We Are Bullish on the Future of Venture Capital

We’re bullish on the future of venture capital. For anyone who thinks the greatest innovations are behind us and questions how much is still left to invent, we would argue that the greatest days of innovation and hence of venture capital opportunity are still to come.

. . . The tools and technologies that are rapidly emerging will be much more powerful and useful than much of what we’ve seen to date. Think about computers and information technology as an example. When the authors were in college, a computer filled a large room, generated so much heat that it required costly air conditioning, and yet had far less power than today’s typical smartphone we all carry around.

Moore’s Law has changed all of that, enabling the modern digital revolution. In 1965, Gordon Moore, the co-founder of Intel, observed that the number of transistors per square inch on integrated circuits had doubled roughly every year since their invention. Based on that observation, he essentially predicted that computing would double in power roughly every one to two years as well. That prediction, of course, was prescient and anticipated the massive increases in computing power that we all enjoy today.

Similarly, we have seen awesome advances in medical and biotechnological capabilities over the past 10, 20, 30 years. The mysteries of our genomics have been solved, and a result has been the ability to tailor lifesaving drugs to specific genetic problems.

. . . We could go on and on, but the point should be clear—we are already enjoying the benefits of technological advances we could not have imagined 50 years ago. Foreseeing enhancements to present known and working technologies and their future combination and integration into more complex forms provides a window on the opportunity for even greater technological innovations in the years to come.

Importantly, the advances already upon us and behind us represent a technological infrastructure enabling and facilitating future advances. Further advances, as they accrue, will enrich that technological infrastructure even further, enabling advances at a logarithmic pace in many fields. Moreover, entrepreneurs in most fields of technology will be helped further by advances in information technology—software and Internet technology—already behind us. Those advances in information technology will enable knowledge to be built and disseminated more effectively and efficiently than ever before, bringing down the costs of initial startup requirements and shrinking their development timelines.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

When Crisis Management Is Required, the VC Can Be Very Important

In the case of seriously distressed situations, the venture capitalist can be expected to take a very active role, particularly if acting as the lead or co-lead investor. In these cases, the VC will become involved in operating decisions and will likely press for management changes, and those with operating skills may even take an active role in the management of the business, however reluctantly.

As previously discussed, when Control Video got into serious trouble, the major venture capital investors engineered the turnaround, kept funding the company week-to-week while the turnaround was in progress, selected a new management team, and then recapitalized the company once it was stable. All this led to the creation of America Online, with its eventual market value of over $350 billion.

A venture capitalist hopefully always adds value, but in some cases can make all the difference.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Unicorns May Be Over-Valued

Interested in the Unicorns? Beware!

Many unicorns have already achieved notable marketplace success and will undoubtedly survive and even thrive over the long term. Nevertheless, even in the case of those making considerable strides in the marketplace, some of their current valuations strain credulity. We believe that, in many cases, their late-round investors risk vulnerability to substantial losses, just like with early-stage deals, but without the huge return multiples possible with early-stage deals. We may be proven wrong, but really, how likely is a big win when the venture is already valued at $10 billion or $20 billion or even $50 billion or more?

Let’s look at Uber and its latest financing round valuation of $66 billion. According to Bloomberg Technology, Uber’s net revenue for the first half of 2016 reached about $2 billion. By net revenue, we mean the revenue they keep after the drivers are paid. At the bottom line, for the first half of 2016, Uber lost $1.2 billion before interest, taxes, depreciation, and amortization. In 2015, Uber lost at least $2 billion before interest, taxes, depreciation, and amortization. Uber, which is seven years old, has lost at least $4 billion in the history of the company. . . .

While Uber still has many markets left to conquer and its achievements to date are indeed impressive, do those results really point to a future justifying a $66 billion valuation? Remember, a future value of anything less than $66 billion will mean a financial loss for Uber’s latest investors. . . .

The respected venture capital industry tracking resource CB Insights believes, as we do, that many unicorn valuations, and hence price expectations, are simply too high. Those valuations were based on growth expectations that now in many cases seem far too optimistic. As CB Insights put it, they are “priced for perfection,” and, as we suggested earlier, such perfection—such ideal alignment of all the relevant forces—rarely happens. . . .

Getting in on a unicorn round is great for bragging rights, but for late-stage investors, getting out with a profit can be tough. We’re betting that FOMO results in lots of loudly bursting unicorn bubbles. . . .

We believe that following the traditional early-stage venture capital investment approach will continue to generate attractive returns for investors who partner with proven professional management and practice appropriate deal diversification. In contrast, we’re betting that late-stage investors in unicorn deals will increasingly find themselves under water.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

When Crisis Management Is Required, the VC Can Be Very Important

In the case of seriously distressed situations, the venture capitalist can be expected to take a very active role, particularly if acting as the lead or co-lead investor. In these cases, the VC will become involved in operating decisions and will likely press for management changes, and those with operating skills may even take an active role in the management of the business, however reluctantly.

