Deloitte Event: The State of the VC Market

Deloitte Event: The State of the VC Market

I attended, and captured the content of, a Deloitte panel featuring:

  1. Scott Frederick of Valhalla Partners
  2. Steve Frederick of Grotech Ventures
  3. John Backus of New Atlantic Ventures
  4. Sever Totia of the Edison Venture Fund

It was a very candid discussion of the state of the VC market, attended by about 30 c-level executives.  Here is a PDF of the brochure.

Transcription of Event:

Good morning everybody. Let's get started. It's always a good sign when we have good networking and conversation to get everybody in the room. For those of you who don't know me, I'm Chuck Carr. I'm a partner here at Deloitte and on behalf of Deloitte and all of our tech venture center sponsors, welcome here this morning. I think we have another, hopefully, good event again for you this morning, hopefully very interactive. As you know we have four very well known local venture capitalists here today, John Backus from New Atlantic Ventures, Scott Frederick from Valhalla, Steve Frederick from Grotech and Server Totia from Edison Venture Fund. We purposely picked each of these for funds that basically are active right now in the market still out there looking, investing. What were going to ask each of them today is just to introduce themselves, tell a little bit about their funds and give you a little about of an idea of what they're seeing out there in the market at this point in time. As usual we expect a lot of interaction. It's fairly small group; as you know we welcome questions and there will be plenty of opportunity for that. Without any further delay, I'd like to start with John.

Sure. Well we were just talking before everyone sat down and I think we concluded that this will be a really strange panel because half the people in the room here could be on the panel instead of us. Since I think between us we probably know about everyone here were not going to be able to BS people were going to give you real answers and stuff.

That's not going to stop us from trying.

You'll probably catch us on it. I'll just going to spend two minutes and probably answer the question that is on most people's minds which is are we active in the market. I actually wrote a blog post on this. You can go to our website which is We have a blog which we update pretty frequently. One of the ones which I did last week was called "Are You Meeting Me for Dough or Are You Meeting for Show?" sort of trying to find out if your venture fund actually has money or not. I used some tips to figure that out so I'll let you go there to figure out what those are. I'll tell you that in the last 18 months we have made 9 investments; we made 6 investments last year so 3 investments so far this year. We are on pace to make one every other month so about 6 every year. Our fund is new; we call about 16% of capital. We made about 9 of what will probably be about 22 investments. So just to give a broad overview, I put categories down. We did two companies in the digital media space, Stitcher and TV Networks, one in the broad advertising space called Ponteflex, 3 in the social community space Fashionplace, [...] and empower player, 2 in what I'll call broad technology space, Cure Command and gaterocket, and 1 that's missed every one of the things that we looked for and everything were not supposed to do in the healthcare services space called Cuelines. So were active and we think it's a great time to be starting a company if you can get funded a lot of other people aren't so you have a bit of a competitive edge if you can get out and get funded.

Okay, I'm Scott Frederick at Valhalla and it says here john speaks and actually we're very similar in terms of where we are in terms our funds and in terms of our pace of investments. Valhalla for those of you who don't know us, we have about 450 million under management, were currently investing in our 2nd fund which is a 275 million dollar fund. Were about a third of the way invested in that so maybe a little bit more than New Atlantic so it puts us in kind of a perfect position given the environment because we have a lot of dry powder left. I think we have done 9 investments out of fund 2 and you know we'll generally try to get 20 to 25 in a fund so as I said we have a lot of dry powder. Our investment pace, we've historically done 6 to 8 deals a year and were right on that pace. We've done 2 so far this year. We have one right now coming up for partnership meeting in the next 24 hours. I'll let you know how that goes. I agree with John. It's actually a great time to be investing. For the entrepreneurs it's a little bit difficult for the reason John said. It's tough to separate the check writers from the tire kickers and it's absolutely imperative that you do that because otherwise you can waste a lot of time. I'm helping one of my portfolio companies raise money right now. It is easy to get meetings. We probably have 22 meetings on the west coast. When I reviewed the list I think there are probably 5 of those that are actively writing checks. So it's tough. Use your advisors. Get the advice and ask tough questions. We'll have to go to your blog. But the obvious questions is when's the last investment you made because a lot of people are sitting on their checkbooks.

