After a decade in Silicon Valley, I’ve learned there’s a difference between what some VCs say and what they do. For instance, there’s the well-worn phrase that nearly every venture firm utters: “We believe downturns are the best time to invest.” And yet, somehow, the investment numbers always go down in recessions.
But University of San Francisco associate professor of entrepreneurship Mark Cannice puts a bit more stock in what VCs say. And to be fair, he’s got some data to prove it. While there are tons of studies that track what VCs did in a quarter, for the last six years Cannice has polled nearly 40 local VCs to ask how confident they feel about the high growth industry in the next six to 18 months. And interestingly, the results almost always presage an upturn or a downturn in exits by a quarter.
For instance, the fourth quarter of 2007 was a banner 90 days for IPOs, but the confidence index plunged. Sure enough, the market plunged in early 2008. Similarly, in the first quarter of 2009, returns sucked, but confidence ticked back up. And in the second quarter we got five venture-backed IPOs.
USF just released the third quarter numbers and for the first time since Cannice started the survey the measure of confidence was exactly the same as the previous quarter—down to the hundredth decimal place. Confidence was pegged at 3.37 on a scale of zero to five.
So what does that mean? In short, they’re still confident, but waiting for that confidence to be backed up by reality.
Here’s the good: VCs still feel there’s a lot of good new companies out there, and they know that to make returns ten years from now, they have to keep the dollars flowing now, according to the survey. What’s more: There are more private tech companies with more than $50 million in annual revenues that haven’t yet exited than ever before. It’s a combo of some dot com survivors whose markets finally caught up with their original hype and some surging newer companies. Both are either having a hard time going public in stock market that ignores mid-cap companies or are run by CEOs that just don’t want to go public in a short-term, Sarbanes Oxley world.
Here’s the bad: VCs essentially have two “customers” and both are cautious buyers of what VCs are selling right now. One are the LPs, who despite the recovering public markets are way over-allocated in illiquid venture capital funds and—whether they believe in the asset class long term or not—they’re being forced to sell stakes or at a minimum curtail investing in the next cycle of funds.
And then there are the markets. There are a backlog of IPO candidates, but they’re largely not big multi-billion offerings that can go anytime. And like we’ve seen with OpenTable, with small deals the floats are modest enough that even if a company gets out, VCs being able to sell their shares without tanking the stock is another matter. As one VC said in the survey comments, “The IPO market is like Hotel California. You can check it but you can’t check out.” Let’s remember: The point of an IPO is to make illiquid shares liquid. If you can’t sell, the corks stay in the champagne.
Sure there’s a lot of optimism about acquisition markets heating up. But– while a positive– those deals aren’t likely to be outsized without the threat that the private companies could go public instead.
A lot of people criticize VCs for tailoring their investing mood based on what the broader markets are doing. Should you really be taking cues from the public markets when you’re supposed to be focused on funding startups? But as Cannice correctly points out, it’s a circle-of-life thing. If VCs can’t spin mature companies off to buyers or public market investors, they have to keep more reserves for them that can’t go to new deals. And without those exits—some firms may not be able to raise their next funds, which also hurts their ability to do new deals.
That means a lot is hinging on the next few quarters and whether this coming IPO boom materializes.
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