The Big VC Thaw – Why The Market is Moving Again (part 2 of 3)

Posted on Oct 1, 2009 | 35 comments


Greenland Disko BayIn my previous post, The VC Ice Age is Thawing (for now) I wrote about the reasons why the VC market came to a screeching halt in September 2008 and remained largely shut until at least April 2009.  There are now signs the VC market has gathered pace meaning it’s a great time to be fund raising.  This post highlights some of the reasons why the market is moving again and what entrepreneurs should do about this.

There’s no doubt (at least anecdotally) that the pace of VC investments in early-stage technology companies has picked up in the past few months.   The real irony of the market thaw is that the biggest symbol of the freeze as I mentioned in my last post is when Sequoia released its famous “RIP Good Times” PowerPoint deck alerting companies to dark days ahead and Ron Conway famously wrote emails to portfolio companies encouraging people to slash and save and prepare for the impending doom in the market.  This is one book-end of the cycle.

I hear from several sources that Sequoia is very active in the market aggressively chasing several deals and even driving up prices on some early-stage deals.  And Ron Conway has proclaimed that he wants to do up to 40-50 rapid-fire deals in the next 18 months in what is becoming known as the “real time web” (e.g. Twitter, FriendFeed and other real-time “feeds”.)

When the NVCA or PriceWaterhouse surveys come out at the end of year I’m not saying they will necessarily will show aggregate $$$ or deal numbers up.  Why?  Because you have multiple forces at work.  Volume has no doubt picked up at active firms.  But there are many zombie VC’s with no more investments left in their portfolios so it’s hard to know which trend has more impact.

So what is driving the new energy in the remaining venture capital firms when we kept hearing how much the whole industry was “against the ropes?” …

1. The Market rebound – Let’s face it, just as investor sentiment is unnecessary shaken when the markets dive it also becomes overly optimistic when markets bounce.  As of near the end of September 2009, we’re up 46% since the March 9th nadir (yes, I need to find a way to use one of my SAT words ; – ) .  Sentiment is strong in personal portfolios and up commensurately with VC’s expectations that their last fund will now be worth something (and along with that increase the partners’ personal wealth).  For what it’s worth I think the market recovery is also driving consumer spending and if the market declines … WATCH OUT! (but I’ll save that for post 3/3).

2. IPOs and M&A have returned – and with them the investment bankers have staged a rebound.  There have been a number of high profile tech IPOs in the recent months including companies such as OpenTable and more recently LogMeIn.  M&A has shown some spectacular results including Zappos to Amazon for $928million, Sun to Oracle for $7.4 billion and Omniture to Adobe for an astounding $1.8 billion.  More tellingly was the sale of Mint.com to Intuit for $170+ million because it showed VCs that a well-executed investment can still garner a quick, solid results (the company was sold around 3 years after its foundation).

Investment banks that last September seemed destined for bankruptcy are suddenly feeling flush and motivated to stimulate more business.  Every major VC has a stable of portfolio companies that were “in a holding pattern” – too small for an IPO yet the VCs didn’t want to sell them cheaply in a fire sale.  VC’s are working hand-in-glove with the investment bankers to prepare for IPOs or create auction-style trade sales.  I can tell you first hand than bankers are out making road shows to gin up interest in VCs and institutional investors.  There is a lot of pent-up demand.  At GRP alone we have a few companies in eight-digit millions in … EBITDA! – IPO-able in any normal market.

When you start to visualize your own portfolio exits your checkbook becomes more available for new deals.

sidelines3. You can’t get paid for sitting on the sidelines – I always tell people that when recessions start managers in large companies get rewarded for cutting costs.  The more Machiavellian the manager is the quicker he/she rises.  But this cycle of cutting comes to an end because ultimately you can’t cut your way into business growth.  Let’s be honest – the same is true for VC’s.  As I mentioned in my last post that between September 2008 – March 2009 most VC’s were keeping their heads down because you didn’t want to be seen investing in an imploding market.  But you can’t keep your pocketbook on the sidelines forever and still expect LPs (limited partners or the people who invest their money in VC funds) to pay you 2% management fees every year.  So eventually the money has to start flowing. (note: there is one rare exception – in 2006 Sevin Rosen declared that Venture Capital was broken and actually returned money to their LPs!  As I often quote Fred Wilson, “The VC business isn’t broken, some of the participants are“)

But in addition to structural reasons such as the market upturn, the increase in IPOs and the need to put capital to work, some real innovation has also encouraged a new round of investment.

