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September 16th, 2009:

Can you trust any VC OVER 40?

Steve Blank at Entrepreneur Corner writes with the inflammatory headline, “Can you trust any VCs under 40?”  He doesn’t actually talk about trust, but instead gives us a gloss on the history of the original Internet IPO bubble (1995-2000) and the subsequent mini-boom in M&As (2003-2008).  His thesis is that any VC under 40 has been negatively influenced by these cycles, and therefore eschews “helping entrepreneurs build companies” in favor of seeking “shortcuts to liquidity.”

Well, I call B.S.  The problem is that Steve starts with a bunch of unobjectionable and demonstrably true statements, then starts layering in misleading or irrelevant stuff, and concludes with what is essentially nonsense.  Observe:

“… Venture Capital firms have honed their skills and strategies to match Wall Streets needs …”

“VC’s make money by selling their share of your company to some other buyer – hopefully at a large multiple over what they originally paid for it.”

“[during the 1995-2000 IPO bubble,] old rules of building companies with sustainable revenue and consistent profitability went out the window.”

… the number of venture firms soared …”

True. VCs are businessmen.  We respond, like all businessmen, to price signals in the market, and when pricing indicated demand for new IPO issues during the bubble, VCs responded.  More people entered the VC market as a result of seeing these price signals.  That these price signals were amplified by bubble psychology is clear, but hardly novel: the Dutch did it with tulips back in the day, and half the country did it with houses in the last few years.

The boom in Internet startups would last 4.5 years – until it came crashing down to earth in March 2000.”

“For the next four or five years [2003-2008], technology M&A boomed, growing from 50 buyouts in 2003 to 450 in 2006.”

Misleading.  The boom in Internet company deals stopped in 2000, but those companies (except for the most egregious flameouts) by and large still existed in 2001.  And the M&A “boom” that Steve refers to is a chimera.  VC-backed M&A peaked for that period at $32 billion in 2007, yes — but this was still down from totals of $41 and $69 billion in 1999 and 2000, respectively (that’s M&A alone, independent of the IPO bubble; source: NVCA 2009 Yearbook).

Plus, it is entirely appropriate that a “boom” in tech M&A should follow, with a 5-8 year lag, a boom in VC investment.  All that Steve shows here is that the VC investments that were made during the first Internet bubble, on average, did in fact build companies that later were sold.  In fact, 2004-2006 is probably a pretty appropriate example: with our ~ $14 trillion economy, growing by ~ $420 billion a year (3%, though sadly not this year), it’s entirely reasonable to expect sustainably to generate $10-20 billion a year worth of M&A in the highest-growth sectors.

“… since the bubble, most VC firms haven’t made a profit.”

“… the message of building companies that have predictable revenue and profit models hasn’t percolated through the VC business model.”

“… [you should suspect that VCs are] trained and raised in the bubble and M&A hype and still looking for some shortcut to liquidity.”

Just plain false.  First, Steve confuses VC firms with VC funds.  Most all firms manage several funds.  The #1 correlate of a particular fund’s returns is its vintage year.  When you look at VC as an entire asset class, it’s like looking at performance numbers for mutual funds: most of them (with the same basic focus / strategy) perform pretty similarly based upon how the markets did in a given year.  A given fund having lackluster returns in a lackluster vintage year isn’t broken; it’s how the system works.  VCs’ upstream investors are asset allocators and make steady investments in an asset class year after year, and are richly rewarded for their patience.

With respect to the implication that profitability needs to “percolate” through VCs’ thick skulls, I urge you, dear reader, to talk to any VC-backed CEO.  I double-dog-dare you to come up with an example, outside of perhaps the top 3 or 4 highest profile growth cases (hint: think “tweets” and “pokes”) where his VCs are not harping on cutting burn, boosting margins, and getting to breakeven.  Heap all the abuse you want on VCs, but we’re not stupid — our “business model” is to respond to market demand.  If exit markets want Webvan and eToys, great; if they want six quarters of profit growth, great.  “Eat all you want, we’ll make more.”

I don’t know how Steve puts his pants on in the morning, but I don’t know of any shortcuts.  Until the magical pants elves start helping me with my trousers, I put them on one leg at a time.  And, as soon as the liquidity fairies start pointing to magical shortcuts, I’ll take them, but I sure as hell don’t know where they are.  “Companies are bought, not sold.”  Does a buyer want to buy an unprofitable company?  Great, if the deal is legit and satisfactory to the shareholders — but that’s called an exit, not a shortcut.

Finally, let me address Steve’s ultimate incongruity: the notion that under-40 VCs are “trained and raised in the bubble and M&A hype.”  I’ve already shown that there was little, if any, unsustainable M&A hype in the mid-2000s (though perhaps 2007 got a bit frothy).  So, disregarding that, we’re left with the “raised in the bubble” (1995-2000) argument.  Well, look: there are essentially no long-term jobs in VC for anybody under the age of 25; those few firms who hire IROCs (intellectuals right-out-of-college) generally treat them as “pre-MBA” positions with a guaranteed kick-in-the-ass after 2-3 years.  So what kind of current VC was “raised in the bubble?”  Let’s take a 27-year-old banker/MBA type who was hired in 1996, and so got a solid bubble indoctrination.  How old is he today, as 2009 draws to a close?  That’s right; the VC who was “raised in the bubble” is now 40 years old.

A modest proposal: maybe you can’t trust any VC over age 40.  Better stick to those of us who started our investment careers after 2000…