Hi I'm Steve Frederick-Scott's cousin (laughter). I'm with Grotech ventures. We too have been active here in this market. We've done 3 investments thus far this year, 7 last year. On a similar pace of about one every other month. Our typical investment tends to be half a million to 5 million initially with more set aside for follow on. Just to echo some of what's been shared, I think it's a really really good time to put new money to work. I have not seen evaluations for later stage companies as attractive as they are now in my decade in this business. I think earlier stage companies have a bounded range that you can't get much below but for companies that are a little later in life it's a pretty good time to put your money to work out there. I will say that getting in around close is taking longer and longer and longer so even for the 3 deals we've done this year it's taken 6 months from initial meeting to final close to get across the finish line. We've done deals in the IT security space and the compliance space and the digital meeting space and social networking space here most recently.

Hi, Sever Totia with Edison ventures. We're investing our 6th fund it's a 260 million dollar fund. We also remain very active with tenure investments in 2008. 3 in the first quarter this year and we're probably looking to make another 5 or 6 investments between now and the end of the year. Across our 3 core geographies, which are here, New York/New Jersey and Boston. I think everybody at this table invests over 5 to 7 or maybe 8 year outlook so most entrepreneurs ask how's the current environment affecting it and the answer is that the current environment is really affecting investments we made 5 or 7 years ago and that has very little to do with what is going to do with our current investments 5 or 7 years out. So that's the strategy. We do see activity in a lot of interesting sectors: digital media, enterprise software, healthcare IT. We invest about 15% of our fund in education and education technology. That's been a market that's been very strong and we're -knock on wood-thankful that were in it. We've got exposure to it. Our special will last about 12 to 18 months. I guess I'll stop there.

Namely just broadly, from your perspective, what's hot and what's not at this point in time?

Traction, revenue, (laughter). You mean beyond that? What's not hot are capital intensive projects. I'm involved in a storage deal that was white hot for the first 4 or 5 years that we were investing in it. We've got a great syndicate. For a while we had a million dollar a month burn. For the early stage startups in this room that price sounds outrageous. When you're trying to build a big revolutionary database storage appliance its actually on the small side and those projects are very hard to finance cause you go out to a new syndicate and they're trying to do that math and they're saying how much can we accomplish on ten, 15, 20 million dollars. But if you're burning a million dollars a month and you don't have the kind of visibility on the top line in this environment, it gets really tough. Capital efficiency is key. Obviously, traction. Digital media is hot. Healthcare IT is real hot and I think as Sever said, education is hot. We probably see less deal flow there but it's certainly a hot sector.

Mobility on the front has become, specifically enterprise mobility-consumer mobility has been around for a while and has been driving a lot of growth-but more importantly enterprise mobility is coming to its own. I've seen at least 3 or 4 false starts in enterprise mobility over the last 10 years. Now I think the stars are aligned for enterprise mobility to actually happen in a nice way to make investments there.

I would just add that there are only 2 types of companies being funded. There are a lot of companies that are almost cash flow positive that are a little later in life that need a little more money for an insurance policy if nothing else. Those companies can raise money right? Maybe not at super high evaluations but they can raise money in this climate. Then there are companies that are early; they're still working out the technology. They don't yet have a sales marketing spin that's tremendous so they get very modest burns and those can be really good bets because coming out of this downturn those can be places that are poised to really take off in a big way. My fear, my observation is that back when all the fireworks went off back in the fall we all proactively funded our companies for the next 12 months to make sure we had enough firepower to get us through the fog. Well the fog hasn't yet cleared and most of us, a lot of folks, are on the sidelines. There aren't a lot of people writing checks. I have this belief that in Q4 of this year and Q1 of next year there are going to be a lot companies out trying to raise money. Unless their existing investors are compelled to finance those going forward, I think there are a lot of companies deciding to shut their doors going forward into Q4, Q1 and Q2 as we go into 2010.