4. The success of the iPhone – The success of the iPhone and more importantly the App Store has led to an increase in early-stage VC fundings that mirror the Web 2.0 style euphoria that swept the Valley beginning in 2005.  Along with Facebook and Twitter investments (see below) this wave is more diverse but no less speculative.

 

The iPhone success is more profound than just iPhone apps.  With the iPhone, Apple finally broke the hegemony that the telecom carriers had over mobile applications and that has stifled innovation for too many years.  While iPhone is really still the only true game in town for mobile applications investors can see in the near future a world in which multiple mobile applications platforms will likely exist – perhaps with Blackberry, Palm Pre and Google’s Android operating system gather more momentum.

Mobile will likely spawn a whole new wave of innovation because it’s pervasive, location aware and always with you.  Players such as Foursquare, Tapulous and Bump Technologies are attracting huge investor attention not to mention the huge hype around augmented reality applications such as Layar.  We’re only in the second inning on mobile.

zynga5. The growth of Facebook and social gaming led by Zynga – Another obvious trend is Facebook.  Notice that I didn’t say “social networking.”  Much like iPhone is the only mobile platform in town, Facebook is the only “closed network” social networking platform in town.

 

There was an initial wave of euphoria when Facebook first opened their platform that led to numerous people announcing Facebook Funds and many companies being formed.  We then saw a lull as Facebook struggled to figure out monetization.  Luckily the social and casual gaming companies showed them the way.  With players like Zynga and Playdom earning nine-fugure millions of dollars it’s clear that there is big money in monetizing social networks.

There have also been many high profile financings of infrastructure players to support these gaming platforms including Offerpal Media, SuperRewards (bought by AdKnowledge), Gambit and more recently LA-based Sometrics.

I attended the Facebook Fund Demo day about a month ago in Palo Alto and it blew me away the pace of innovation and the focus on monetization that came out of this group.  Hats off to Dave McClure, Hiten Shah and others for instilling a “money talks” attitude in this group.  There has already been at least one high profile funding from this class, which is Thread – a product that raised $1.2 million even before the demo day to help you integrate your social network with dating ambitions.  Seems an obvious fit.  With First Round Capital, Sequoia and Founders Fund obviously a lot of respected investors think highly of its potential.

At 300+ million users, money is bound to be made from Facebook platform companies and about every innovative company that I see these days is integrated with Facebook Connect to scrape a user’s social graph.

6. The growth and $1 billion valuation of Twitter and its impact on business – The Big Thaw discussion would obviously not be complete without discussing Twitter.  The fact that Twitter recently raised money at more than $1 billion valuation in just 4 years of operations energizes VC’s to believe that there is money in them thar hills.

But more important than Twitter’s value is the ecosystem.  Although too early to call, it seems to me like this phenomenon is gather more steam than even the first two.  What Twitter certainly got right was making itself a narrowly defined platform with an open API and encouraging all of the data that flows through its system to be open.   This has unleashed several classes of companies:

(the following list not comprehensive – I don’t have the hours or MIPS to do a full research here – just from the top of my head)

-          Twitter clients including Tweetdeck and Seesmic for desktops, UberTwitter, TwitterBerry, Tweetie and many more for mobile devices and CoTweet and HootSuite for businesses.

-          Twitter search tools like OneRiot and Collecta

-          Twitter URL shorteners like Bit.ly

-          Twitter listening technologies that help brands monitor mentions of their brands and judge +/- sentiment like Radian6, Buzzlogic and Visible Technologies

-          Twitter content hubs and traffic drivers like Social Approach

-          Twitter authority like Klout

-          Twitter ad networks like Ad.ly

-          Twitter analytics platforms like Awe.sm

-          And really broad players like PeopleBrowsr that seem to fall into many of the categories

Frankly, I could just keep going such is the scope and breadth of this emerging ecosystem.  So what does this mean for you if you’re an early-stage company looking for funding?  It means that now is a good time to raise money.  Don’t wait for your perfect business development deals to come to fruition that are 6-months away in your pipeline.  Remember the proverbial words of wisdom, “strike iron while it’s in the fire.”  I see too many people who say, “I want to only raise X now, because in 6 months I’ll be worth more when I get X,Y, Z completed.”

