Professor Raiton’s Inside Perspectives: Entrepreneurship, Creativity, Innovation

By Tim Mullaney, Bloomberg.com

Venture capital investments will probably fall this year for the first time since 2003 as the financial crisis cripples the markets for acquisitions and initial public offerings.

U.S. startup funding may drop in the third quarter, said Tracy Lefteroff, a managing partner at PricewaterhouseCoopers LLP, which does consulting work for venture capital firms. In July, Lefteroff said investments in 2008 would be “on par” with the $30.7 billion invested last year.

Turmoil in the credit markets is making it more difficult for young companies to raise money as venture capital firms concentrate on existing investments instead of making new ones. The number of deals closing sank last month, and the aversion to risk is even spreading to clean-energy companies, one of Silicon Valley’s hottest sectors since 2006, said Greg Blonder, a partner at Morgenthaler Ventures.

“Everyone I know has had their come-to-Jesus partners meeting,” said Blonder, referring to sessions where people confront unpleasant truths. “This will create another hole in the market.”

A locked-up market for IPOs and a 30 percent drop in the average price acquirers pay for venture-backed companies are causing the most pain, said Geoff Yang, a founding partner of Redpoint Ventures in Menlo Park, California.

(Read More)

Tomio Geron writes this dispatch about the venture capitalists behind Bill Me Later. Geron is a reporter for VentureWire, a Dow Jones publication and contributor to Deal Journal.

Bill Me Later’s agreement to be acquired by eBay for $945 million in cash and options is the third-largest acquisition of a venture-backed company this year and looks to have earned its venture investors some sizable returns.

Bill Me Later’s first venture investor was Crosspoint Venture Partners, which in 2000 put $17 million into the company, a service that enables Web shoppers to extend payment for products for a fee. James Dorrian, a general partner at the firm, said the investment was “very successful,” especially given the tough environment at that time. “For anybody making any investment in early 2000, there was no exit strategy really,” Dorrian said. “You had to say, ‘Can this be a good company?’ And let the market take care of itself.”

Azure Capital Partners was Bill Me Later’s largest venture investor, first investing in the Timonium, Md., company at a valuation below $100 million, according to Mike Kwatinetz, general partner at Azure. Kwatinetz declined to specify his firm’s overall return, though the return from the initial investment would be at a multiple of about eight. Azure returned to invest in later rounds.

Later institutional investors included T. Rowe Price and Legg Mason, while strategic investors included Amazon.com, First Data and Chase Paymentech Solutions.

The third venture-capital firm to invest in Bill Me Later, GRP Partners, expects a return of five to six times its investment, according to Steve Lebow, managing partner and co-founder of GRP. “I loved the deal,” Lebow said. “(CEO) Gary Marino and his team are brilliant.” Bill Me Later was ahead of its time in figuring out how to quickly provide credit to consumers, he said. It just took time to build the company to where it is today, Lebow said.

Venture capitalists have endured a tough environment for exiting investments, with the industry on track for the lowest number of M&A deals involving venture-backed companies this decade. The only bigger venture-backed M&A deals this year were Dell’s purchase of EqualLogic in January for $1.4 billion and Sun Microsystems’ purchase of MySQL for $1 billion in February.

The National Venture Capital Association has produced its first online video.

The video spoofs the fund raising process, following the desperate protagonist to an Entrepreneurs Anonymous meeting. It might amuse those in Silicon Valley who recognize the deal makers who double as actors in the skit. (The cast includes people with Goodwin Proctor, Levensohn Venture Partners, Matrix Partners and Scale Venture Partners).

But it also serves the more serious purpose of educating the public about what exactly venture capital is, said Emily Mendell, the association’s vice president of strategic affairs.

(Read More and View the Video)

By CLAIRE CAIN MILLER, New York Times

From the day he founded Etsy in 2005, Rob Kalin refused to raise money from venture capital firms to expand his company, which hoped to bring the sale of handmade crafts from small local fairs to the international marketplace of the Web.

He met with several top firms, but they all wanted a 20 percent stake in his start-up company, and he was hesitant to give an investor that much. When one of his board members advised him to visit Fred Wilson at Union Square Ventures in 2006, he went grudgingly, certain the meeting would turn out like the others.

Instead, Mr. Kalin was impressed when Mr. Wilson said he would settle for less than 5 percent of the company in the first round of fund-raising.

Union Square Ventures has built its portfolio making small bets on young companies.

“We say, ‘Let’s go on this ride together,’ and if we do get great traction, we’ll try to invest in a second round as well,” said Brad Burnham, who co-founded the firm with Mr. Wilson.

(Read More)

Thinking startup? David S. Rose’s rapid-fire TED U talk on pitching to a venture capitalist tells you the 10 things you need to know — and prove to a VC — before you fire up your slideshow.

(View the Video)

With bubble-era venture funds getting ripe on the vine, more firms are looking to unload them to secondary firms.

Early-stage French venture firm Innovacom Gestion is the latest to do so, selling its stakes in 10 companies to Saints Capital for about $50 million.

