the future of venture investments cycles, trends and opportunities

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  • Copyright President & Fellows of Harvard College

    Journey Conference

    October 25, 2012 Israel

    Felda Hardymon

    The Future of Venture Investments Cycles, Trends and Opportunities

  • VC is really an adolescent asset class Venture capital is still very young:

    Not recognized as a real asset class until 1978

    Venture capital is still very small:

    In largest market, U.S.:

    Only about 4000 professionals.

    Average of 1,500 companies funded for first time annually, 2000- 2008.

    Relative to 1 million businesses started annually.

    In Israel:

    Less than 250 professionals

    Less than 25 Series As each yearmany more seed deals

  • VC is really an adolescent asset class Venture capital is still very young:

    Not recognized as a real asset class until 1978

    Venture capital is still very small:

    In largest market, U.S.:

    Only about 4000 professionals.

    Average of 1,500 companies funded for first time annually, 2000- 2008.

    Relative to 1 million businesses started annually.

    In Israel:

    Less than 250 professionals

    Less than 25 Series As each yearmany more seed deals

    Whether or not you raise venture capital: if you are in high techthe health of the VC industry affects you

  • Venture capital has had a profound impact in the US economy 13% of all public firms at end of 2008.

    8% of market capitalization ($2.0 trillion).

    6% of total employees.

    Particularly true in high-technology industries.

    And over the past decade has become important globally

    Israel ahead of the curve on thisactive VC since mid-80s; a real industry in the early 90s

    VC responsible for bringing dozens of multi-nationals to Israel through M&A

  • Venture capital has had a profound impact in the US economy 13% of all public firms at end of 2008.

    8% of market capitalization ($2.0 trillion).

    6% of total employees.

    Particularly true in high-technology industries.

    And over the past decade has become important globally

    Israel ahead of the curve on thisactive VC since mid-80s; a real industry in the early 90s

    VC responsible for bringing dozens of multi-nationals to Israel through M&A

    VC is the oxygen for high tech innovation

  • Today The Theory The Reality Current State Starting a Company Now What Works

  • Venture Capital

    The Theory

  • Georges Doriots insight

    Worries about dangers of post-War stagnation in U.S. Current system did not work well: Limitations of banks, public markets. Need for new financial institution playing three roles: Sorting. Certifying. Governing.

  • What VCs Do Selection

    Pick which projects to back

    Driven by profit share self interest (carried interest)

    Credential

    Indicate to acquirers, banks, large customers, potential employees, etc that this is a substantive project

    Governance

    Regularly monitor progress at a meaningful level and effect changes if necessary

  • What VCs Do Selection

    Pick which projects to back

    Driven by profit share self interest (carried interest)

    Credential

    Indicate to acquirers, banks, large customers, potential employees, etc that this is a substantive project

    Governance

    Regularly monitor progress at a meaningful level and effect changes if necessary

    What VCs dont do

    Run Companies

  • Because of its structure, VC is a long latency business

    Blind pool

    May be a broad investment charter (healthcare vs. IT, start-up vs. growth equity, etc).

    Long lock-up

    10-15 years

    Long investment life

    Time to liquidity 5-10 years

    Apprenticeship

    15-20 years to know if a VC investor is any good

  • 13

    The Venture Capital Intermediary Chain

    Savers Gatekeepers (e.g., Fund of Funds)

    Venture Firms

    Portfolio Companies

    IPO

    3 10 Years 3 10 Years

    Fund Managers

    (e.g., Pension Funds)

  • 14

    The Venture Capital Intermediary Chain

    Savers Gatekeepers (e.g., Fund of Funds)

    Venture Firms

    Portfolio Companies

    IPO

    3 10 Years 3 10 Years

    Fund Managers

    (e.g., Pension Funds)

    Historically American and European; recently SWFs and Asia have become important. It is a longer chain for Israeli VCs.

  • VC Interim Performance is Hard to Measure

    Mark to market cannot be accurate

    Comparison based: But what are comps for new businesses?

    Interim financings often more affected by exogenous variables (fund cycle, buzz, speculation, etc) than by company performance

    Company progress often driven by a series of experiments and is inconsistent over time until established.

    VC fund performance quite dependent on liquidity environmentwhich varies greatly over time.