It’s true that we may be at the “beginning of the end” of the recession.  But we may also be at the “end of the beginning” (to quote Churchill) of the deep recession.  I believe the data are not yet clear.  In my next post I talk about what worries me ahead and why I think you’re better off raising money now.  To be clear, I don’t have a crystal ball that forecasts the future or I’d quit my VC job and purely be a day trader.  But I do believe it’s too early to proclaim victory.

So get out there and start raising your capital!  And my final post with my views on —>>  VC Funding in 2010 – 2011

  • Pingback: The Great VC Ice Age is Thawing (for now) – Part 1 of 3

  • http://lmframework.com/blog/about David Semeria

    (wistfully…) I wonder how many Italian VCs read this blog….

    Perhaps I should just tape this post to their office doors. Won't take long.

  • http://seekingventurecapital.com jasonspalace

    “We’re only in the second inning on mobile.”… and it's only the first season.

  • nathanbeckord

    awesome post, Mark, and directly echoes the conversations I've had this week over lunches with two different attorneys. One has been involved in 25 seed financings over the summer (most angels and 'super angels'), and the other has just completed 3 seed deals done by larger VC firms (who normally don't make seed investments). His thesis is that some of the larger funds are putting down small investments now as an 'option'– or a way to get a seat at the table– for future, larger financings later this year or early 2010 when things start to pick up. Let's hope he (and you) are right…

  • http://twitter.com/LarryChiang Larry Chiang ✰

    I agree. This is the bottom of the VC market. Sevin Rosen = Patent office dude who declared “we're full and should shut down”. They were across the st on Uni Ave

  • http://bothsidesofthetable.com msuster

    Thanks, great to hear more data points. I should warn, though, that my thesis for 2010 isn't necessary as rosy. But I'll save that for post 3 ;-)

  • Shane

    Mark, it seems to me that building a company with Twitter or Facebook as the backbone could be potentially foolhardy for a couple of reasons. First and foremost, you have iLike, the de facto music app on Facebook selling for only 20MM (after taking over 10MM in VC). Doesn't this price start ups based on the Facebook platform kind of low? Zynga aside, most have struggled to find their way in what would seem to be a goldmine. To me, the Twitter/Facebook craze mirrors the social networking craze of 2005-2007, a lot of hype, but not a lot of real innovation or real problem solving.

    Second, I don't know if building a company on top of those other services is necessarily sustainable in that they are constantly bound by the restrictions and rules of their platforms. I mean, if they wanted to, Twitter could start charging for access to its API and crush a large percentage of the applications built on it.

    Thoughts?

  • http://bothsidesofthetable.com msuster

    I agree on some bits and not on others.

    re: platforms … I've always said to people that Facebook, Salesforce.com, iPhone are “channels” not a place to build your whole business. So on that we agree.

    re: hype – I think the creativity initiated by iPhone apps will trump most of what you've seen in the past few years. The impact will be enormous. As I said, iPhone won't be the only game in town. But they cracked the hegemony. Build for now and port to other platforms when they are more pervasive. Facebook is the same.

    re: Twitter – this is unique in all regards. It is changing the nature of how we use the Internet and mobile. It is totally different and is open. It is changing the pattern of consumption of users and driving us toward link-sharing. It has made Google pay attention. I don't know who will ultimately win but this is one of the big 4-5 initiatives when the history of the Internet is written in 5 years.

    re: the API crushing – no, I'm not worried. Twitter is looking to grow faster than anyone. Stunting growth by overly optimizing the short-term revenue is no way to grow.

    Finally, many businesses fail because so many are created and even more so now that it's cheap to do so. Too many are FNACs (features, not companies). Great companies will be built. They will be few and far between.

  • http://bothsidesofthetable.com msuster

    Excellent analogy!

  • http://lmframework.com/blog/about David Semeria

    (wistfully…) I wonder how many Italian VCs read this blog….

    Perhaps I should just tape this post to their office doors. Won't take long.

  • http://www.jasonspalace.com/ jasonspalace

    “We’re only in the second inning on mobile.”… and it's only the first season.