I would add that if you have raised a lot of money in the past and don't have a lot to show for it you are really hurting. If you go out there and you try to raise money and raise a bunch and haven't done much with it you're going to have a hell of a time. If you think a continuum where one end of the spectrum is what I'll call the fairy dust where great ideas and you can get everyone excited about it, you can probably find some early stage investors many of us who might buy into the idea then what happens is a harsh slide of reality comes. You start executing the numbers don't come through and you hit this sort of valley. Until you climb out of the valley and actually have numbers, revenue, customers showing, these two ends are getting funded but if you're in hear where you've raised money you've seen around and been around and you've struggled and you're struggling all of a sudden were not going to buy the fairy dust and were going to look at the numbers and say the idea sounds good but it's not working; the numbers aren't very good. Let's give it more time. You really have to be at either end of the dumbbell.

Very well said. For those of you who know, the Gardner height curve, that's the trough of disillusionment. For an entrepreneur that's a lousy place to be. The humbling reality is that we're all in those deals too.

Back to John's point, were generally investing for the last 15 to 20 years. All our investments are, 9 out of 10 investments, are doing 4 or 5 million dollars in revenue or more. And even that end up in between milestones where they're trying to go for 5 to 10 or from 10 to 15 but they hit potholes on the way there. That's when you've got to double down and get through.

How do you compare the environment here in this area or even east coast versus the west coast at this point in time, climate wise? Are we in better shape?

You know it's sunnier over there.

I would say we invest mostly up and down the east coast but of the last 9 deals we've done 3 here, 1 in New York, 2 in Boston and 3 on the west coast. We've looked at all the different markets and we've put money to work in all of them. One say the funds here have done a lot better than Boston and silicon valley is that we haven't been raising a funds every 12 or 18 months so a lot of the valley funds got caught with pants down because they raised a fund, they invested it like a bat out of hell and all of a sudden last fall hit and they're sitting there with 18 companies in the portfolio and they want 20 or 22 and they have to reallocate all the money they have left in the reserves. Scott made a point that they have 20 some meetings with companies out west but maybe 5 of those have capital. That's pretty real. If I look at the venture investors in greater Washington area, I think a higher percentage of us have capital to invest relative to Silicon Valley. Boston is somewhere in between.

I agree with that position on the spectrum. I think the west coast was particularly hit, as john said. On average, they hold a lot more board seat. A lot of that is part of their model. They tend to do investments a lot quicker. Everyone's focused on the lack of the exit window and people said well its obvious what the ramifications are for venture firms IIR. If you're holding a company that much longer. The second order effect is think about what it does to board seat load. If you have a GP that's doing 3 to 5 deals individually a year and they're use to rotating off of those on a 2 to 3 year clip and suddenly they're on those board seats for 8 or 9 years, that math creates a world of hurt. I have a lot of firms for the west coast that are sitting on boards of companies that they invested in '98 or '99. That math doesn't work for our business. I think Silicon Valley got hurt a little more on that. I also think as john said, reserve management. I think east coast firms tend to be a little bit more processed oriented. Valhalla probably on the far end of that. Were very processed oriented. I think that really helps. We take reserve management very very seriously. For those of you who don't know what that means, it's basically the art and science of managing the very last dollar in a fund. A lot of people are just too rough math saying we want to target 20 investments but if you're not looking at each and every one of those companies and having a very good idea of what the future cash flow needs of those businesses are, you are a world of hurting in this environment. In a tough situation where you have to pick between your children and that's what a lot of the valley firms are in right now. Edicts are coming down from the Monday partner meetings saying everybody gets to support 2/3 of their companies. Tell us next week who's getting a bullet. It's bizarre stuff like that. I don't think you're seeing that nearly as much on the east coast. I also think the west coast is more exposed in terms of where they get their money. A lot of their money was more heavily oriented toward endowments and universities and those LPs are a little more upside down than fund of funds and pension funds which are where were headed so they're a little bit more exposed also to LP falls.

All that said which I agree with I think Silicon Valley is the most optimistic place in the valley. Hope springs eternal in a significant way and the aggregate there's still more money out there. There are companies I know of locally that are being funded by firms on the west coast still. That's countered with we don't invest on the west coast so when I get calls from my buddies in California saying we've got a great deal on California we really want someone anchored around the beltway who can help with, then you know they're on their last leg. So that's happened more frequently.

They want access to Obama.

It's a good spin.

