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More Money for VC

This week got away from me as we were on the road raising money for our new fund, Sempre Management.  Meetings with prospective limited partners went very well, and we have many weeks and months of fund-raising ahead of us.  It's very exciting, especially when we continue to get such positive feedback on our strategy.

One LP told us that he expects a lot of money to shift from buyouts to venture capital in 2008.  This may be good for funds like ours that have a VC-like strategy, applied to a different market.  But, it also means that there will be a lot of investors looking to raise their exposure to more typical venture capital.  Although this may sound good for VCs, I think that it actually isn't.

Too much money in the VC segment means that investors will 1) overfund existing companies, 2) fund more marginal opportunities in order to put more money to work, and 3) be more content to live off of their larger fee base rather than focus solely on making strong returns for their investors.  This also, in the long-term, is bad for entrepreneurs.

Entrepreneurs may have more VCs willing to fund their companies, but those companies are more likely 1) to face increased competition from more well-funded start-ups and 2) to be over-funded themselves, leaving less room on the upside for the entrepreneurs, except in the cases of the largest outcomes.  Entrepreneurs don't start companies for the salary -- they start them for the equity upside which only comes from great exits.

In general, I think that over-funding the VC segment flattens out the distribution curve representing the outcomes of start-ups.  With increased capital, there will be some even bigger wins that could only happen with a lot of capital available.  There will be fewer mid-level outcomes and just a broader range of outcomes, including bigger, more spectacular losses.  If you happen to be at a company that ends up a the high-end of the curve, this is a good thing.  But, the curve probably also shifts to the left, meaning that the average return drops significantly.

I have long felt that the venture capital segment can only productively absorb a fixed amount of capital.  That amount slowly grows over time, perhaps just a bit faster than GDP growth (this is my guess -- no numbers to back this up!).  Like most investment segments, over-funding the segment leads to lower returns for everyone.  The only saving grace for VC is that most other investment segments are over-funded, leading to lower returns across the board.  This is why the big institutions are looking for more alternative investments in segments that are less well-funded, hoping for bigger returns.  At least until everyone else follows them and over-funds these segments, too.

Luckily, we feel that our strategy is unique, at least for now.  It seems like our prospective investors agree.


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Agree with your opinion in today's market.

But may be the vc fund can find opportunity in new market like China.


You are exactly right. An entrepreneur is best served by taking in a little capital and making the most out of it. However, VCs are pressured by large fund sizes to put more capital into companies and fund more companies. So, how can the frugal entrepreneur compete in a crowded and over-funded environment? I think that this puts a premium on innovation and great execution. Companies that can maintain financial discipline, come up with an innovative technology and/or business model, and execute really well can do well for themselves in this environment. Otherwise, like the VCs, entrepreneurs will end up working for their salaries rather than the upside.

Mike - interesting (if depressing) analysis. It would seem then, that entrepreneurs are in a bit of a pickle - unless they can get to exit on bootstrap or angel funding. I also see another axis to evaluate - the depth of possible exits. If you have to be the #1 giant to have an exit (e.g. YouTube or Google), the risks are already huge but now are compounded by easy money funding lots of competitors. If, however, you enter a space where there are many potential exit partners who all need or want what you and your competitors are building, then perhaps a mid-curve business is still viable. At that point, sticking to your guns about not taking too much VC funding is going to make all of the difference in your return as an entrepreneur. Some company may take in 3x the funding, become the leader in your space, but the founders may not do all that well on exit. In contrast, a less-funded company may get to #2 or #3 and have a nice respectable exit that does very well for the founders. Now the big problem is finding VCs who won't make you take "an offer you can't refuse" and over-fund your business.

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