Posted by The Founding Member on 2009-07-22
A lot of changes are in-store for venture capitalists in the second half of 2009, and recent data published by the National Venture Capital Association shows concerning trends. Venture capital firms raised a meager $1.7 billion in the second quarter of 2009, almost six times less than the $9.2 billion raised in same quarter last year. Meanwhile, firms invested $3.6 billion in Q2 ‘09, more than twice as much as they were able to bring in. With more money going out than coming in, here are some predictions for the coming months.
To start with, the number of “Hail Mary” investments into under-performing startups will decline further throughout 2009. The number of later stage financings has already dropped precipitously from 661 in Q2 ’08 to 379 in Q2 ’09. Capital for later stage deals is now being reserved for the best performing businesses.
Any company with “hockey stick” growth will be able to raise historically large amounts of capital in the second half of 2009. Deals for $100 million or more will have company-friendly terms and nine- or 10-digit valuations. Managers and employees will take millions off the table in private transactions. The $100 million purchase of Facebook common stock by the Russian firm, DST, serves as just one example.
Venture capitalists have started pumping their remaining capital into hundreds of seed and early stage deals, looking for the next big thing. Dollars invested in these opportunities have already jumped from $893 MM to $1.49 billion between Q1 and Q2 of 2009, and there will be more increases in both Q3 and Q4.
Early stage companies have strong prospects of raising significant capital in a “make it or break it” round. Venture capitalists are offering more cash up-front with fewer chances for follow-on investments. The average early stage deal size jumped from $4.1 million to $5.6 million in the first two quarters of 2009, and this number should increase to around $6 million for the remainder of the year.
If a funded company needs more money without achieving significant market traction, the remainder of 2009 will be difficult. More than 50 percent of venture capital portfolio companies will be left with insufficient capital to operate. Many of these companies will be gutted and put into “life support” mode or sold off to competitors for stock, allowing venture capital firms to maintain inflated portfolio valuations. Any acquisitions that generate precious cash will get pushed through at historically low returns of less than 2x, like the recent story of Mochi Media.
The government will likely bail out some of these companies and the venture firms behind them in the second half of the year. The Small Business Administration is considering policy changes that would allow $2.2 billion of liberal government dollars to prop up portfolio valuations.
But that government money comes at a price. Large limited partners in venture funds, many of which are government affiliated like CALPERS, are starting to complain about the 2 percent management fees and 20 percent carry (the share of profits received by VC partners) that firms earn, so, like the big banks, venture capitalist pay cuts are on the horizon in 2009.
Given many of the challenges facing the venture capital industry, there has already been a brain drain. Just over 10 percent of the top 2,000 venture capitalists rated on TheFunded.com have quit according to auto responder messages on a recent mailing. By the end of 2009, at least a third of the top VCs from the previous generation of funds will have left the industry.
The number of firms started by “new managers” approached a 10-year high in Q2 ‘09. For the most part, these funds are started by entrepreneurs looking to bring about change, like the recent $300 million fund by Marc Andreessen and Ben Horowitz, or the fund announced yesterday by Michael Birch of Bebo.
Change is in the air, and TheFunded.com will chronicle changes through the "roundup" updates.PRIVATE: Members Only