SOUTHWEST VENTURE

As hot as private equity is, and as cold as Venture Capital can be…

The funding markets are shifting, with Private Equity more interested in software/tech than in recent years (see Red Herring Private Equity / Software article ), and able to do the riskier deals that would have gone to VC’s in the past.

This is interesting on a number of levels.

From a life cycle perspective, VC’s have traditionally worked the front end, working with companies climbing the development/growth/shakeout mountain, where VC portfolio companies can benefit from VC partner expertise in building technology, deploying capital, and securing market access through dealmaking. All classic early-stage skillsets.

Private Equity has meanwhile been more about financial engineering, making mature or early-decline stage investments where the drivers of value are process improvements and cost reduction. As private equity gets more aggressive, doing smaller, earlier deals and becoming more active in technology, it creates an fresh auction environment for those deals that makes it hard for the VC’s to compete, forcing VC’s to look at earlier stage deals that promise a longer, less attractive time horizon to an exit.

It also forces private equity investors to do things they have not traditionally been good at, which include implementing messy, uncertain, early-stage value creation strategies.

In effect, this process is a rebranding of VC, pushing it as an investment class towards earlier deals, and a repositioning of PE, allowing it to be effective and to invest in earlier stage deals.

Which leads to the question - as long as capital is available and the market knows where to secure it, does it matter what name you call it?

Texas more or less loses Sematech, but we now know what to do about it.

Every metropolitan  community hopes to build its tech infrastructure.  Although the news is not as bad as it originally sounded, the Sematech headquarters decision re-raises the topic of how to get the tech development flywheel moving.  Hence  ”How to be Silicon Valley”, which carries the interesting thesis that it just takes rich people and nerds.  But the right kind of each…

-JR

  Musings while it rains throughout the family beach vacation:

One topic of these columns has been the contrast of good Texas investment opportunities with limited capital availability.  This relates to the Texas growth companies at different stages that I’ve visited this year. As types of opportunities, they are categorized for discussion here as:   

  A little synchronicity this week between the Founders Fund based in San Francisco, and a breakfast panel led by Pearson Partners…

February 20 – an informal breakfast meeting was arranged by Dallas’ Adam Ross to introduce Founders Fund II  to a Dallas audience.   The Basic Idea is:  Founders Fund Principals have “experience-based” investing advantages, in fact have had enormous success in investing personally, (PayPal, facebook, IronPort) and then in the first Founders Fund, and are now raising their 2^nd fund. 

An interesting feature of the discussion was the dealflow resulting from one seminal deal in particular – PayPal – whose early founders and senior team members went on to lead LinkedIn, YouTube, and IronPort, among others.  The family tree co-investment implications are like the “flywheel effect” quoted in, among other places, “Good to Great” by Jim Collins.  

Success breeds success.  Cash-outs drive innovation.  The effects are local. 

So what about the Texas Technology Company Family Tree?  There is a project to place it all online at the Telecom Corridor Genealogy Project led by UT Dallas.  One implication is that there is a great Texas lineage to leverage especially in telecom, but somehow the communications between generations is more fragmented here. 

That doesn’t mean Texas business conditions aren’t good.  I visited with Keith Pearson of Pearson Partners, who held a breakfast this morning regarding the strategic role of the CIO.  We discussed how I’d bemoaned local capital formation for technology companies, and I asked that given a capital-constrained environment, how healthy is the market for executive search assignments?  Keith said that his firm’s Texas-based search assignments for the last year had great urgency – it was the busiest year for his firm yet. As one measure of the health of the environment, he mentioned it was harder to pry good talent loose in this market than it was in the late 90’s.  His opinion is that the strength of the Texas economy is underreported, which ties back to the value thesis here. Part of the message of the Founders Fund is that there are still good values at the ‘A’ round level, although the later rounds are getting priced more and more aggressively.  The successes of the first Founders Fund would indicate that Fund II will get raised and invested.  Their partners would do well to look outside of the Bay area to Texas for a few of their future ‘A’ round investment success stories.

-John Reed   

   Can both of these statements be simultaneously true?

    The value equation for profitable ventures involves intangibles beyond the spreadsheet.  A candid breakfast discussion in with some local legends in Dallas this morning, organized by Tad McIntosh at HumCap, gave some unusual insight into what it takes to be a “great place to work” and some bottom line implications.

 Stan Richards – Stan quantified the reduced turnover benefit of a good workplace environment – “We get great value from being a great place to work” – one point being, in advertising it is not unusual for a person to have 7 jobs in 10 years…  thus that person never really gets to know his clients, perhaps just as he knows them he leaves.  As a result, longer tenure at the Richards group leads to greater tenure with the client, leading to greater understanding of the client and what it takes to make their business grow.  A flip side to that is not everyone who joins is perfect for his firm.  Stan reiterated the challenge of not firing people who are not going to work out soon enough.  “Make the call early”.  Stan also covered the open culture at the Richards group.  This was in line with the overall cross-functional, non-siloed, casual contact across-lines-of-function theme of the breakfast.  He said that to operate in an office environment without doors “There are certain things the CEO has to give up.  One of them is privacy.”  This is because, in his case,  “agencies are hotbeds of paranoia” where the rumor of client loss leads to rumors of layoffs, leading to speculation one the part of the employee about their fate, etc.  Thus closed door meetings lead to loss of productivity

     The 3-point VC Funding Checklist

I’ve spent the last several months with the VC/private equity community, and with entrepreneurs/owners that want to take their business to the next level.  These posts have been about today’s disconnect between investment opportunities – which are currently very good – and available capital in this regional market, which has been better.

In talking with entrepreneurs about getting funded, the conversations keep coming back to a 3-part model that gets drawn on the best available napkin.  Nothing really original, it’s kind of a strategic mutt that gets to the heart of any funding discussion.  The three elements:

The 1) Team and the 2) Technology make a business interesting, investigable.  As an entrepreneur, no one cares about your model or sector or idea without knowing about your people (smart, good track record, sector expertise) and technology (for competitive entry barriers and exit valuation).  But if the team and technology check out, then it’s the 3) Model that makes your deal investable. 

A common phrase in VC pitches is that “this will be a great little business”.  This is spoken without knowing that across the table your audience just mentally closed your file. (“Run Away! Run Away!”) If the sector is not large enough to support nice growth, or is not itself growing, or the business does not scale profitably, then that deal is in the large class of “great little businesses” for the principals to earn a living, but not for investors to earn a return on exit that matches the investment risks:

These intriguing blurry thumbnails are from a presentation made last fall to the Dallas alumni of Monterrey Tech.  The full image won’t post here, but email me: ‘Southwestventure’ at Gmail for the powerpoint version.  The point, and I do have one, is not to get too lost in pitching the wonderfulness of your widget or idea, at least not until the answers to these three questions are convincingly made.  Or else that exit your audience is planning may be from you.

-JR

    Some interesting news this morning from the NVCA and Thomson regarding venture investment last year and especially in Q4.  This release coincided with a good presentation made by Stephane Dupont of the NVCA this morning at SMU’s SWVF breakfast in Dallas.
 

Stephane reviewed the usual 2006 trends:
 

1. Despite the national trend towards an increase in life sciences investments, Texas lags the national average in this category
   
2. Polarization – the larger funds are attracting increasingly greater percentages of the annual $ raise
   
3. Exits remains at 90+% M&A, (vs. majority IPO for the 90’s) – Stephane quoted “six years of darkness” for VC IPO’s, with 157 IPO’s/y 1991-2000, and 27 IPO’s/y 2001-2006.