Howard is leaving venture capital


3 July 2005

Howard Anderson writes in Technology Review why he is leaving the venture capital industry. He gives several reasons.

  1. First he feels that “technology supply is bloated”, not because there is a lack of useful innovation but because he senses that businesses have reached the limit on what they can usefully utilize.

I think the symptom is right and we are seeing a slowdown in business adoption of new technologies, but my sense from the market is the the cause is slightly different. It is not, as Howards seems to suggest, that the technology is not useful and would not transform your business if deployed. Rather it is that you as a business has reached the end of your capacity to change. There is a real lack of leadership in many enterprises, and with every business unit that isn’t outsourced being restructured two-three times per year, the change is not going to come from the bottom.

  1. Second, he complains that “the hype machine is broken” and technology is no longer viewed as strategic but simply as a cost, and a cost that must decrease year-on-year.

I would agree with this to a large extent. I hope and expect that some of the early adopters will cause the rest of the industry to follow based on achieving superior business results, but that is a much slower process than the good old hype machine.

  1. Third, “financial markets for technology companies are no longer exuberantly irrational”.

True. Bad for the huge returns that some VC companies enjoyed, but possibly a good thing for society. It couldn’t last, Howard, and it shouldn’t last.

  1. Fourth, the markets are not cyclical any more. “VCs actually like cyclical markets; we can buy in cheaply and wait for exuberance to bail us out.”

This seems to me to be similar to the thrid point. The example quoted is good and useful:

Here’s why: it takes about $30 million to get a startup software company to break even–and even great software companies rarely grow more than 100 percent a year. In irrational times, a software company with $30 million in sales would have been worth $180 million, or 600 percent of a VC’s investment. Which is good, but not great. Unfortunately, in rational times, the company would be worth $47 million to the investors, or only 157 percent of their investment. But that’s over five years! Per year, it’s a return of only 11 percent–and that’s for a winner. Remember: in venture funds, only 20 percent of investments are winners. Forty percent are in the middle, 20 percent are losers, and another 20 percent are write-offs.

  1. Fifth, “there’s too much venture money pursuing too many deals”.

Actually, I would argue that there isn’t enough money, at least here in Europe. It is true, as Howard points out, that there are more VC funds than ever and that they are much (by a factor of ten) bigger than they were only ten years ago, but therein lies the problem. With the funds ten times bigger, their minimum investment is ten times bigger. Have you tried to raise VC funding for less than, say, £25 million recently? It is tough.

This is a problem because the lack of funds in this space reduces the availability of deals in the higher spaces. The venture capitalists are victims of their own success. But venture capitalists used to work in this space in the past. And they used to make a nice living, though maybe not $50M annualy or whatever was the going rate for a partner during the dot-bomb era. And there is still very attractive returns to be made in this space, all the previous points notwithsanding. So let’s get back to basics and start building useful companies.