Venture Capitalists and the Stock Market… Why?

So this post by VC Mark Suster caught my eye yesterday – Stock Market Drops. VCs Hold Partner Meetings. What Happens Next? | TechCrunch.  My immediate reaction was – why is a VC concerning themselves with the stock market?  VCs are long term investors right?  I guess that since exits are few and important events for VC funds – I suppose it makes sense to think about the stock market with regard to the impact on investment monetization.

Then I read the post and got really disturbed.  The post wasn’t about impact of a weak market on exits – it was about how the stock market effects funding decisions on the front end…   Wait… let that sink in.  The stock market tanks – VCs convene and decide to not invest.  Am I reading this right?

Regarding the stock market

We thought the following:

  • No new deals close until we figure out WTF is going on with the market. We need some visibility.
  • Let’s review all of our existing investments. Let’s make sure each has enough cash. Cut where needed. Finance where needed. Anyone not going to make it?
  • Who has deals in process? Let’s help get their funding get finalized or the company sold if it’s already in play.
  • Fawk, man. This is really bad. Depressing. Harrumph.

Wait… seriously?  While I am certain Mr. Suster doesn’t speak for all VCs, the environment he paints is a troubling one for both entrepreneurs and LPs – one where VCs are being driven by short term and business cycle thinking when they are getting paid to be thinking long term and making investments in companies that are game changing – and should be at some minimum insulated from the business cycle.

It seems to me that at the time the VCs should be most focused on making investments – when there is less competition for good ideas and valuation pressure (though I’d be curious to see how much that really matters) they are doing the exact opposite of what you would expect.  Based on the portrayal of the process in this post I had the following points:

1. VCs Appear to be Overly Focused on the Short Term Stock Market When Making Investments.   The mean time from initial funding to exit is in excess of 5 years.  The mean length of a bear market is 310 days, and a bull market is 915 days.  This means that for most start-ups they will ride at least one bear/bull market cycle before exit.  Even if a VCs’s assessment of “what’s going on with the market” is twice as pessimistic that the norm – an investment would expect to live through at least one cycle before being ready for exit.  Essentially, today’s stock market is irrelevant for today’s investments.

2. Is the Business Cycle That Important?  Obviously its easier to build a business when you have a stiff tailwind of economic growth to drive your top line…  but VCs aren’t making investments in restaurants…  they are supposed to be making investments in disruptive technologies.  By definition these are supposed to take share from the companies being disrupted… So while, yes its less risky to invest when the cycle is good, if the idea has true merit, that shouldn’t be a make or break point.   Or is what is being said that VCs don’t actually know and are instead masking selection error with a good business cycle and selling the risk of the business to later stage investors?

3. IPOs Appear to be Overstated and M&A Understated.  Obviously IPOs are heavily influenced by market conditions (though Wall Street has all sorts of problems with the IPO market I won’t get into here) – but the reality is that most exits are M&A driven.  Now M&A is influenced by the market – though not as much as you might expect or as portrayed.  It depends on what size acquisition you are talking about.  The chart below shows the volatility in deal volume quarter-to-quarter compared to the volatility of the Nasdaq.  As you can see the volume of small deals doesn’t change radically from good markets to bad – where it changed significantly is when deals are above $250MM in size.

Even in early 2009 the M&A market was open for sub-$250MM acquisitions.  Volume ebbs and flows with the market – but they still get done – good markets and bad.  This is not like what we see in larger sized deals  (above  $250MM) where M&A volume has a much higher volatility based on the stock market.  Deals above $250MM are tough to do in a bad market.  Perhaps this means that VCs are overly focused, or their business model is overly reliant, on the home-run (where the market would be closed) rather than hitting for average.

I think all three of these points are important considerations in today’s market.  Given that we are in the middle of a systemic shift in the way we deploy technology (cloud) and purchase technology (consumerization of the process) – VCs that pull in their horns because the stock market is flailing about are likely to be left behind.

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