Venture Capital Not Insulated from Broader Market Turmoil

Investors opening up their 401K statements for the first quarter of 2008 will probably need a large supply of Pepto-Bismol to assuage their pain with the Dow Jones Industrials offer more than -500 points. A rally on the first day of the second quarter was quickly dispatched by Fed Chairman Ben Bernanke's sick April Fool's joke that the economy could very possibly contract in the first half of 2008 sending stocks tumbling.



While at first glance, the Venture Capital industry should be insulated from the broader market and economy, new data out from the National Venture Capital Association and Thomson Financial indicates that may not be the case.

Short Line @ Exit Sign

The NVCA provided data on Venture Backed Exits in the First Quarter of 2008. In short, this is a count and measure of the magnitude of liquidity events - Mergers & Acquisitions (M&A), Initial Public Offerings (IPO) - by companies that were previously financed through venture capital funds.

The number of M&A deals was down -31% to 56 deals, from the first quarter of 2007, and even more significantly when compared with the Q1 2006. The value of those deals was down -45% to $2.491 B.

Further, the data reveals that 38% of the M&A transactions valued the venture-backed startups at less than the initial VC investment.



Even starker is the IPO trend. In Q1 2006, Venture Backed companies accounted for 18 IPO's with a combined value of $2.2B, and an average of $121.7 million. In the first quarter of 2008, those numbers were 5 deals for $282 million, and an average deal of $56 million.

According to the Wall Street Journal & Dealogic (registration required):

There were fewer IPOs in the first three months of 2008 than in last year's first quarter in every major region of the world. Globally, the number of IPOs fell 60% to 100 deals and the amount raised slid 10% to $35.9 billion, according to data from Dealogic. In terms of the number of new offerings, it was the worst period world-wide since the third quarter of 2003, by Dealogic's count.

Now, the IPO market is typically very sensitive to the overall trend in the market, and venture capitalists, entrepreneurs and investment bankers alike will often postpone an initial public offering when the market is going through a correction. IPO's are meant to allow founders and VC's to take some money off the table as well as create a publicly valued currency that allows the company to engage in some of its own M&A activity. However, the magnitude of the slide is significant, and if you strip out the Visa IPO, everything looks a bit less rosy.



Plenty of $$$ for Now, Financing is NOT the End Game

While the exit picture isn't so rosy, plenty of money is still out there, particularly if you call yourself an Open Source technology company. Further, VC's are so desperate for deal flow that in some instances, they are willing to buy out the owners personal stakes according to the founder of thefunded.

It is important for entrepreneurs to manage their burn rates and work to produce revenues quickly, though, because this funding could easily dry up. Smaller deal size could be a leading indicator for a slowdown in the supply of funding, especially in light of falling confidence among VC's, according to Silicon Valley Venture Capitalist Confidence Index.

Where's the Beef?

Might as well use this Leap Day to get one more blog post in before the month of February ends...

Two weeks ago, a blog post by Redfin CEO Glen Kellman entitled "How Green was my Valley" prompted a quick reply by TechCrunch founder Michael Arrington. At issue was their argument as to whether or not Silicon Valley or Seattle was better for life, love, and most importantly entrepreneurial success.

Now I grew up outside of Atlanta, and have been in Chicago for ten years, but 7.5 years of policy debate and the diaspora of my friends has provided me plenty of access to folks from both Northern California and Seattle. In addition, I've been exposed to the platitudes, "The West Coast is the Best Coast" and "NorCal is hella cooler than SoCal." I was on my way out west after finishing my MBA when I got waylaid by my dream job at Mpayy.

I have no dog in the race, and would certainly argue that either is a more nurturing locale than Chicago for starting a company than is Chicago. As PWC Moneytree demonstrates, the $2.399 billion that Silicon Valley pulled in the fourth quarter in VC funding far outstrips the $439 million in the Northwest and the $244 million in the midwest.



If you drill down, you will see that the $405 million in Software in the Valley, which leads industries there, is much higher than the $57 million in software in the northwest, which is still almost twice the $29 million in the Midwest. So, the funds are certainly there, especially as so many alumni of successful high-tech startups move into Angel/VC roles.

What Does it All Ad(d) Up to?

Here again, I am not in a position to comment on the fashion and social mores related to commenting on websites at parties in either Silicon Valley or Seattle. My question from this detached position is related to the insights and filters that are applied to business models (or lack thereof) and valuations that are derived.

Yelp raised $15 million yesterday at what is rumored to be a $200 million valuation, and the company has "Revenues are rumored to be sub $10 million/year," again from the Blog of Record. At the high end, that is a 20x multiple on revenues in a crowded marketplace. TechCrunch mentions Insider Pages, Yellowbot, City Search, Google & Yahoo Local, to which I would add grayboxx, Kijiji, and Zagat off the top of my head. Not to mention TripAdvisor, Frommer's and Viewpoints for specific properties.