Many venture firms have funds from 1998 to 2001 that need to be wrapped up by their 10-year timeframe. With the current weakness of both merger-and-acquisition and IPO opportunities making traditional venture exits difficult in the near term, some portfolio companies from the aging funds are still waiting for an exit - and limited partners are waiting for returns.

“If you go back to funds that are 10 years old now, you have essentially one in four companies that are still illiquid today,” said Ken Sawyer, managing director of Saints Capital.

The average time to liquidity for venture-backed start-ups used to be about four and a half years, but today is about seven, and in a couple of years likely will be closer to nine, Sawyer said. This makes the work of secondary firms more common in the industry.

Saints is buying out all of Innovacom’s interests in Actelis Networks Inc., Air2Web Inc., Aperto Networks Inc., Envivio Inc., Kirusa Inc., KXEN Inc., Netasq, Selligent SA and Xtime Inc., as well as a partial share of Witbe.Net.

Most of these are later-stage companies that were founded in the late 1990s. They cover Innovacom’s late-1990s focus in telecommunications equipment, semiconductors and software.

From Get Venture by Mark Davis

In my prior posts about the market for investable capital and the market for investments I described two markets in which VCs must operate.

While each market has independent forces that drive valuations, they are also interrelated. When you think about the market dynamics in the market for investments that drive fluctuations, it’s important to realize the role of the market for investable capital. VCs need to generate returns that are competitive with other alternative asset classes (e.g., hedge funds and leveraged buyout shops). In order to generate sufficient returns, they have a minimum threshold on the valuation that they can accept in their investments.

There are a few implications of this minimum.

• First, creating favorable negotiating dynamics can impact valuation, but only by so much.
• Second, the comment that VCs generally take too big a cut in a transaction reflects a lack of understanding of the underlying cost of capital - the next best option an institutional investor (who invests in VCs) has in the alternative asset class.

From Get Venture by Mark Davis

As I mentioned in my post, The Market For Venture Capital, there are two markets that exert pressure on VC return requirements.  The first market is the market for investable capital. The second market is the market for investments, where VCs jockey to get money into startups and vice versa.

One force in this market is simple supply and demand.  If there are lots of VCs bidding for a startup, the terms of the eventual investment are likely to be more favorable to the entrepreneur.  Similarly, if there is only one VC interested the terms are more likely to be favorable to the VC. 

Additionally, substitution plays an important role in this market.  If there are lots of great startups chasing a number of financiers, a VC may be able to get a better deal. 

Another way of looking at the market is the risk-return ratio.  Investing in startups is an inherently risky business, even for investors with a good eye.  There are lots of exogenous risks that might undercut a perfectly reasonable venture along the way.  Nothing shocking here - VCs need to own enough of the company to ensure that they are compensated for the risk they are taking - higher returns are required to offset the high risk of losing everything.

From Get Venture by Mark Davis

In my post, The Market For Venture Capital, I stated that the VC valuation market is a two sided market.  The first side of that market is the market for Investable Capital, referring to the market for capital that VCs need to raise in order to invest it in startups.  Venture Capitalists typically get their funding from institutions, such as pension funds and universities.  Like VCs these institutions create portfolios of investments, of which venture capital is often only one asset class.

These portfolios are typically divided into pools of capital that are allocated to traditional assets (e.g., public stocks and bonds) and alternative assets (e.g, hedge funds, leveraged buyout and venture capital).  While some institutions earmark portions of their portfolio for venture capital, many only decide what portion will be allocated to alternative assets, leaving the various types of alternative asset managers (e.g., hedge funds, leveraged buyout and venture capital) to duke it out for a share of the pie.

While institutions evaluate alternative asset managers based upon a number of criteria, returns not surprisingly play a key role in determining whether or not a manager gets the investment.  As a result, when VCs make their investments in their portfolio companies they are investing with an eye toward realizing the type of overall portfolio return that they need in order to generate competitive return that will enable them to raise their next funds.

In sum, the performance of other alternative asset classes and the return expectations of institutions in no small part drive VC return objectives.

From A Sack of Seattle 

The below is from the Nollenberger Capital Report

• This is the first time since 1978 that no venture-backed company made it public during a quarter. The last venture-backed IPO was ArcSight in February 2008. In the first half of 2008, there were only 5 IPOs that totaled $283 million. That compares to 43 IPOs during the first half of 2007 totaling $6.3 billion. During the first half of 2008, 42 companies were in registration for an IPO.
• For 2Q 2008, 50 M&A deals were announced involving venture-backed companies which totaled $2.4 billion. The first half of 2008 was the slowest first half M&A market since 2000 with only 142 deals. During the first half of 2008, there were 120 venture-backed M&A deals, compared to 169 during the first half of 2007 which amounted to $6 billion, compared to $8.5 billion in 2007, a 42% decline for investors.
• In the first half of 2008, U.S. venture firms raised $16.2 billion, a 5.41% increase over the same period in 2007. The $85.5 billion that LP’s invested into LBO funds was 20.5% below the $107.6 billion invested in the first half of 2007. This is the first time since 2003 that we have seen Y/Y fund raising decline as PE firms experienced capital raising delays for their latest buyout funds. 72 new venture capital funds raised money, 10 more than in the 2007 period. The largest raise was $800 million for Lightspeed Venture Partners VIII LP fund.