ETRE 2008 – day 3, part 3, The Good, The Bad and the Ugly

Chair: Alan Cane
Massimo Lattman
Herman Hauser
Tomasz Czechowicz
Giles McNamee

When you have a room full of some of the most influential VCs in the world  on then it would be almost foolish not to ask them what it was that they wanted to invest in him in the coming years. Given the state of the world’s financial markets immediately post-credit crunch, and given the recent doom and gloom scenario spread by Sequoia capital, and there was a real feeling of anticipation before the session: everybody genuinely wanted to know where money would flow over the next year or two.
The session was called the good, the bad, and the ugly. So in traditional reverse order let’s start with the ugly ones.
Money would not be flowing, in the opinion of the panel, towards the following areas in the immediate future:
1.    High capital intensity businesses, because of the dilation and risk
2.    Novel drug development, because the timeframe is too long for even the larger ten-year funds
3.    Companies where they had a multi-round fund-raising forecast, because it was risky in the current market, because of dilutions, and because it provided such a distraction for Management
4.    Companies where the share capital structure had already been spoiled, because of the legal complexity and risk of failing to execute
5.    Businesses where there was substantial government regulation or substantial government subsidies, because of the greatly increased political risk
6.    Anything driven by exit values into an equity market
That is not to say that some companies which operate in these areas won’t find funding and provide a counter example, but that is far less likely that companies with any or all of these factors would be fully funded by VC investment in the next 18 months.
Companies where there was definitely appetite, so let’s call them the good ones, were likely to have some or all of the following characteristics
1.    The very early stage, because most investors were blind to (or unable to execute efficiently for) very early stage opportunity and the competition for good companies was marginally less
2.    Companies where they had low capital intensity, because they have less risk of pollution and generally provide high returns
3.    Companies with a Web business model and has locked in intellectual property, because of the very large scaling that can be achieved
4.    Life science companies that had low capital requirements, especially in soft life sciences because there was no need to wait 10 years to get regulatory approval
5.    Social media companies serving real needs to defined communities, because they were so rapidly scalable and very easy to sell
6.    Stem cell research companies, because of the rapid advances in that sector and the very real chance of making a substantial new businesses
7.    Any business where the team included top-class serial entrepreneurs at the top, because they have markedly lower risk and generally more rapid growth
8.    Companies where they were rapidly advancing highly scalable hardware because of the very large profit stream and exit values
9.    Anything on the mobile Internet, because it has good cash flow and could exit routes
10.    Companies where they only had to invest once to break even
11.    Web-based application developers, because they are cheap, scalable, and have ready trade enquiries
12.    Video games companies, because of the defined market large profits scalability and these effects it.
13.    Entertainment media companies because they generate their own PR, because they have leveraged, and because they generally have good cash flows
14.    Storage, power cells, and batteries, because of the obvious global need
15.    Transportation companies especially involving novel energy-saving or low carbon technologies
16.    Some specific small clever areas of clean tech (although this panel wasn’t really in the mega-scale cleaning tech investment business)
All of the panel, when asked, are still prepared to invest in new deals, but they all admitted that there would be more cautious and tend to rely more on great entrepreneurs that they already knew. While they were optimistic, they were in no mind to be foolish or hasty.
The final message of the day was focused on trade sales. With the near death of IPO is an exit route, it was critical that any investee company clearly defined its cost control approach, its strategic partners, an exit strategy, and made immediate progress towards business (and preferably) revenue target in order to retain investor confidence.
That’s a pretty wide list. And I think it shows one of the very important things about venture capital in this post credit crunch month, which is that venture firms tend to be smaller than banks, take idiosyncratic risks, are highly heterogeneous, almost completely non-leveraged, and are therefore able to search for the low price bargains that this down market provides. Right now we see many of them who are sitting on cash now looking to invest for the huge future gains they last saw post 2001 tech bubble.