Time To Rethink ‘Walking Dead’ VC Firms?

Recently, an entrepreneur I once worked with reached out to me for advice on raising his next round. During the conversation, he rattled off the names of a half-dozen or so venture firms that he was in discussions with. Evidently, these discussions were not progressing as well as had been hoped. I suggested two more firms particularly focused on his space that he should be speaking with. Upon hearing the firm names the entrepreneur responded that he had already dismissed the idea of approaching one of the firms because it had appeared on a list of “Walking Dead VC” firms on a VC/tech-focused blog. I was startled at the entrepreneur’s haste at dismissing the firm and his willingness to so quickly accept as gospel what he read on a blog without further investigation. This was particularly unsettling given the entrepreneur’s company hung in the balance. This got me to thinking…

Over the last few months I have seen various reports in the trade media about ‘Walking Dead’ VC firms and the apparent parlor game going on in some quarters about handicapping which funds will successfully raise a follow-on vehicle in the future and which firms will likely shut their doors. I understand the schadenfreude behind some of these exercises but I think it has reached a pitch that is troubling, possibly damaging, and certainly counter productive.

To be sure, the venture industry is going through challenging times. Some recognized firms are being wound down and more will undoubtedly follow. [I have written on this subject extensively and even called it a 2010 trend to watch earlier this year.] There are those that argue that this winnowing of firms is long overdue. There are others that posit that venture capital has been over funded for some time and that this is simply a Darwinian process that must occur so that the industry can emerge more healthy and so that limited partners can see regular distributions and more stable returns again. For the most part, I have no argument with any of that.  

What troubles me is the idea that there exists some sort of demarcation line between healthy firms that will successfully raise follow-on vehicles and those that will not. I have even heard one observer posit that if a venture firm has not raised a vehicle in the post-2008 financial crisis era, it is as good as doomed. This is nonsense. There are many firms with funds raised pre-2008 that have plenty of dry powder to make investments (both new and follow-on) and plenty of time to shore up their respective funds’ performance–that is, assuming that performance needs shoring up–in order to raise follow-on vehicles. These are hardly ‘walking dead’ firms. Indeed, one could make the argument that firms like these are precisely the firms most likely to be actively looking for new opportunities.

Unless a firm has publicly announced that it is winding down, it is better to avoid labeling a fund as “walking dead.” Tagging a fund in this way has consequences.  As in the case above, it can impact deal flow as companies seeking funding may think twice about approaching a firm believed to be in that category. It can hurt a firm’s prospects of being invited into syndicates and even potentially damage a firm’s existing syndicates. It can jeopardize relationships with current and prospective LPs if a forthcoming fund is even a notion among the firm’s GPs. Finally, and perhaps most troubling of all, it can even damage the prospects of portfolio companies backed by these supposed walking dead VCs.  

These same sentiments apply to start-up companies as well. Talk in the press of start-ups ‘circling the drain’ are often poorly reasoned and based upon shaky anecdotes and innuendo. Venture firms, like start-ups, can go through rocky patches only to emerge stronger and more successful than ever.

There exist many examples of firms thought by some to be ‘walking dead’ that went on to enjoy big exits and raised follow-on vehicles. It’s startling what one big exit can do. One significant success can reverse the fortunes of a moribund fund almost overnight. I’ve seen it many times.

It’s an old cliché that a rumor is often just a premature fact. However, the appearance of problems often brings about precisely those problems. The mere mention of troubles at a certain firm can too often become a self-fulfilling prophecy. Once the proverbial blood is in the water, things begin to take place that can hasten the demise of a firm that might have otherwise recovered from its challenges. Rumors have consequences. Ask Bear Stearns or Lehman Brothers.

Water cooler conversations have their place, but I prefer never to count anyone out until the lights go dark and they start selling off the furniture. Until then, it’s anyone’s game and it’s better to wish them well than predict fume dates and pink slips. The venture business is challenging enough.

My 2010 Predictions: A Look Back

Around this time each year we in the tech/venture community turn our attention to the year ahead and pick trends and themes that will presumably shape the coming twelve months.

To my mind, no view forward is complete without a retrospective on the year drawing to a close and, with it, a re-examination of themes that were ostensibly to define the year. From that perspective, let’s take a quick look at the trends I identified in my Ten Tech Trends For 2010 post from January and assess how I fared.

