Tonight saw the 15th edition of the Churchill Club's "Hot or Not" event where top VCs share their views of interesting investment spaces, and where they will focus their energy and capital. Since the press was well represented in the attendance, my post will deal with my areas of interests, and the current focus of my business: software, and particularly social media, search and consumer plays.
On deck were Jim Breyer from Accel Partners, and Chairman of the NVCA (National Venture Capital Association), Bill Gurley from Benchmark Capital, and Joe Lacob from Kleiner Perkins Caufield and Beyers. A great panel of Tier 1 VCs, who was moderated by one of their peers, Geoff Yang from Redpoint Ventures. Jim, Bill and Geoff are investing in enterprise and consumer plays, whereas Joe is focusing on healthcare (and a few other things) - hence bringing a different perspective.
I have attended, and participated to, a number of VC panels, and it is very difficult to go beyond VC 101 and generalities. These 4 did a very good job at sharing some genuine insights on what each believed, and disagreed. A special mention to Geoff who I thought did a good job as a moderator.
About 500 people were attending the event, and the room certainly looked almost full. That, plus the number of IPOs in 2004, the number of companies in registration, and M&A and VC investment statistics ($22B invested last year) led Geoff to ask whether "the Valley was back". Jim commented on the broad agreement that there was too many venture firms, and too much money to invest. However Limited Partners commiting to venture funds have a set allocation for the asset class, that leads them to invest in the funds they can have access to (and don't believe that any pension fund or fund of fund has access to the VC funds they choose, it is certainly not the case with Tier 1 funds). Hence the oversupply of capital.
It is therefore up to the VCs to avoid over-investing in interesting spaces, plunking money in me-too plays mimicing investments made by other funds. Bill added that for him August 03 is when things turned around in the Valley, thanks to increased spending by consumers and enterprises, and the "return" of experienced entrepreneurs (who had been sitting on the sidelines during the burst of the bubble).
On software, Jim shared that Accel would not consider investing in a traditional enterprise software company that does not have an open source component, and relies on the traditional perpetual license model. Subscription based, managed service offering, are definitely favored. And capital efficiency (i.e how much money needs to be invested to get a company to a major milestone like profitability) will be a must.
It is true that VCs have a hard time getting excited in these plays, because it is difficult to find genuine "white spaces" in which a large company can be built. There are obviously exceptions, but the bar has just gone higher on the need for differentiation, proof of ROI, etc.
On Entrepreneurs, two types were mentioned: experienced executives with a strong track record and surrounding themselves with a strong team (here is the Splunk example, recently funded by friend and ventureblogger extraordinaire David Hornik). And innovative "twenty-something" looking at new ways of leveraging the internet as both a media and a distribution mechanism, and coming up with radically different solutions, products and services.
This notion of "twenty-something Stanford dropouts" as a source of radical innovation is recurrent in Mike Moritz's interviews. Looking at two of his most successful investments, you'd appreciate why: Jerry Yang and David Filo (Yahoo), and Sergey Brin and Larry Page (Google) all were of these kinds.
There is a now a wide recognition that companies have to be structured around centers of competencies, where the skills, costs and market equation can be optimized. VCs will there have to learn making investments in companies where engineering might be in Israel or India, the market in Europe and executive management in the Valley. This led to a discussion on China, which is obviously an area of great interest for VCs, but where the traditional US model will be challenging to replicate.
Consumer/Internet plays were mentioned by the panel as an area of major opportunity: digital home, community plays, peer-to-peer media sharing and blogging, etc. The issue is always the business model at scale, and how to monetize gazillions of users.
Unless you have a proven track record in building such (.com) companies, you will have to find ways of bootstrapping your initial go to market (on angel/friends and family funding). I have heard quite consistently that a million users (give or take) is the magic number that would get VCs potentially excited.
Because these bootstrapping costs are limited thanks to LAMP-based open source architectures, there will be a plethora of services that will be developed and released by very small teams, and will be delivering value to their users upon launch. Great examples of such services are del.icio.us or Memeorandum, developed by Gabe Avalos (who I met at BloggerCon III). He got exposure through Robert Scoble, who really liked his hack and blogged about it. Now the issue is to figure out how to turn this very cool feature into a product, and a company (if this is of interest, I'm leading a BMA Roundtable on that topic mid-february).
This discussion led to a mention of a 2003 Hot sector: social networking, with a claim from Bill that we will be blown away by the revenues of such companies in the next couple of years. Benchmark invested in Friendster back then, LinkedIn just launched their (paying) job feature, and Redpoint is investing in Myspace, a site which has developed a very impressive traction lately. We'll see.
Bill mentioned his interest in gaming companies (Benchmark just invested in Linden Lab and Sulake - the Finland-based maker of Habbo Hotel, and Jamdat recently IPO'ed), and how big an opportunity they represent. Part of the business model of Second Life (Linden's game) is actually to enable "real" commerce of virtual items, allowing game experts to make a living out as a result of their build-up of virtual assets in the game. Players of EverQuest or Ultima Online have been used to purchase virtual assets on eBay for a while.
Geoff concluded on a note of caution, expressing his hope that the industry will have learnt from its mistakes in the late 90's, and his concern that the recent performance improvement of the stock market will drive private valuations higher - potentially higher than VCs would like to pay.
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