Wednesday, December 17, 2008

Lux et veritas- Light and truth

Yale University announced yesterday that the value of its liquid securities within its endowment dropped 13% during Q3 + October. More meaningful, the overall endowment, that includes 'Alternatives' such as Venture Capital investments, LBO's and Real Estate dropped by 25%. As the market continued to punish investors, and the Alternative category tends to report write-downs later than public valuations are reported, the news for the full year, will surely be worse.

It's clear that the primary source of funding for venture firms; endowments, family offices (hello Mr. Madoff), and pension plans are under tremendous pressure to meet current obligations. The TRUTH is that the private equity community, (including the fund of funds) will see a rapid trickle down effect from these mark-downs that will include sales to secondary funds who will continue funding LP obligations (best case), defaults of current obligations (worst case), and a shut-down of funding new groups (certainty).

Companies are only as healthy as their customers. The customers for venture funds are their LP's that entrust their precious capital to firms in an effort to mitigate risk and seek healthy returns. If the customers (LP's) are not healthy, there is less funding, and a contraction of fund sizes, coupled with the gross number of firms who receive capital.

Unlike real estate and the LBO world, in the venture business, this may ultimately be good news as the thirst for capital, from a per company perspective, from early to mid-stage companies, appears to be diminishing as the recipients of their capital harness capital efficiency garnered from just in time infrastructure (Amazon's EC2), just in time sales, and just in time development.

Similar to the secular alignment during '01-'03, when many funds reduced their size and raised smaller successor funds, we may be at the verge of a similar, but horizontal shift throughout the industry. The TRUTH is that this painful ecosystem environment may align the business models of mainstream venture with the trend for capital demand by its constituency. If so, all this pain will give us a healthier ecosystem.

A return to 'little game' venture, coupled with the entrepreneurial spirit of self-exploitation by building equity through working insane hours at below market rates, is what brought us MSFT, AMAZON, Ebay, LINUX, ORACLE, DELL, etc. The foundation of the venture industry has been paradigm shifts started by small disparate groups of entrepreneurs, and initially supported by no or little capital, often disparaged by large organizations and too small for large venture to properly deploy capital 'efficiently' for their business model (notable exception is Kleiner Perkins).

I believe the Grateful Dead said it well; 'Once in a while you get shown the light in the strangest of places; if you look at it right'

No comments:

Post a Comment