28% of these M&A deals were “fire sales”, well below the venture capital investment. The largest M&A deal this quarter was the $945 million  Bill Me Later acquisition by eBay, completed this November.

The 2009 outlook looks grim for the Venture Capital industry. In the words of Mark Heesen, president of the NVCA:

“The most significant impact of the US financial crisis on the venture capital industry has clearly taken place in the exit markets. The inability of our strongest companies to go public and the softening of acquisitions activity continue to have a major ripple effect that now reaches every stage of the venture investment lifecycle. As a result, new investments and fundraising will slow considerably in 2009 until the exit markets re-open and the pipeline is cleared. The venture community is poised and ready to bring the next generation of great companies to the capital markets and strategic buyers and, as we have done historically, contribute substantially to economic growth and innovation.”

The venture capital model is based on exits north of $100 million and over 300% return. Now that the exit pool is dry, I see a real opportunity for VCs willing to take the risks and diversify. Remember all those entrepreneurs with great idea that you previously called a ‘feature’ or a gimmick? Now would be a good time to pick up the phone and call them over for a chat.

As can be seen in this Google Insights for Search query, global interest in venture capital online is hitting new lows. So how can the VCs make themselevs relevant again?

venture-capital

“The next big idea is being venture-backed, today”

1. Invest early

People say that in times like this, one has to switch the word ‘crisis’ with ‘opportunity’. In my opinion, looking through the opportunity lense opens up a few options. Rather than sticking to the same old principles and assumptions, VCs should invest light, invest early, and look for small exits in the range of $20-$50 million.  Look at TechCrunch’s web tablet, which received a lot of buzz yesterday. TechCrunch is by all means not an electronics manufacturer, but they had an idea, they executed on a prototype, and many large electronic manufacturers would be very happy to buy the technology early on.

2. Build the team

A friend of mine who runs a successful venture back software company, said that his favorite side effect of the recession is the ability to get talent for cheap.  VCs have a unique opportunity to act as headhunters. Rather than turning away a good idea with a poor/inexperienced team, VCs can invest in the idea and build the company themseleves. VCs have access to jobs accross their portfolio companies, and bringing in their own people to the company increases their control over the investment. I know this is being done by Sequoia, but other VCs should embrace the model as well. A first step could be the “Venture Backed Job Board” for those who lost their jobs in the recent layoffs wave.

3. Mashup Services

A strong synergy is one that produces better results than the sum of its individuals. VCs should not wait for their companies to do biz dev – they need to open their contact list and ‘mary’ companies together. For example, an analytics company can probably benefit from relationships with ISPs (similar to the Hitwise model). If they are not local, chances are that the process is going to be long and painful. VCs should learn from Angels like Yossi Vardi, who walks around conference floors with a trail of 20 entrepreneurs (you can watch this live next week  at DLD in Munich), who get introduced to executives in big companies. It’s a win-win for Vardi, the start up and the big company looking for innovative ideas. That’s a synergy. How many venture backed entrepreneurs can say the same thing about their VC?

It is projected that 30% of the hedge funds will not survive the current economic crisis. That is probably a good thing. What would happen is 30% of the VCs closed their doors?

Eze Vidra
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Eze Vidra

Chief Innovation Officer at Antidote
Eze is the Chief Innovation Officer at Antidote, a startup helping patients search and match to clinical trial, to accelerate medical breakthroughs. Previously, Ezewas a General Partner at Google Ventures Europe. Before GV, Eze founded and led Campus London, Google's first physical hub for startups, and was the Head 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.
Eze Vidra
Follow me

Eze Vidra

Eze is the Chief Innovation Officer at Antidote, a startup helping patients search and match to clinical trial, to accelerate medical breakthroughs. Previously, Eze was a General Partner at Google Ventures Europe. Before GV, Eze founded and led Campus London, Google's first physical hub for startups, and was the Head 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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