Sunday's
Globe column dealt with the shrinkage of Boston's VC universe. Column got snipped quite a bit, so I'm publishing the full version below, along with the video.
Venture capital sector makes adjustmentsFor Boston’s venture capital community, headquartered on the placid plateau of Mount Money in Waltham, 2009 will be a year of wrenching change. The stream of capital flowing to venture capital firms, who invest it in innovative-but-risky private companies, is turning to a rivulet – and that means the firms themselves will have to get smaller.
“Last year, our industry raised about $28 billion in new investment capital,” says Michael Greeley, chairman of the New England Venture Capital Association and managing director of Flybridge Capital Partners in Boston. “I think we’ll raise between $8 billion and $12 billion this year, nationally. That’s a dramatic reduction. My sense is that the average fund size will be cut in half, and they’ll have to cut the number of partners who work for them as a result.”
The shrinkage of Boston’s VC sector will be tough for the VCs, obviously, and also for entrepreneurs who ascend Mount Money with their PowerPoint presentations, looking for funding to launch a company or keep one going. But it could also have a silver lining.
Here’s what’s happening.
Two local VC firms have already put together smaller investment pools than they’d hoped for. Atlas Venture, in Waltham, had aimed to raise about $400 million but wound up with $283 million; as a result, last month Atlas jettisoned two of its partners and shifted two others to less active roles. Boston-based Bain Capital Ventures will likely wind up raising between $475 million and $550 million for its latest fund, rather than the $750 million it had set out to collect. Money in a venture capital fund is typically invested over the course of a decade.
Kodiak Venture Partners of Waltham has reduced the number of investors on its roster and is shifting its focus toward life sciences and medical technology as part of an attempt to burnish its appeal to would-be investors. Andrey Zarur, a partner there, says Kodiak isn’t out looking for new money right now, but plans to be at some point in the future.
“Kodiak just hasn’t had enough liquidity events to make their limited partners say, ‘I’m ready to step up again,’” says Howard Anderson, an MIT lecturer and former venture capitalist. (Limited partner is the term for the university endowments, wealthy individuals, and pension funds that funnel money into venture capital.) One example Anderson cites is Egenera, Inc., a Marlborough company selling technology for data centers that raised $176 million but never managed to go public. Anderson should know: his old firm, YankeeTek Ventures, was an early investor in Egenera.
Many other local VC firms are on the road, talking to prospective sugar daddies. Some have been at it longer than others. Among the firms trying to scare up more money in 2009 are Boston Millennia Partners, Highland Capital Partners, Polaris Venture Partners, Prism VentureWorks, Oxford BioScience Partners, Charles River Ventures, and North Bridge Venture Partners. New firms, like Genovation Capital and a medical device oriented fund called Makaira Venture Partners, are also out trying to raise their first funds.
Venture capitalists are prohibited by the Securities and Exchange Commission from discussing their fund-raising activities. But one partner at a Boston area VC firm that’s trying to put together its next fund told me last week that fundraising is happening “on a molasses pace,” adding that “universally, everyone is going to be lower than what they’d hoped to raise.”
One reason that the limited partners are avoiding commitments to new VC funds is that many of them have formulas for how they allocate their assets. If a certain percentage is devoted to bonds, a certain percentage to stocks, and a certain percentage to venture capital and private equity, for instance, things start to look out of whack when the stock portion of the portfolio plunges and the value of the VC portion stays roughly the same. (The valuations of the private companies in a venture capital firm’s portfolio isn’t updated very frequently, unlike publicly-traded stocks.)
If a limited partner needs to get their mix of asset allocation back in order, investing in new VC funds simply doesn’t happen. (Some limited partners, including the endowment managers at Harvard, Duke, and Columbia, are actually trying to sell the stakes in VC funds they already own – but there are few buyers.)
And investors who can’t get their money into the best-performing venture firms may simply be disappointed with the financial returns they get. “I’ve heard limited partners say that the VC business, in some cases, is like getting Treasury bill returns with venture capital levels of risk,” says Michael Feinstein, an ex-VC. “If you look at the median venture capital return over the past eight years, it’s about one percent a year.”
Josh Lerner, a Harvard Business School professor who studies the venture capital industry, describes what’s happening among limited partners as “a changing of the guard.” University endowments and U.S.-based pension funds are becoming smaller players in new venture capital funds, Lerner says. But what’s not clear is who will take up the slack – though sovereign wealth funds and pension funds from Australia are two potential candidates. “We can see who’s going out,” Lerner says, “but not who’s going in.”
The upshot is that VC firms will be managing smaller funds, and some firms will go out of business. Anderson, who refers to Atlas’ situation as a harbinger of things to come, predicts that some funds that aren’t in the 25 percent when it comes to delivering financial returns will simply fade into the sunset. “Everyone will swear to be in that top quartile, but this isn’t Lake Wobegon – not everyone is above average,” he says.
Fewer firms and smaller funds will obviously mean fewer jobs for venture capitalists and the staffers who support them. It’ll undoubtedly get harder for start-ups to raise money. It will take longer, and those that do manage to attract an initial jolt of capital will get less of it than before.
“There just won’t be as much money flying around,” says Todd Dagres, founder of Spark Capital in Boston. “And there’s good in that. If you can raise money for your start-up now, there’s going to be a lot more uniqueness value than there used to be.” In other words, entrepreneurs will run up against fewer well-funded competitors than they once did. That could help the entrepreneurs and their backers both.
Still, a contracting VC universe isn’t going to be as fun to inhabit as an expanding one – at least for most people, at least in the near-term.
Labels: Atlas Venture, Bain Capital Ventures, Flybridge Capital Partners, Howard Anderson, Kodiak Venture Partners, Michael Greeley, Spark Capital, venture capital