We also invest primarily on the east coast: Maine to Florida. Primarily in the DC, Philadelphia, NY and Boston metro areas. We've seen as everyone recognizes a big down draft not only the number of venture firms that are active. It's a long term cycle because most venture firms are on a 10 year fund cycle and so we've seen a drop off after the first. I think the second shoe is going to 2009, 2010, 2011 on those funds. Funds that are managing existing portfolio companies, not making new investments, are going to stop. That's what's going to be the 2nd reality of what the venture world is headed. It remains to be seen whether is 600 funds left or 400 funds of 700 funds or however many there will be over the next 10 years.

When you're contracting in a positive number I am seeing more venture activities in New York. Some Boston firms are putting people full time in New York and even some west coast firms. So I'm seeing a lot of activity there.

On the positive front, we have 62 companies in our portfolio and exposure in all different sectors. So for example we saw companies that had exposure to the retail logistics sector had a lot of hurt last summer now the growth rates are coming back. We have about 25% of our fund invested in companies that deal with financial services and financial technologies. We saw that curl last summer in Q3. Now that there is stabilization there for sure and growth rates are starting to come up. There's a business cycle that some of our companies entered that are seeing uptake back up. Of course, healthcare IT and education powered through all that. Those are great signs to see as the business cycle comes out of the fog as, Steve said.

I think there are some signs of hope out there. It's a real economic headwind. Our firm like many, our CFO likes to look at these companies separate from the color that we as general partners add as part of their progress. Every quarter we look at companies ranked on performance, that plan, quarter over quarter financial growth, year over year growth. Not every company is continuing to grow in this environment. There are a lot of companies and sectors that are continuing to beat their plans and continuing to grow. As a new investor looking at new opportunity I think this market really does a lot of your work for you. You look at the wealth of opportunities out there in which to put money in. The market is sending very decisive signals saying these guys have traction and these folks don't. I think there's never been an easier time to determine which companies are attractive then there is right now.

If you do the math on this panel, we all sort of talked about what we've invested in and what we're looking for to invest in, this small of a group of 4 peoples is probably going to do another dozen deals this year, in the second half of the year. None of us do a heck of a lot of a lot in July and August so that means that were looking at a pretty active labor day on.

So you take off two months?


What are your views on the active environment? Maybe not just right now but maybe in the future? When do you see it coming back and is it going to be an M&A? Do you think there's an ideal market that will begin to open up at some point in the future? What types of companies and talk just a little bit about that.

I think we're going to net, return to the mean of history. If you look at 20 years or 30 years or 40 years venture capital, 85% of that is M&A exits and 15% are IPL and I think we're going to return to that kind of model over time not in 6 to 12 months but over time. At Edison we have a 20 year history so we've seen 87 unmade transactions and we've been lucky enough to see 14 IPLs. That's kind of the model that we hope to get back to in the next 3 or 4 years. If we don't get back to that model there are a lot bigger problems in the world to worry about but I think were headed back there now. In the M&A front, we've certainly seen some of the strategics come back more in the last 6 months than the prior 6 months. They can certainly get their house in order. Unlike the last bobble, this time around the business sector is actually in better shape. Last time the business sector was overinvested and went through a massive retraction. This time around it was the consumer. Companies that are buyers of our portfolio companies are in better shape overall but there are fewer of them. That plays a role. On the IPL front, you've seen the market open up a little bit here with the number of successful IPOs in the last 30 or 60 days. I think that there's no shortage of real demand from small cap growth public company investors. They're looking for growth and that's the issue. Where are they going to find growth companies other than the ones that come out of our venture cycle? In the public market were talking about single digits, low single digits to high single digits growth rates, for anybody that's over a billion dollar market cap. As the markets pick up we'll see more IPOs.

I do think the next 3 or 4 years are going to be challenging. The IPO market, for all the reasons everyone's read about, is highly stressed for venture backed companies and while M&A activity may, the hard numbers continue or at least they did until September of last year, those folks are looking to be opportunistic too. If you were on corporate development for Amazon, the world is your oyster. You can buy companies for fractions for what you could buy them a year ago. The only way we all make a lot of money is when people overpay or pay a premium for growth. In order to pay a premium for growth you have to have a currency in your market, your security has to be valued at a premium in order to part with a premium until the markets returns to a robust top of the cycle which we can all take our guesses at how long that takes but it's not happening tomorrow.

