Venture capital is risk management and the finest exponents of the practice are still in Silicon Valley, California.
Plenty of things with entrepreneurial companies can, and often do, go wrong but being aware of what these issues are hopefully allow for more sensible pricing and funding of these companies.
David Mes, managing partner at secondaries firm Arc Venture Partners, said he would only question his process if a portfolio company failed from a risk he hadn’t considered.
At last week’s GCV drinks reception co-hosted and held at healthcare company Johnson & Johnson’s innovation centre in Menlo Park off Sand Hill Road, he talked about one of his angel portfolio company, virtual reality technology developer Skylights, which has contracts to provide its headsets for planes, and the challenges it was taking on to improve passenger experience.
The list was the lengthy but the founder’s user and business experience and successes so far gave Mes hope of a substantial win over the next few years.
It is classic venture capital by an experienced investor in perhaps an underappreciated area. Mark Suster, managing partner at VC firm Upfront Ventures, in his excellent outlook for the technology startup world and venture capital overall, WTF Happened to Winter?, said: “A large number of VCs believed that virtual/augmented reality [V/AR] and the blockchain, while interesting, would take a few more years to mature.”
Perhaps that is why angels, such as Mes, are getting involved in V/AR – a classic stage of development for them to get in before an area of technology becomes mainstream.
But what is more interesting in the Skylights example is the other participants in its development. There appears to be an increasing willingness of large businesses to use such a startup as Skylights’ services even if the technology is nascent. The pressure is on incumbents to compete and speed and innovation is coming from their partnerships with entrepreneurs rather than necessarily internal developments. In turn, these contracts increase the chances of success to the startup.
Mes described Skylights’ two contracts with major airlines, with two more in the offing, while major media companies, such as 20th Century Fox, have struck content deals with it.
Skylights, therefore, seems able with relatively modest funding to cover a full stack of hardware development, content distribution and sales. If it gains traction any later-stage rounds will likely be bigger and more expensive, which is great for the entrepreneurial shareholders and early investors.
Entrepreneurs in some areas are able to cover the full stack at lower costs but corporations are able to develop these ideas and take them into the business. It would be little surprise if any of Skylights’ partners tries to take a stake in the startup.
This, in turn, is helping underpin a potentially seismic change in the venture market. Traditionally, venture capital has been procyclical – one where more is invested in faster-growing economies and less in recessions – and dictated to by VCs’ sentiment. If venture becomes more mature and steady throughout an economic cycle because the investors are looking beyond just financial returns then trying to time an economic cycle becomes less of a risk factor for entrepreneurs to take into consideration.
No greater sign of the shift in this direction has been the relative stability of the past 12 to 18 months in global activity.
The US pessimism 12 months or more ago that valuations had gone too far and funding would fall only in a new venture winter – hence the title of Suster’s analysis – has in fact only seen a muted and short-lived fall.
While this probably is primarily due to the relative economic strength in the US and world economies over the past year, it also points to the relative healthy interest in venture from other investor types. GCV Analytics tracked corporations involved in rounds worth an aggregate $83bn last year, compared to the total $134bn seen in nearly 10,000 deals by data provider Preqin last year.
As data provider Go4Venture noted in its report last week: “Although VCs did cut investment, did take a more cautious approach to the burn rate of their portfolio companies, and did see a decline in valuations, overall the innovation financing market has been lifted by money from outside the classic VC realm.”
Looking at these investors and their likely reaction to any recession has become increasingly important given an economic downturn is an increasingly likely probability given the US is eight years into its recovery from the global financial crisis and China is preparing for slower growth and looking for systemic risks.
As a follow-up to GCV’s survey, in association with Stanford, Harvard and Chicago university business schools, of more than 200 CVCs at the end of last year, the straw poll of corporate venturers at the Global Corporate Venturing Leadership Society roundtable discussion before the drinks reception found about half fearing the rapid growth in their community over the past five years could see some decline if the economy slowed down substantially or went into recession. Their worries were if the momentum swung towards cost cutting rather than seeking growth then CVC would be an area targeted, especially if portfolio company valuations fell or strategic insights yet to be realized or a new product unit built off venture.
The other half of the vox pop were more confident. Fear of missing out (Fomo) is a powerful driver for corporate, government and sovereign investors (directly or as limited partners in VC funds).
So far, therefore, the risks are outweighed by the opportunity with CEOs bluntly tasking their CVC units to effectively “find the next big thing”.
Whether this will be V/AR, artificial intelligence/machine learning (favoured by a majority of VCs in Suster’s survey) or a host of other sectors, including healthcare according to noted consultants Cambridge Associates, remains to be seen.
But being around to see the results will be important.
The GCV-J&J roundtable held an interesting discussion on what leadership in the industry would look like in five years’ time and how to provide means for sustainability through financial and strategic returns. These insights, shared under Chatham House rules, will form a separate article and complement the qualitative interviews of about 40 CVCs as an Insights Project carried out by consultants Bell Mason Group and also to be published by GCV.
Combining data with insights makes more sense of the venture world and managing its risks than relying on one or the other.