Fred Beste, of MidAtlantic Venture funds, was the speaker at this month's New Jersey Entrepreneurial Network lunch. The title of Fred's talk was "Overfunding by VC's." Many people in the audience, including yours truly, wondered if such a thing is possible. The high points of the talk are covered below.
It seems like, in the current environment, that even worthy companies have trouble getting funded, overfunding is the impossible dream. However the last twenty years have seen tremendous growth in the venture capital industry. In 1980, venture funds had $3B under management, in 1995 $37B, and in 2004 $224B. The high yields obtained by venture funds in the recent past have atracted a lot of new money. At the same time it seems that old experienced venture money is now in the process of cashing out. With $224B available the venture funds need to deploy about $20B annually. There aren't enough good companies around. Too much money is chasing too few deals.
During the internet bubble companies were able to go public with valuations greater than $250M, and therefore an adequate return was obtained even if $25M had been invested pre IPO. Now after three very slow years things are improving. In 2004 there were 59 successful IPO's and 2100 mergers allowing investors to cash out. However companies are going public for more modest valuations in the $50M-$100M range. If VC's have put $25M into these $100M IPO companies, their internal rates of return are going to suffer. A total pre IPO investment of $5M to $10M seems more sustainable.
Another problem with overfunding is that it encourages entrepreneurs to be careless with cash. Overfunding entrepreneurs puts them on a 5 star cruise to nowhere. Common sense often evaporates when there is a pile of money in the bank. When VC's throw too much money at a company they end up with noveau riche execution. A lean, cash-efficient company is much more likely to keep its eye on the ball. Nothing focuses an entrepreneur's mind like the prosepect of imminent failure of the company. Small deals, under $5M, still remain the best option.