I think over the next couple of years M&A is going to dominate. I don't think anyone here will disagree with that. I think we're actually going to see a real spike in M&A in the next 6, 9, 12 months. The big question is going to be whether it will be financial buys or strategic buys. Like Steve said, there will be a whole lot of companies running out of cash. Some of those will be force sales. What does that mean for us as investors? Obviously we look for companies that can be stand alone successes but it also puts it's a real premium on, I look for differentiative technology that can look attractive to multiple strategic buyers. To Steve's point, what hurts in our business, if you're looking to sell to a financial buyer and, literally just wrote this in one of our newsletters, you're basically selling at the exact same multiple that were likely to interact. If that's the case, the only return from the VC fund is the inherent growth of the company, the organic growth. That's tough to make a lot of money. It doesn't protect you from losses. The venture business has historically been about big wins that more than make up the losses at least in the early states. What we're looking for are the big strategic exits. In the IPL markets its tough to figure. We're looking at open table success, log me in this week looks like it's going to be very successful. It's not big volumes but the numbers are very good. Those stocks are popping.

For companies with meaningful revenue on a significant scale which is the way it should be perhaps but not necessarily the way it was.

Not necessarily a lot of proven profitability of an open table on the margin there. I'm having trouble figuring out the public market. The ones that are getting out seem to be well received. If I had a fear systemically, I really miss the olden days with all the boutique investment banks, I worry as you get concentration of investment banking but also concentration in the mutual fund business. It's the exact same dynamic that's hurting angel investing for entrepreneurs. Where the venture firms get too big they can't write the small checks for the angel investments. Same thing happens on the IPO side. I argue that a software company shouldn't go public and raise more than 50 or 60 million dollars. What are you going to do with more than that? The problem is to go public with that sort of flow. The mutual funds just can't weigh in. Bill Miller can't touch it until you end up with this weird gap in the ecosystem so if I had a systemic fear, it's that something needs to happen there to return to the IPL heyday.

I think Scott's idea to identified what I think is the biggest problem in the IPL market which is a structural problem. If you go back to the 80s, we had Montgomery Securities, Roberts and Stevens, these guys were out there taking companies public, raising 10 or 15 million dollars. You go back to Apple, Microsoft, sun, big names; they raised 10 or 15 million. They didn't raise 50 or 100 million dollars. That market is dead right now. Goldman Sacks, Morgan Stanley, and all those people aren't going to go out and under ride IPOs there going to raise 15 or 20 million dollars and that next tier just isn't there. There are a lot of efforts that are trying to be hatched right now whether companies are going public overseas and then come back over a year whether there's talk right now of some private equity exchange or a qualified purchase for alternative market where you don't have to go through SEC registration and basically trade and sell securities to people who are qualified purchasers who meet a higher standards. So there are a lot of talk about all the ways of achieving. My opinion is that unless we fix the structural problems and go back and have more boutique investment banks and more boutique mutual funds that aren't going to demand to have 15 million dollar in a company that's just not going to change. On the M&A side, M&A is not broken. It's cyclical. In a good economy, companies buy technologies. Big companies are inherently bad at innovating. There are a couple of outliers out there that are good examples of innovators like 3m but most are generally bad. Some companies like SYSCO get it. Their R&D strategy is an M&A strategy. And they say were going to consciously spend a certain amount every year to buy companies. What happens in an economic downturn, the first thing a CFO looks at is what are my discretionary expenses? Marketing, R&D. and they cut them back. In an upturn, companies make up for what they've caught and they buy companies so I agree with everyone else up here which is when the economy turns you're going to see is a buying spree of interesting technology companies that are IT based. People are going to make up for what they didn't do in the last couple of years.

Any questions from the audience?

