When Adeo Ressi opened up membership
in TheFunded.com after an
invite-only trial period, 1,000 entrepreneurs signed up to the venture capital
rating Web site on the first day.
The chance to spout off about
venture capital firms and their partners proved irresistible to startup
executives who routinely have to parade from one firm to the other, hat in
hand, asking for capital.
As personal experiences poured in
about broken promises, canceled meetings or ones that venture partners spent
checking BlackBerry messages while ignoring a presentation, Ressi saw
confirmation of his thesis for starting TheFunded.com. After three decades in
which venture firms held all the power in the fund raising game, the time had
come for a change.
“The VC industry is
broken,” according
to Ressi, who was once almost ousted by a board of directors he’d helped
recruit from a prior company he founded.
Ressi was referring specifically to
the dismissive way that many venture capital firms treat entrepreneurs seeking
funds.
But a growing pile of evidence
suggests that problems in the venture capital industry go beyond arrogance and
lousy communication skills.
The second quarter of 2008 was the
first in 30 years wherein not a single venture-backed company executed a successful
public stock offering. That’s zip. Nada. Not a single instance of the
most-profitable exit for VC firms.
The number and value of acquisitions
was also down significantly from the year before, according to the National
Venture Capital Association.
Worse still, venture firms are
facing more competition for early-stage investments from angel investors — and
from each other, as more VC money was raised in 2007 than at any time since the
bubble years. That’s driving up the price of equity.
Paying more up front, and getting
fewer big exits, is depressing fund returns, with the internal rates of return,
or IRR, of many funds, coming in negative in 2007, according to data reported
by the University of California last September. And things have only gotten worse
since then.
This comes as a growing number of
funds that were raised during the boom time of 1998-2000 are at or near the end
of their 10-year investment cycle.
And because many companies in those
portfolios that haven’t already been acquired, gone public or turned cash-flow
positive are going to need more money, venture firms will have to take out
loans to keep their funds going.
In a sign of how bad things have
become, the market for secondary loans and investments made to venture capital
funds and startup companies is booming.
“You’re starting to see a
contraction in the venture business,” says Nick Sturiale, a managing
director with the Carlyle Group, the global private investment firm that
manages $100 billion worth of companies and capital.
“I think you’re going to see a
lot of annex funds,” says Sturiale, raised by second- and third-tier firms
that are unable to raise new funds.
The key metric for the health of the
industry, according to Sturiale, is how many partners are receiving so-called
carry checks, which are paid out only after a fund makes enough profit to pay
out the firm’s limited partner investors.
“You probably have less than 30
guys who have gotten a carry check this year,” said Sturiale, formerly of
the venture firm Sevin Rosen Funds.