  • nathanbeckord

    awesome post, Mark, and directly echoes the conversations I've had this week over lunches with two different attorneys. One has been involved in 25 seed financings over the summer (most angels and 'super angels'), and the other has just completed 3 seed deals done by larger VC firms (who normally don't make seed investments). His thesis is that some of the larger funds are putting down small investments now as an 'option'– or a way to get a seat at the table– for future, larger financings later this year or early 2010 when things start to pick up. Let's hope he (and you) are right…

  • larrychiang

    I agree. This is the bottom of the VC market. Sevin Rosen = Patent office dude who declared “we're full and should shut down”. They were across the st on Uni Ave

  • http://bothsidesofthetable.com msuster

    Thanks, great to hear more data points. I should warn, though, that my thesis for 2010 isn't necessary as rosy. But I'll save that for post 3 ;-)

  • Shane

    Mark, it seems to me that building a company with Twitter or Facebook as the backbone could be potentially foolhardy for a couple of reasons. First and foremost, you have iLike, the de facto music app on Facebook selling for only 20MM (after taking over 10MM in VC). Doesn't this price start ups based on the Facebook platform kind of low? Zynga aside, most have struggled to find their way in what would seem to be a goldmine. To me, the Twitter/Facebook craze mirrors the social networking craze of 2005-2007, a lot of hype, but not a lot of real innovation or real problem solving.

    Second, I don't know if building a company on top of those other services is necessarily sustainable in that they are constantly bound by the restrictions and rules of their platforms. I mean, if they wanted to, Twitter could start charging for access to its API and crush a large percentage of the applications built on it.

    Thoughts?

  • http://bothsidesofthetable.com msuster

    I agree on some bits and not on others.

    re: platforms … I've always said to people that Facebook, Salesforce.com, iPhone are “channels” not a place to build your whole business. So on that we agree.

    re: hype – I think the creativity initiated by iPhone apps will trump most of what you've seen in the past few years. The impact will be enormous. As I said, iPhone won't be the only game in town. But they cracked the hegemony. Build for now and port to other platforms when they are more pervasive. Facebook is the same.

    re: Twitter – this is unique in all regards. It is changing the nature of how we use the Internet and mobile. It is totally different and is open. It is changing the pattern of consumption of users and driving us toward link-sharing. It has made Google pay attention. I don't know who will ultimately win but this is one of the big 4-5 initiatives when the history of the Internet is written in 5 years.

    re: the API crushing – no, I'm not worried. Twitter is looking to grow faster than anyone. Stunting growth by overly optimizing the short-term revenue is no way to grow.

    Finally, many businesses fail because so many are created and even more so now that it's cheap to do so. Too many are FNACs (features, not companies). Great companies will be built. They will be few and far between.

  • http://bothsidesofthetable.com msuster

    Excellent analogy!

  • http://www.sceneclips.com John Dugan

    Re: Twitter – Building a business on top of another unproven business… it's like driving a car blindfolded with no gas in the tank.

  • http://bothsidesofthetable.com msuster

    I don't think Twitter is completely unproven. I think they just haven't focused on monetization yet. But I get it that Twitter isn't guaranteed to be successful. I think in-stream businesses will continue to be large no matter who wins the space and starting with the right channel partner doesn't hurt as long as you don't box yourself in.

  • Pingback: 2010 VC Funding Outlook for Startups – Prepare for Winter (Part 3/3)

  • http://www.sceneclips.com John Dugan

    Re: Twitter – Building a business on top of another unproven business… it's like driving a nice car blindfolded with no gas in the tank.

  • http://www.sceneclips.com John Dugan

    Twitter is over three years old… when do you start focusing on monetization? Last I checked, Twitter was in the for-profit business. They are burning through a massive amount of cash and have yet to generate any significant revenues… how are they NOT unproven?

    I get that Twitter is sexy, I dig Twitter – but they have no gas in the tank.

    Re: Channel Partners & Boxing yourself in – too bad they named it TweetDeck… dang.

  • http://bothsidesofthetable.com msuster

    I don't think Twitter is completely unproven. I think they just haven't focused on monetization yet. But I get it that Twitter isn't guaranteed to be successful. I think in-stream businesses will continue to be large no matter who wins the space and starting with the right channel partner doesn't hurt as long as you don't box yourself in.