1. Green Shoots But No Chef’s Salad. Given an abysmal 2009 by most accounts, that 2010 demonstrated greater activity across the tech landscape—from rising public and private company valuations to overall investment pace—was hardly cause for jubilation. That said, the pace of financings, the froth in early stage valuations, and the continued strength of the M&A market surprised many of even the most bullish of observers. Grade A-

2. Physical Media dies..a little more. On September 23, Blockbuster dropped the other shoe and finally, unceremoniously—and mercifully—declared bankruptcy, thereby joining the ranks of now-defunct juggernauts Tower Records and Virgin Megastore  and putting a very public face on the continued disintegration of physical media.  Grade A

3. Strongest IPO market in (almost) a decade. We began the year with some impressive tech names filing their S-1s, or threatening to do so, but few of the most closely watched companies ended up taking the public exit route in 2010. While the pace of IPOs in 2010 was a significant improvement over that of 2009, Facebook, Zynga, LinkedIn and Silver Spring Networks all remain privately held entities, albeit very successful and very well-funded ones. To be sure, the vigorous secondary market and the continued institutionalization of that market played a significant role in enabling these companies to be cavalier about the prospect of going public. With no shortage of capital available at often sky-high valuations to companies like Facebook and Twitter, a key pressure point for CEOs seriously considering a public exit—providing liquidity to early employees and investors—was largely mitigated. Grade B

4. Entrepreneurs Reign Supreme. Facebook, inarguably the most closely watched privately held technology company, is still helmed by its 26-year old founder despite its torrid growth and its having raised hundreds of millions in capital. Groupon, which this past week reportedly turned down a $6 Billion takeover offer from Google, is considered the fastest-growing technology company in history and will reportedly generate $2 Billion in revenue this year. It’s CEO, Andrew Mason, is all of 29. The story of the ‘return of the entrepreneur’ cannot be told properly without remarking on the revival in consumer internet and how there exists renewed investor comfort and appetite for young founding teams that really understand consumer web services and products. Grade B

5. Changing of the VC guard escalates. Despite a frothy early stage market and big (still private) successes like Zynga and Groupon becoming household names in 2010, fundraising for venture firms remained challenging. One explanation offered in my January post was the lack of distributions from many venture firms for the better part of a decade. The fundraising picture did not particularly improve in 2010, despite a strong M&A market and some decent venture-backed IPOs. While first-time managers have long faced headwinds in the LP community, in 2010 many branded legacy firms struggled to raise follow-on vehicles as well. In cases where established funds were successful in raising follow-on vehicles, many of those vehicles were considerably smaller than their predecessors.  

Venture funds that moved too slowly to adapt to changing market conditions, or who have not managed partner succession adroitly, or who missed the boat on fast-moving areas of investment will continue to struggle to maintain relevancy in 2011. Grade B+

6. Vertical Social Networks Catch Fire. My position that users would “continue to demand rich content, ubiquity and connectivity of social networking platforms” has certainly been supported by the marketplace. However, the predicted boomlet in vertical social networks did not come to pass in 2010, although usage across the category expanded dramatically. That said, there were a number of recent product launches and acquisitions by the large “horizontal” social networking companies that appear to support the notion of offering robust vertical solutions with custom applications idiosyncratic to those vertical markets. Grade C+

7. EnergyTech has its Moment. The clean-tech community rang in 2010 with high hopes that a big-name IPO coming from the space would spur a wave of exits in its wake and finally quiet naysayers that felt the sector was overheated and would not generate returns to overcome the significant investments made there over the past decade. Twelve months in, Silver Spring Networks remains privately held and there is some speculation that investment pace and enthusiasm has cooled in EnergyTech as of late. Grade C

8. Early Stage VC Returns To Form. In perhaps the biggest story of 2010, early stage venture investing—particularly around consumer web, cloud computing, digital media and web services—came back with a vengeance. The year also brought new terms to the venture lexicon such as “Micro-VC”, “super-angel” and “Angelgate.” Personal note: Thankfully the BIN 38 kerfluffle has blown over and I can make the wine bar my regular post-dinner nightcap spot again. I don’t have a problem with what happened there (or didn’t happen there, as many insist.) I just wished the people in attendance that night had chosen an iHOP. Grade A

9. Alternative Fund Models Gain Momentum. 2010 undeniably brought creativity back to the structuring of investment funds. The clearest winner was the Pledge Fund, which never really went away but, rather, benefited from renewed interest in seed stage investing. While the emergence of novel fund models was partly an answer to a tough venture fundraising environment, 2010 also brought new categories of funds that were derived for specific purposes—such as to purchase early employee and angel investor stakes in popular technology companies. Grade A

10. RIP the 2 & 20 Fee Model. Tough fundraising environment or not, the 2 & 20 model is alive and well and remains baked into the subscription agreements of a majority of venture firms. That said, few new venture funds were actually raised in 2010, raising the prospect that should 2011 be similarly difficult for fundraising this debate may re-ignite. Grade C+

In summation, I’ll give myself a B+ average. A few items were clear winners and there were no glaring missteps. Share your thoughts here. In next week’s column I will issue my Top Tech Predictions for 2011.