[Some question]

It depends. Scott said if it's a financial buyer, its someone's just trying to earn to their customer base, you're going to get kind of a crappy multiple. You're not in the fairy dust quadrant you're in the revenue and earnings quadrant and big companies are generally going to want to do an accretive transaction if they can. And they're not going to look great. They're going to be something less than the company's E less than 25. That means you have ten E to get there and if you don't have the E for the financial buyer you're not going to get hell of a lot. For the IT buyer, it really depends on how many people want the technology at that point. There is a real interesting analysis that is very dated that I saw about 20 years ago. The Solomon brothers did it. It basically looked at the best time to sell a company in a buying frenzy or when there is industry consolidation. It basically said you don't want to be the first to sell your company but you don't want to be the last. Because there's a finite universe of buyers you want to be sort of the 2nd 3rd or 4th cause that's when the premiums go up. When someone buys the first company no one's set the market price. The second and third companies are saying the damn I got to get me one of these! So the 2nd 3rd and 4th ones get up and at some point most everyone has a seat at the table and if you're still out there holding out there for the last, best and highest dollar odds are you're going to end up competing with those big player instead of getting the highest price.

One interesting dynamic, and John's exactly right on with the E part, most acquires want something to be accretive. The nice thing about a strategic acquisition, one of the fascinating dynamics, is how big the big buyers have gotten. Look at the concentrated cash positions of a Microsoft, a SYSCO, a Dell. Dell just announced a billion dollar bond offering in this credit market to get more cash to do more acquisitions. That's pretty exciting. They want to aggressively grow. But those companies are all so big that they can actually with some smaller companies paying very big multiples can basically pay for with it with stock gains on the announcement. It all comes down to how sexy or strategic it is. But if you look at what happened with data domain, both EMC and NetAperna, kind of a big word for that property, I believe when NetAp raised their bid, their stock went up to more than make up for the dealt because the streets say, hey this is great. It's aggressive. They're going to grow big. They're just small little stock moves make financing even a 500 million billion dollar purchase relatively easy. So that's going to be our bread and butter. In a weird way, and were making a real effort at Valhalla to get to know those corporate customers much better, were reaching out to the corporate big heads, Sysco, Intel, Microsoft, Google. That's where we're going to be selling most of our companies. That's where the dollars are.

I actually think the Darwinian shakeout is in the midst of occurring across all the thousands of companies that we've funded for a long long time. It's going to bode well for companies that get past that on the M&A front. If you're a corporate buyer, first you say, hey is this something I need? Are my customers asking for it? Are my strategic engineering teams telling me I need it? And then you debate do I need to build it or do I need to buy it? If you conclude that you have to buy it, how many places are there that I can buy it from? If I'm SYSCO or IBM I don't have to buy the number one vendor from any sector if there's a price premium. I can buy the number two potentially and make that number two the number one, depending on what the gap is. Right now, to folks in our business, there are a dozen if not 5 dozen companies in any given sector that are compelling and so the buyers are sort of a big platter of a of smorgasbord options. If we know that cradle it bodes better for the few that are left.

I agree with all the comments here I just want to add that one of the important factors in an M&A cycle is the buyers business case cause they have to go up to the CFO, the CO, they have to make a business case for what they're about to buy. That has to do with taking what they're about to buy and putting it in their sales channel and how much revenue is that going to generate over X number of years. In addition to multiples and strategic values and scarcity, a business case is something that you as a small company and us as investors have to understand way before we get down the pike in the sale cycle. I've found that to be a very big driver. Speaking the same language on that front about the business case. On IBMs sales channel its showing them how they can generate 150 million dollars or 300 million dollars or 500 million dollars of revenue from their side of the table which can potentially move the needle on their multibillion dollar needs. That's a very worthwhile conversation that I've seen change the pace of an M&A transaction.

To give a concrete example story that I'm surprised didn't get more attention locally is the Clear Standards acquisition that was issued. I don't want to say numbers but it treated the entrepreneurs and the investors very very well and the lessons there were they were very capital efficient. These were some product development guys that knew how to build software. They got out in front of a very sexy market and a carbon energy trading management. It got a product out there. I think they closed that deal in something like 45 days since the first meeting with SAP. It was just stunning. They sold an enormous multiple. SAP can basically, I don't want to belittle the technology, in some ways it's an inexpensive PR move by SAP. They are so big to get out in front of a green initiative and just buy it and claim that they own the space relative to Oracle learning or any of the competitors. That's the math they're doing. This is relatively cheap PR that they're doing but it made a very nice venture return and it made some entrepreneurs a lot of money. It's a great story.