  • http://www.sceneclips.com John Dugan

    Twitter is over three years old… when do you start focusing on monetization? Last I checked, Twitter was in the for-profit business. They are burning through a massive amount of cash and have yet to generate any significant revenues… how are they NOT unproven?

    I get that Twitter is sexy, I dig Twitter – but they have no gas in the tank.

    Re: Channel Partners & Boxing yourself in – too bad they named it TweetDeck… dang.

  • http://www.chubbybrain.com/ Anand

    Mark,

    Great post. As support of your points above re: the iPhone & Twitter inspired companies and associated venture funding flowing to them, we took a quantitative look into this and the numbers were impressive.

    Over $100M has been invested in iPhone startups by VCs and $23+ million has gone to Twitter-predicated startups.

    http://www.chubbybrain.com/blog/2009/06/the-iph

    http://www.chubbybrain.com/blog/2009/06/the-iph

    Note: These are numbers for the first half of 2009. With Twitter's recent funding and continued iPhone momentum, we're seeing even more recent fundings for startups predicated on these channels/services/platforms. We'll do an update on these figures to reflect these new investments at some point.

    Thanks for the great read.

    Regards,
    Anand

  • http://www.chubbybrain.com/ Anand

    Mark,

    Great post. As support of your points above re: the iPhone & Twitter inspired companies and associated venture funding flowing to them, we took a quantitative look into this and the numbers were impressive.

    Over $100M has been invested in iPhone startups by VCs and $23+ million has gone to Twitter-predicated startups.

    http://www.chubbybrain.com/blog/2009/06/the-iph

    http://www.chubbybrain.com/blog/2009/06/the-iph

    Note: These are numbers for the first half of 2009. With Twitter's recent funding and continued iPhone momentum, we're seeing even more recent fundings for startups predicated on these channels/services/platforms. We'll do an update on these figures to reflect these new investments at some point.

    Thanks for the great read.

    Regards,
    Anand

  • Pingback: 2010 VC Funding Outlook for Startups – Prepare for Winter (Part 3/3) « The SiliconANGLE

  • Pingback: The Big VC Thaw – Why The Market is Moving Again (part 2 of 3) | CloudAve

  • http://bothsidesofthetable.com msuster

    re: “no gas in the tank” … they just raised $100+ million so gas in the tank isn't a problem. Twitter could monetize tomorrow if they chose to. Their optimizing for growth right now. The choice is, do you take short-term revenue that MIGHT impede growth or scale as quickly as possible and turn on revenue when you're a huge company. They are focusing on the latter.

  • http://bothsidesofthetable.com msuster

    Thanks, Anand. Very useful data points. I suspect Twitter investments will accelerate but look forward to checking out updated figures on ChubbyBrain when they're published.

  • http://bothsidesofthetable.com msuster

    re: “no gas in the tank” … they just raised $100+ million so gas in the tank isn't a problem. Twitter could monetize tomorrow if they chose to. Their optimizing for growth right now. The choice is, do you take short-term revenue that MIGHT impede growth or scale as quickly as possible and turn on revenue when you're a huge company. They are focusing on the latter.

  • http://bothsidesofthetable.com msuster

    Thanks, Anand. Very useful data points. I suspect Twitter investments will accelerate but look forward to checking out updated figures on ChubbyBrain when they're published.

  • http://www.sceneclips.com John Dugan

    I rather see a business get money from customers, not investors. If Twitter can monetize tomorrow then perhaps they should… And instead of optimizing for growth, perhaps they should optimize for customer retention: http://bit.ly/Bfgbj …wait, can you even call their users customers?

    I am utterly hesitant to buy into the euphoria around Twitter.

  • madair2004

    Great post, Mark. Let's keep moving toward the zenith, my SAT word…

  • madair2004

    Great post, Mark. Let's keep moving toward the zenith…my SAT word.

  • Guest

    Great post, Mark. Let's keep moving toward the zenith, my SAT word…

  • Guest

    Great post, Mark. Let's keep moving toward the zenith, my SAT word…

  • madair2004

    Great post, Mark. Let's keep moving toward the zenith…my SAT word.

  • madair2004

    Great post, Mark. Let's keep moving toward the zenith…my SAT word.