As previously discussed, when Control Video got into serious trouble, the major venture capital investors engineered the turnaround, kept funding the company week-to-week while the turnaround was in progress, selected a new management team, and then recapitalized the company once it was stable. All this led to the creation of America Online, with its eventual market value of over $350 billion.

A venture capitalist hopefully always adds value, but in some cases can make all the difference.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Selecting a Venture Capital Firm to Invest With

Unless you already know a lot about venture capital and also have a lot of time on your hands, we’d suggest you focus on venture capital firms and exclude angel groups from your consideration set. Angel groups generally require considerable time from their members, who typically handle the venture screening, due diligence, and investment administration tasks that are handled for you by professionals at more traditional venture capital firms.

. . . The practical reality is that you can scratch all those billion dollar-plus firms off your list of possibilities, because they won’t even take your money. . . . Unless you’re really wealthy, or extraordinarily well connected, or willing to invest a big portion of your net worth with a single VC firm, you shouldn’t even consider the big firms. The minimum commitment for such firms could be in the millions of dollars. These firms’ funds are generally limited to big institutional players like pension funds, college endowments, or a fund of funds.

. . . Once you exclude those behemoths, as well as the do-it-yourself angel groups, you’ll still need some way to segment the remaining number of choices in order to make your selection process manageable. There are a number of dimensions on which to segment the field. These include the stage in a venture’s evolution when they most often invest, venture industry, and venture geography.

. . . So why should you care so much about the venture stage where a firm is focused? . . . From a financial standpoint, as we’ve discussed, investment at different stages carries different degrees of risk and associated potential gain. Quite simply, generally the earlier the venture/financing stage, the lower the share price, so the greater is the return potential, but the greater as well is the risk . . . .

. . . There are ways, though, of managing the greater risk of earlier-stage investment. One is through a firm’s more insightful screening and rigorous vetting of its investment candidates in order to do a better job of deal selection. Another way is through your own investment diversification—just invest in more seed and/or early stage ventures to hedge your bets, as some percentage are likely to strike pay-dirt.

. . . Some venture capital firms differentiate themselves based on the industries in which they invest. They may invest in some predetermined range of strategic industries or perhaps even focus in just one or two. . . . Some investors select a venture capital firm based on its focal industries. Perhaps an individual believes strongly in the growth potential of certain industries and therefore wants to focus her venture capital dollars in those industries. Or perhaps an individual is particularly knowledgeable about an industry. That person might then have a greater interest as well as possibly better ability to select specific venture capital deals in that industry.

. . . Some firms focus their investment activity in particular geographic regions. That’s not as surprising as it might sound. Venture capital management is a labor-intensive endeavor. A VC may review hundreds of deal opportunities in order to find a small number to really zero in on for the most rigorous vetting. Vetting those finalists may require extensive observation of their operations and management teams. There’s sometimes no substitute for onsite observation in such analysis. Geographic proximity makes that much easier and more efficient.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Accessibility to Individuals Finally Here through New Online Firms

Accessibility to individuals is finally here, though, through the establishment over the past few years of several online venture capital firms, including Angel List, Our Crowd, Funder’s Club, Circle Up, and VCapital, founded by one of the authors (Len), with the other (Ken) serving in an advisory capacity. These online firms generally offer both individual investment deals and pooled investment funds.

Some of the firms perform extensive due diligence for greater selectivity in the investments they offer while others appear to perform somewhat less. Some of the firms have extensive experience in VC investing and some considerably less. Since online VC investing is so new, these online firms have little return history or realized IRR performance data based on actual exits to provide an investor with confidence. So the individual investor needs to understand the features and makeup of a likely home run investment, and how to track them down, or more realistically recognize the venture capital firms that have the ability to find those home run opportunities.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Accessibility to Individuals Finally Here through New Online Firms

Accessibility to individuals is finally here, though, through the establishment over the past few years of several online venture capital firms, including Angel List, Our Crowd, Funder’s Club, Circle Up, and VCapital, founded by one of the authors (Len), with the other (Ken) serving in an advisory capacity. These online firms generally offer both individual investment deals and pooled investment funds.

Some of the firms perform extensive due diligence for greater selectivity in the investments they offer while others appear to perform somewhat less. Some of the firms have extensive experience in VC investing and some considerably less. Since online VC investing is so new, these online firms have little return history or realized IRR performance data based on actual exits to provide an investor with confidence. So the individual investor needs to understand the features and makeup of a likely home run investment, and how to track them down, or more realistically recognize the venture capital firms that have the ability to find those home run opportunities.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Prospecting for Gold, or, Better Yet, Drilling for Oil

Prospecting for venture capital gold can be as challenging as was prospecting for actual gold back in the gold rush. Many other miners are also searching for the mother lode. You will need a competitive advantage—all the known art plus some entrepreneurial inventiveness—to prevail.