My question is about your relationship with the testing markets. I was talking to a major of a hedge fund and they were talking and admitted to me that for the first time in the [...]

I'll take a crack at that one. It's something we all thought about for a moment in time and always somewhat since then too. At some point in the 6 to 9 months we all kind of tested the waters did a capital call and asked do we have a problem in our portfolio, asked some of the secondary funds. The problem with most institutional LPs they have liquidity issuses, not asset issues. Meaning their portfolio values gone down, they're not getting distributions, they don't have any cash. The issue is a hell of a lot bigger with private equity funds, with buy-out funds, than with venture funds. Were all a couple hundred million dollar funds or lower up here. Were not a fifteen million dollar buyout fund where they have a 10% buyout they've got at least a billion and half dollar commitment to one of our funds they have 10, 15, 20 million dollar commitment. There are institutions out there that have issues. What's different from our perspective as what should be encouraging from your perspective as entrepreneurs, there is now a somewhat efficient secondary market out there. If an endowment has a 10 million dollar investment or fund, and says I can't make the capital call, the penalty from not making it from our funds is basically you're screwed. You're going to give up everything you've put into the fund and walk away from it maybe a little bit better but that's about it. They look at that and say well I can either have zero or sell it on the secondary market and pricing out there sucks on the secondary market but at least I can get something. But at least there is some currency value out there. The few people that actually have liquidity issues can find a buyer last resort. Most of those issues that we've seen indirectly have been companies like Washington Mutual, companies got bought by someone then the acquirer killed the programs.

Definitely a bigger problem for the buyout fronts. The scale is that much bigger.

[audience question] In the old days the argument would be that the investors in the entrepreneur. The entrepreneur only needs a million [...]

From my perspective the advice I've always given entrepreneurs is that at any moment in time you're raising money for the next 18 to 24 months. It may be a million dollars or 4 million dollars. Sit down and figure out your plan: the milestones you need to achieve, and then the finance way there but never raise less than 18 months or so cause if you have less time then you have a higher probability of being in death between milestones. It varies company by company.

I would add that I think you're seeing a whole lot less of people throwing money at opportunities because money is scarcer now. I think you're seeing when folks form syndicates to invest they try to get enough money around the tables in the form of a few deep pockets so that if necessary they can fund that thing all the way to cash flow positive because in today's world the model of you make progress then you go out and someone pays you a step up is in question so you've got to have the world to fund it all the way. There's entrepreneur on that front because if ever your investors are reasonable on that value you can always go out and test the market when you have a plan b in case that's not realistic.

I think you're staging is more likely in much younger companies. If a company has revenue and earnings then were not going to put in 6 months of cash but if a product is pre-product release were not going to put in 3 years of cash and say good luck, were going to pull the reigns back a little. I think there's a lot more syndication going on right now. There are two companies that were interested in that we've got term sheets on that were looking for syndicate partners on. We said in our partnership that we don't want to go this long. We want to do this with a partner and we want to have 10 million dollars on the table between the two of us. We don't want to take external financial risks. If as Scott said the company is capital efficient we think that that initial investing syndicate would have a good chance in getting the company across the finish line. I think there's a higher bar right now investments to get a syndicate partner.

[audience question ...] I'm wondering if you could comment on that if you believe that [...]

Maybe it's cause they spend less time with the companies. (Laughter)

I have no idea.

I have seen that data cut both ways so I don't know. We look to do price 60% of our deals in the mid Atlantic. We only go out of region if it's in our wheelhouse so that might help explain why you could have out performance out of region. We have a very high bar to go out of region. Example we did the Left Hand Networks deal in Boulder. It treated us very well. It was a big sale. That's a storage play; we knew that market very well. That might be behind it. People have a higher bar out of region. I'm also skeptical of a lot of those studies that can have a loss small numbers problem, the data can be skewed by one or two deals. I'm much more comfortable closer to home. I do believe in the concept of value add. I believe in being in close touch with the entrepreneurs. Board meetings are consumed by corporate hygiene. If that's your only touch point with a company, it's hard to help. It's much more fun if I wanted to be a stock picker id go to a hedge fund the velocity of money is faster id be much richer. What's fun is to help build companies and I think that gets fun when you can have coffee together, you can go get drinks, you can think about what keeps you up at night. What gets you excited.

