Turmoil over the continued viability of the venture capital business model, coupled with a maturing collegiality among angel investors, has created an interesting and challenging dynamic for potential entrepreneurs, one that could have implications for economic recovery.
Amidst a chorus of critics who contend the venture capital model is broken, Seattle venture capital leader Andy Dale says a course correction is under way for the industry while the managing partner of what has been one of Washington State's most successful VC firms says it's too late.
The latest blow to the VC image came Wednesday when a new study by the Ewing Marion Kauffman Foundation titled Right-Sizing the U.S. Venture Capital Industry suggested that "as opportunities shrink, the venture industry should shrink too, possibly by as much as 50 percent."
"Contrary to popular belief, the venture capital industry is not a necessary condition in driving high-growth entrepreneurship," the report said, suggesting that while venture capital will continue to be crucial to some forms of high-growth companies, "the sector's size must be reduced to be viable."
Dale, managing partner of Seattle-based Buerk Dale Victor and president of the Evergreen Venture Capital Association (a partnership of Washington State venture firms), said in an interview before the release of the Kauffman report,"the model isn't broken but it does need a little fixing. There may be too many venture capital firms and we may be financing too many companies."
But Tom Simpson, whose Spokane-based Northwest Venture Associates has invested in more than 40 Northwest companies as one of the state's most successful VC firms, says it's too late for a fix and points to venture capital's reliance on initial public offerings as a key reason for his belief that the model is broken.
Simpson, who is winding down his fund and becoming an overseer of angel-investor activities in Spokane, says "the model needs to change such that returns are not tied to the health of the IPO market and are not so reliant on short-term returns."
In fact, it's the dramatic decline in the number of IPOs in recent years that has the VC industry nationally looking for how to change the model of the past, with the National Venture Capital Association suggesting that "a vibrant IPO environment" is vital to economic health.
It's important here to understand the distinction between venture capital investing, in which professional investors manage funds and seek high returns for a group of investors, and angel investing, usually wealthy individuals investing their own money for start-up or expansion and the opportunity to make better returns than with conventional investments.
Bill Payne, regarded by many as the father of angel investors and sent by the Kauffman Foundation to help angel groups understand how to be better angels, suggested in a recent speech in Spokane that "angel investment is getting better. It's much easier to find angels today than it was 20 years ago."
Angel investors have begun being more aware of working together, not just in their own communities but with geographically more distant partners.
Payne, who summers in Montana and winters in Nevada, suggests "angel groups are actually seeking syndication with other angels, much like early stage VCs.
It is possible that as angel investing becomes more sophisticated, there could be some cooperative initiatives to alleviate the VC challenges." Payne suggested.
Mike Elconin, member and past chair of the San Diego Tech Coast Angels, a group Payne founded, says that so far, syndication is "more talk than action, but I believe its time has come. There are some technical issues related to sharing due diligence, but I think they are not insurmountable."
Dale says flatly that "a certain percentage of angel deals will require venture capital," noting that one of the challenges facing capital-seeking entrepreneurs is that "venture firms are set up to provide follow-on capital for future financing. Angels are going to have to be willing to provide follow-capital" to help fill any VC funding gap.
But he says "angel investors are a critical part of the private growth capital economy. They provide a majority of the dollars and always have" and suggests that VCs and angels might well seek to work more closely.
Many angel investors have been critics of the VC model because of its inherent strategy of seeking a highly profitable exit strategy, mostly IPOs, at the earliest opportunity.
Simpson has suggested an "evergreen funds concept" as an alternative to the quest for IPOs. He explained that in an evergreen fund, investments are made and held, with new businesses subsequently backed "as the early portfolio investments mature and generate liquidity," rather than automatically seeking exits. Warren Buffet's Berkshire Hathaway "is essentially an evergreen fund," Simpson says.
Another Kauffman Foundation study, released last week, suggests that "challenging economic times can serve as the rebirth of entrepreneurial capitalism, leading to the creation of much-needed new jobs."
The entrepreneur-focused Kansas City-based foundation says "entrepreneurs may view unemployment as an opportunity to start a company."
But the challenge to that optimistic premise, and perhaps an important component of economic rebound, is that available capital is vital to widespread entrepreneurial activity. And a venture model in transition, and shrinking, could leave capital-hungry entrepreneurs needing to rely much more on angel investors.