Yelp has three lines of revenues:

1. Sponsored Search Results Placement
2. Advertising
3. Branded Goods

I don't know how quickly Yelp-gear is taking off, but a 20X revenue multiple raises some eyebrows.

Kara Swisher recently put out numbers from a facebook all hands meeting that point to -$50 million in Free Cash Flow (FCF) based on $150 million in revenue and $200 million in Capital Expenditure. Even if that were +$50 million, it would be a 300X FCF multiple compared with Google's 34X FCF after the recent drop in its share price. Swisher also questioned the $50 million valuation placed on PayPal co-founder Max Levchin's Slide.


My questions respectfully are as follows:

• What is the scenario that drives these valuations, and how frequently is that "Winner Take All"?
• What is the exit for these companies, and how frequently is that assumed to be a strategic buyer in the form of Google, Yahoo or Microsoft?
• Online advertising rose 25% last year, and is expected to continue to rise. However, there is clear evidence that click-through rates are falling to an industry average of about 0.25%. Search engine marketing text links are higher, but are they concentrated enough among the highly atomized online publishing community to run a business based on this revenue stream?
• What effect does the "Bandwagon Effect" play in many of these investments in crowded sectors? Money is also flowing into the Open Social/Data Portability sector with a number of players, most recently Gmail-creator Paul Bucheit's FriendFeed. Similarly, as I discussed here, survey participants expected Clean Tech as the sector most likely to receive investments and be over-valued in 2008.

Turning the Mirror Inward

Electronic and Mobile Payments startups is certainly not an empty marketplace, and it's a frequent discussion about how to distinguish ourselves from the pack. We will swear up and down we have the most economical and efficient payment solution for Internet Retailers and Online Sellers alike. We give folks free and efficient means to send money to friends through Mpayy, our widget that launches 3/2 and our mobile site. The speed with which I can diagnose a payment processing system has accelerated significantly since I came aboard Mpayy. The quest to distinguish ourselves from the money launderers, store & forward companies, those who charge the consumer, and those without a qualified merchant model continues. For a complete discussion of capabilities of payment processors, click here, and pricing here.

Torrents of Green Flowing to Green Tech

Before I get to my observations on the money flowing into Green technology, forgive me a moment of shameless self promotion...

Mpayy is less than two weeks away from launching to create the new payments standard. The product enters User Acceptance Testing on January 9th, and will deliver the best value to consumers and merchants alike with 1% Cash Back on all purchases over $50 and a single low rate for secure payment processing and 0% fraud liability for merchants.

On January 2nd, I posted here about a recent National Venture Capital Association survey for 2008 venture capital investing along with some spiffy charts, but I realized I did not link to the survey data, which is here. One interesting trend from that survey is the...

Torrential Money Flows into Green Tech

I posted this image from the survey, but failed to note the top of the chart. Fully 79.5% of those in the know predict that Clean Technology investments will grow.



To their credit, those folks know their industry well enough to predict that green technology will be the most overvalued sector in 2008.



This is not terribly surprising. Unlike Internet and software companies, which can be started with a few hundred thousand to a few million dollars (Peter Thiel just return 50X his investment on facebook in just a few years), green technology is a massively capital intensive industry in which tens of millions of dollars can be spent PROVING a new methodology, let alone commercializing it. Even companies with proven sources of alternative fuels will require massive capital expenditures on the part of gas stations, electricity companies, etc. to deliver those sources to consumers.

What Next With Coal???

Last weekend, I had brunch with Andrew Perlman, President and CEO of GreatPoint Energy, who is an exciting and successful repeat entrepreneur. His company is in the process of commercializing its patent-pending BlueGas product that will turn coal into natural gas. With oil at $100/barrel, and gasoline over $3 across the country, Perlman et al are working to make clean use of coal, a commodity that is in abundance in the United States.



GreatPoint secured $100 million in funding from a syndicated group led by Kleiner Perkins in the 4th quarter. Their only competitor is a public-private partnership called FutureGen.



At the very least, it will be an interesting case study in the efficiency and success of private enterprise vs. federal innovation.

However, this market raises the question of what happens for companies like Freight Pipeline, which secured $1 million in funding today to create "Green Bricks" from coal's by products or BlueGas competitor EnerTech, which secured $46 million today to use human byproduct, or "slurry" to produce energy.

Watching the VC headlines for clean tech will be interesting to watch not just over the next year, but the next ten as the global economy determines what solutions to adopt to reduce the human environmental footprint. For Mpayy, we'll continue to stand on the sidelines as we hopefully close our $2 million round in the next few weeks to deliver the new payments standard.