  • Venture Capital

    The Reality

  • Big Hits Drive VC Actual Performance

    It is a risky business

    Over half of VC investments do not return whats invested

    About 15% of VC investments drive all VC returns

    Great companies are started every year, BUT there are only a few and access is key

    Drives tiering of the business

    Exacerbates VC cycles

    Makes allocation of time more important than allocation of capital.

  • VC is Cyclical

    Greatly affected by IPO/M&A cycle

    First real measurement of VC fund performance

    Liquidity itself is a big indicator for raising a new fund

    Underlying start-up cycle

    Macro economics (recessions help!)

    Innovation cycles

    Role models

    Returns negatively effected by overfunding

    NOTE: Debt cycle is not a performance factor (does affect LP fundraising somewhat)

  • The VC industry underperforms when overfunded

    20 28

    18 9 10 9 13

    15 18 20 33 34 34

    52 56

    75 82 77

    14

    - 18 - 23 - 32 - 40

    - 20

    0

    20

    40

    60

    80

    100

    Strong Returns

    Bad Returns

    Firming Returns

    Good Returns

    Bad Returns

    LP R

    etur

    ns (

    %)

    Very Good Returns

    20 28

    18 9 10 9 13

    15 18 20 19 33 34 34

    52 56

    75 82 77

    14

    - 18 - 23 - 32 - 40

    - 20

    20

    40

    60

    80

    100

    Strong Returns

    Bad Returns

    Firming Returns

    Good Returns

    Bad Returns

    Source: Cambridge Associates

    1

    10

    100

    1,000

    10,000

    100,000

    1,000,000

    PC Boom Internet Boom

    Dol

    lars

    Com

    mit

    ted

    to

    US

    VC

    Fu

    nds

    ($M

    )

    70s 80s 90s 00s

  • U.S. fundraising and pooled IRR

    0

    20

    40

    60

    80

    100

    120

    140

    160

    180

    0.00

    5.00

    10.00

    15.00

    20.00

    25.00

    30.00

    1969

    -197

    5 19

    76-1

    979

    1980

    19

    81

    1982

    19

    83

    1984

    19

    85

    1986

    19

    87

    1988

    19

    89

    1990

    19

    91

    1992

    19

    93

    1994

    19

    95

    1996

    19

    97

    1998

    19

    99

    2000

    20

    01

    2002

    20

    03

    2004

    20

    05

    Fund

    s (20

    02 $

    B)

    IRR

    (%)

    Pooled IRR

    Funds Raised

    Source: HBS databases and Thomson Reuters.

  • U.S. fundraising and pooled IRR

    0

    20

    40

    60

    80

    100

    120

    140

    160

    180

    0.00

    5.00

    10.00

    15.00

    20.00

    25.00

    30.00

    1969

    -197

    5 19

    76-1

    979

    1980

    19

    81

    1982

    19

    83

    1984

    19

    85

    1986

    19

    87

    1988

    19

    89

    1990

    19

    91

    1992

    19

    93

    1994

    19

    95

    1996

    19

    97

    1998

    19

    99

    2000

    20

    01

    2002

    20

    03

    2004

    20

    05

    Fund

    s (20

    02 $

    B)

    IRR

    (%)

    Pooled IRR

    Funds Raised

    Source: HBS databases and Thomson Reuters.

  • VC is Not Process Driven

    Judgment and effectiveness of the VC partners counts most

    Great firms are somewhat consistent across partners; merely good or second rate firms are not at all consistent across partners

    VC is an apprenticeship business

  • VC is Not Process Driven

    Judgment and effectiveness of the VC partners counts most

    Great firms are somewhat consistent across partners; merely good or second rate firms are not at all consistent across partners

    VC is an apprenticeship business

    Advice to VCs Go to the best firm you can to learn the business

  • VC is Not Process Driven

    Judgment and effectiveness of the VC partners counts most

    Great firms are somewhat consistent across partners; merely good or second rate firms are not at all consistent across partners

    VC is an apprenticeship business

    Advice to Founders Choose firm 1st, partner 2nd

    Advice to VCs Go to the best firm you can to learn the business

  • VC may be the most concentrated financial industry on earthbecause of Persiste

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