We commented on a post on Hacker News which linked to a TechCrunch post that suggested that to close this week’s venture capital neurosis, aka the Series A crunch, we need to start more VC funds. We have copied our comment from the HN post below for your viewing pleasure with some edits for clarity.
This post is quite off the mark as there are some massive leaps of faith/logic which I’ll try to address.
Quote from original article: The solution to this structural problem in the startup economy is simple: we need more venture funds. Unfortunately, thousands of funds around the world have been killed off since 2007.
This is really not accurate or realistic. Many venture funds have died for a reason – their returns were terrible. In short, they deserved to die because they didn’t perform. The Limited Partners in those funds decided not to invest more, and as a result, those funds are no more. This is a good thing as its the way markets and resource allocation are supposed to work (for the most part). If anyone can name a fund with an above benchmark IRR that was “killed”, we will stand corrected.
The one negative of these crappy returning funds is is that some of those LPs may have soured on the VC asset class overall and so might be gunshy to invest in another VC fund. That’s perhaps happened but nevertheless, the idea that funds were “killed off” is inaccurate. They were given some rope and hung themselves with poor returns.
Quote from original article: First, you have a large number of high-quality companies that need capital, while the competition to provide capital is decreasing. Second, you have a pool of frustrated limited partners looking for new managers.
Capital will find its way to great opportunities. And that capital may not always come from VCs. We track hedge funds investing in private companies through sidepocket funds, family offices investing their money in these companies, angel individuals and groups making investments as well as corporation making investments, etc. If there is a good opportunity, someone will invest especially now when it seems everyone wants to invest in the next FB, Twitter, Groupon, Zynga, etc.
The problem is that “high quality” as a descriptor means nothing. Great companies whose metrics are killer, whose growth is up and to the right and who are in the right space (mobile photo sharing app anyone?) will get their Series A. It’s the folks who are a bit up and a bit down that have trouble. Are these high quality companies? Who knows? They might be good companies one day but maybe the odds of them generating venture level returns is now not realistic. And so they’re orphaned and they’ll die if they need to raise more money. Or perhaps they’ve become sustainable businesses on the seed investment and don’t need a Series A. The death part may sound terrible but there is a VC conversion funnel and has been forever. Not everyone gets follow-on funding. It’s simply the rules – Darwinism at its best.
Quote from the article: Just 1 in 100 angel deals may get funded by venture capitalists today, yet there are probably at least 10 strong startups in a 100, if not more.
There is no support for this beyond a gut feel.
Finally, here is the reality on Seed VC deals. If done by a large VC, they are “call options”. If the company ‘kills it’ (translation: performs outstandingly) with that money, the VC has the first look at them and can invest in the Series A. If they don’t grow like heck, it’s just a seed investment so not lots of capital at risk.