Chris Miller – Notes from Southeast Venture Conference

Chris Miller is a good friend and offered to share his notes from attendance at the recent Southeast Venture Conference.  Chris first published this on his blog: RockyTopMBA

Spent a couple days last week at the Southeast Venture Conference, held this year at Tyson’s Corner outside of Washington, DC.  Saw many interesting companies pitch and met some great people.  Here are some interesting notes and comments from the event:

State of Venture Capital

• Market has stabilized after seeing a loss of capital and funds over the previous three years.  The industry will continue to struggle with growth until some of currently deployed capital realizes returns.  At this point, IPO capacity returns are the only outcome that justifies the time and resources tied up in many of those opportunities.
• Which brings us to the next point… venture will continue to be weak until the IPO market rebounds.  ((On a personal note, the IPO market is absolutely and without a doubt left anemic by over-regulation.  The legislative desire to prohibit big losses like the 2000 dotcom bust has inadvertently limited the ability to realize significant upsides traditionally limited to IPOs.))
• World is flat also applies to venture capital.  Funds can’t ignore that good deals are coming from areas other than traditional hot spots.
• Venture capital is learning that a “no man’s land” exists at between $500 million and $1 billion funds.  Those funds don’t have the capital to play competitively in the correlated footprint and profile.
• While $1 billion + funds are still competitive at raising funds, limited partners are starting to understand that those funds need returns in the $1B plus range to make the fund viable.  Doesn’t take long to do the math and realize that there isn’t room for very many of those funds, given the scarcity of $1 billion + liquidity events.  ((Another personal note, most funds should seek opportunities with exits commensurate with the amount of capital under management.  I.e. a $100 million fund should invest in companies capable of exiting for $100 million)).
• Boutique funds are a better fit for the current limited partner appetite–funds between $100 million and $500 million that have a well defined and compelling value proposition around a specific geographic or industry focus.
• Limited partners are very focused on finding VC’s with a track record of adding and building value in portfolio companies.  Picking winners is no longer enough to satisfy the limited partner.
• The denominator effect for limited partners is exasperated because of mark to market requirements. Creates an artificially high denominator of unrealized value.
• States moving from defined benefit retirement programs to defined contribution is a huge, huge, huge issue for industry over the next two decades; called the most critical issue for the industry as it relates to limited partners.  As more states move pensions from defined benefit to defined contribution, venture capital will see less and less limited partners from this asset class.  Pensions have traditionally been a significant piece of limited partner contributions.
• The lesson for financial markets from the previous twelve years is that venture capital isn’t an asset class that scales.  Smaller and more aggressive funds is a better and more natural fit with the end goals.
• Venture capital struggles with financing usage innovation over core innovation.  ((Personal note–social media, web 2.0, etc are great examples of usage innovation))  Funds seeking the $1 billion exits need to focus on core innovation.  These are long-term, more capital and resource intensive, but capable of huge exits.

Companies Seeking to Raise Venture Capital

• Biggest turn-offs to investors–complex and/or undefined business model, inability to quickly communicate your value proposition, lack of appropriate advisers
• Cost of starting a company significantly less than 5 years ago.. Business models should take that into consideration.  The kinds of teams VCs want to invest in should be able to get to a Series B on $250K of “scaling expenses” ((personal note– I’m thinking scaling expenses are operating expenses less salaries and marketing))
• Be careful about setting price on angel rounds too high.  May feel great at the time, but you’re setting the stage for a down round right out of the gate and/or renegotiating with earlier investors. Also watch for crazy discounts on convertible angel commitments.  VC’s won’t take the discount, so the founders end up eating that dilution also.
• Never, never, never set price in a bubble.  Doesn’t matter how many times you’ve done it.
• Start raising money 6 months before you need it.

M&A Outlook and Strategies

• 2012 looks to be a big year for middle market M&A.  Buyers are motivated by pending tax changes, baby boom demographic retiring and exiting companies, and private investment groups that must deploy capital or surrender management of it.
• Historical top M&A activity drivers are currently sitting with $12 billion of cash assets on balance sheets.
• Wild card issue is repatriation tax issue.  If a tax holiday s given for repatriation of foreign profits, M&A will be the big winner.
• Profitability has become the primary driver of M&A attractiveness, compared to ten years revenue was the driver.  Lots of attention to gross margins.
• Some big players are focusing on talent acquisition, buying early with managerial “buyouts” to keep talent engaged and enjoy value creation.
• Every sector and industry have its own story of valuation, metrics, and drivers.
• Entrepreneurs need to plan sale of company 3-4 years out, showing a balanced strategy around growing and selling the company.
• Have a list of suitors be part of the company’s strategy and a regular topic of conversation at leadership meetings.
• Hot sectors for M&A include: big data, decision-making platforms (both are attractive to IBM, Oracle, SAP, etc), value-oriented mobile applications, cloud infrastructure, vertical software platforms
• Generic multiples– 1x revenue on hardware, 2-4x on software

LP Outlook

• Focus today is on small, boutique funds less than $250 million
• Funds are taking 18 months to close a raise
• Contrary to what some think, first time funds are getting raised consistent with earlier levels, but with stellar teams leaving larger funds.  52 first time funds in 2011.
• Funds showing very disciplined approaches to executing strategy and a track record of execution are getting funded.
• Scrutiny for funds focusing on being a Series B investor.  LPs flooded with interest and need to previous success in the footprint.
• For GPs raising with currently unrealized funds, need to show embedded value in current portfolios.
• GPs shouldn’t worry about over communicating.  LPs never complain about getting touched too frequently by GPs.
• Many institutional LPs are timing their involvement 12-24 months out.
• Most LPs can swallow that 50% of a VC funds portfolio won’t return capital.
• LPs are getting very frustrated with GPs incapable of cutting losses.  LPs don’t want to see walking dead in portfolios.
• LPs want to invest in GPs that have a track record of singles and doubles.  Singles and doubles drive liquidity.

Last, a quote from someone (I think Adrian WIlson of Square 1 Ventures): “My career has seen at least three periods when venture capital was supposed to be dead.  Now is the perfect time to invest (in venture capital) because valuations and terms are great.  It is opportune timing as we turn back from the bottom.”

FG_AUTHORS: Shawn Carson

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