The flaw in the assertion in that study is that every deal that gets done has local investors. The local investors are often the first investors in a company. I think the better conclusion is that, and by definition is that they're making a bigger return than the out of town investors who invest in the 2nd or 3rd round, companies that raise money over time from geographically dispersed investors perhaps do better and have more liquidity cause they have more touch points, they have better connective tissue, or more relationships to leverage. That's the conclusion I would take.

Be careful confusing correlation with causation. They're not the same. As Scott said, well set the bar higher. If we're going to do a company in Austin Texas were going to say it better be a damn good investment. Steve, Scott, John, are you willing to spend three days a month in Austin?

Time for one more question.




Shouldn't we ask the entrepreneurs that question?

It's tough. The second quarter just ended so anybody on a normal calendar year is at that midpoint and a lot of companies set the bar too high on what they were shooting for in '09, there are a lot of difficult board level decisions. What do you do with a work force that is unlikely to earn their performance bonuses. The flip side of that is there are a lot of people that recognize that they're really thankful that they still have their jobs. There are a lot of companies that cut back significantly in Q4 of last year and Q1 of this year. Our hope is that our entrepreneurs are focused on the long term equity play and not the short term cash compensation. Those are all things that factor into the discussion. We only win if our entrepreneurs win. We need them locked in and happy. We try to find innovative ways to do that. From my experience the companies I've made the most money with are indemoniable entrepreneurs. They're going to win no matter what they make in the short term. There's just no stopping them from getting their baby to the big time. Those are the people we like to back. You see it in their eyes, it's contagious because you want to go to war with them.

I think where you see this called into question is when you have companies in that "plan A didn't work, I'm now at bat hard on plan b and maybe that's working but maybe not working I know this is a tough environment so what does the future hold" what happens there is that those teams naturally look to their investors to say hey! Give me an early read. Are you with me or am I floating on my own? If I'm floating on my own, I need to know that early so that I can address that with my team early. It's uncertainty that we as humans don't deal well with that. That can have a very negative slippery slope dynamic to it.

I agree with Scott's point on this. The great entrepreneurs are actually being aggressive in this timeframe. Their competitors are on their heels, the big guys are not investing in R&D properly, they're cutting back. They're being much more aggressive in the market. Accelerating whatever was working before to capture more market share, get more customers, etc.

One interesting twist here is that if you take it down a level from the executives, one of the things I'm dealing with one of my companies and it's fascinating. I don't know what the right answer is. It's a company that prided itself on an open management. Every number was disclosed through the rank and file monthly. They literally had discussions so that everyone understood the key operating metrics and really knew what was driving business. This is a company with a lot of industrial exposure, sold #D CAD software, so they were very well positioned but they were selling the general motors and ford so the last two quarters weren't particularly good. If you show that data every month to your rank and file, you've created some management issues where suddenly people are wandering in saying, "my cousin just got laid off at his company and I saw that we just missed by 40% what does that mean for me?" I don't know what the right answer is. If you were to ask me 6 to 9 months ago I was praising this team for such great open management.

There's also, what I've seen which I don't like, is an increasing bias during down times toward cash compensation. Cash is king. People devalue equity. I've looked at some people we've tried to hire recently from some companies and people willingly, enthusiastically, traded off equity for cash. There are also more people on the street which means you're not necessarily poaching but you've got a lot of people coming to you. It creates a management issue. If you post a job somewhere and you get hundreds or thousands of resumes and it's not necessarily the ones you want. From our perspective, when it comes to year end, and it comes to bonus time we look at, how did the company do versus its milestones and when you have a reset there's always the difficult conversation at the end of the year about does the reset count for bonus? If the companies not profitable, the bonus is not a bonus. It's a distribution of investor capital to the employees. Bonuses should really come out of profit. You have hard conversation that come throughout the year especially when you want to do a reset. People feel even after that reset that they're entitled to the cash bonuses. It presents some naughty issues.

Once again thank you to each of our panelists. It has been a great event with great information. Very interesting. On behalf of everyone here at the Tech Venture Center, I'd like to offer a token of our appreciation. Thank you all.