Current Venture Capital Environment Q4/2009, part 1: Why it is like it is, now

The current capital environment sounds like the news we hear every morning lately about the economy: “less bad is good” but we are still jobless.

Digital Hollywood’s venture panel convenes 3-4 times each year, and I am honored to chair it every time during these past many years. The audience and I get to learn the current status and opinions of early stage VCs nearly every quarter. http://tinyurl.com/yh2jaw7

I love chairing this panel, because it is important, if you are an entrepreneur seeking capital, to understand your immediate environment.

This season, autumn of 2009, there are signs of new activity among the venture community after a long lull: a few new investments, but many more in their existing portfolio of companies. The bottom of the venture investment market was spring of 2009. We are seeing a small uptick now. There are several reasons for these conditions, both the bottom and the uptick:

There is less capital in the VC’s funds, given the wretched state of the economy and the serious downturn in institutional and corporate portfolios. 2009 marks a 10-year low (since 1998) in Funds. And, the best years for VCs’ return on investment (ROI) was 2002/2003 (their post-dot-com bust investments). So, there is less capital for the VCs to invest, and lower returns in recent years, and this makes them more careful, because the success of their new Fund raises depends upon the ROI of their existing portfolios.
Deals with entrepreneurs are more difficult to complete, as the VCs encounter resistance from a company’s early shareholders and angels to “downrounds” – the offer of new investment capital at a lowered valuation than the previous round. The “bottom” in this investment cycle was about six months ago (Spring 2009), when many VCs were seeing up to 75% of their offers as downrounds.
The VCs are seeing more competition now from a new source– “SuperAngels.” These are wealthy individuals or very small groups with private-money Funds of $10-20M, investing $250K-$1M into early stage (sometimes even concept stage) ventures. During the dot-com boom, there were many kinds of small angel groups, mostly washed away in the tech crash of 2000. After recovery, more formal, larger angel networks were solidified, which still exist, and which tend to collaborate with the early stage VCs. And only a few years ago, the VCs found their competition from hedge funds, which left the scene during a more recent economic crash. So now the VCs must compete with SuperAngels.
The recent uptick of the past few months is due to the fact that there has been so little investment in the past 18 months, that the VCs must put some capital to use in order to create the ROI on their portfolios within the 7-10 year cycle of a portfolio (from raise to exit to ROI). And some of the uptick is a response to the entrepreneurs who have kept on building their new companies these past two years with no outside capital (just self-funded or by friends and family and sweat equity), who now have ventures that are far enough along to be less risky to the VCs.