Part of the known art is recognizing that there are far more effective and efficient approaches than the old miner’s panning technique. That technique called for the miner to continuously slosh water around in the pan until the gold settled to the bottom. The equivalent today would be reaching out to all those 1,200 venture capital firms and angel groups, hat in hand, hoping for enough gold to settle in your venture. Raising the funds you need that way could take years—maybe your whole life—and you might still come up empty. And implementing your idea can’t wait for years. The fast-moving marketplace waits for no one.

In order to have a reasonable shot at your venture reaching the market while there’s still a market available to it, you’d be better off figuring out where the small number of highest potential sites are and digging intensively there, more like the way oil companies search for the few best places to drill for oil. This approach involves pursuing just five or six VCs, selected using the following three-step method:

  1. Find the VCs located geographically near your company. Some venture capitalists may even want to walk or bike to your office or at least be able to drive there.
  2. Narrow your list further by considering only those who invest actively in the deal stage where you’re at. We’ll review in a minute how the industry defines deal stages so you’ll know the stage where you’re at, the way the VCs look at it.
  3. Narrow your list still further by zeroing in on firms that show an interest in the industry sector you aim to enter. We’ll discuss shortly how to find that out.

By identifying the firms that meet all three criteria, you will have narrowed your list down to a more manageable number.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

It Makes Sense Even for Conservative Investors

. . . The question we need to answer here is, why should you invest in venture capital? While we’ve both made money at it, if anyone tries to sell you with promises of guaranteed wealth, don’t believe him. As we’ll remind you repeatedly, this is inherently a high-risk asset class. Nevertheless, there are sound, rational reasons for participating, even if you don’t consider yourself a big risk-taker.

. . . I’d characterize myself as being pretty conservative, a “belt-and-suspenders type” is how one of my longtime friends put it. Both my wife and our longtime financial advisor agree. I’d characterize myself as a value investor.

My interest in venture capital started after retiring from a career in Fortune 500–type companies. The retirement was fairly premature, as I was just in my mid-50s, when a serious heart attack scared me badly. . . . That triggered my decision to leave my career. I’d done well, and didn’t need to continue working to live comfortably. I hadn’t quite reached that proverbial gold ring and won the CEO lottery, so we’re not super-wealthy, but we’re comfortable.

. . .  So why did this conservative retiree decide to invest in venture capital? I’m the analytic and strategic type. Having a lot more time on my hands, and without more highly compensated work planned at the time, I began to think hard about how to manage our assets. I figured they needed to last another 30 or 40 years, at least for my wife and hopefully for me, too.

My reading on the subject kept bringing me back to the importance of asset allocation and the need for that asset allocation, notwithstanding my conservative personal nature, to include some portion invested in more aggressive growth vehicles. With the 2008–09 financial crisis upon us, the stock market plummeting, and interest rates heading rapidly toward zero, I recognized that long-term Treasury bills were certainly off the table and that I’d better find ways to hedge against a possible sharp run-up in inflation sometime in the future.

Fortunately, my financial advisor is very bright, competent, and truly focused on his clients’ financial well-being. When I asked him about investing in Batterson Venture Capital, even though his affiliation with a major brokerage firm precluded his benefiting at all from any such investment, he encouraged our jumping in.

He explained that venture capital doesn’t have a tight correlation with the stock or bond markets. He viewed it as he would look at other alternative investments as well—as an asset class that over the long haul can help smooth out the ups and downs of the stock and bond markets, effectively reducing overall portfolio risk, despite the inherent riskiness of each individual venture capital investment. He explained that this benefit would be present as long as we took a reasonably diversified approach to this different asset class.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Co-author Len Batterson a Leading VC for Individual Investors

Len (Batterson) has been one of the nation’s leading entrepreneurial venture capitalists for over 30 years.

. . . Len’s series of notable successes began while at Allstate, where he played an integral role in the financing and restructuring of Control Video Corporation, which became America Online, Inc. (AOL). On its merger with Time Warner, which remains the largest merger in U.S. business history, AOL was valued at $364 billion. While at Allstate, Len also introduced to the venture capital community Allscripts, which was funded by Allstate after Len left the company, and which also grew to unicorn status and still generates over $1 billion in annual revenues.

After leaving Allstate, Len went on to found or co-found a number of highly successful entrepreneurial venture capital funds, pioneering venture capital investment for high-net-worth individuals. His long-term success is exceptional. Len has generated investor returns averaging 28%/year over nearly 30 years, with annual gains in the double digits in every decade, even through the 2000 tech bubble as well as the financial crisis of 2008–09. In addition to AOL and initial involvement with Allscripts, his investments that became unicorns include CyberSource and, more recently, Cleversafe, a data storage innovator sold to IBM in late 2015.

Most recently, Len founded VCapital LLC (www.VCapital.com), providing contemporary online access while continuing to focus on early stage, institutional quality, technology investment opportunities for individual accredited investors.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund