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Venture Capital - Tuesday, February 21, 2006

VCs In A No-Win Bind

Like Bill Burnham, Peter Rip at Leapfrog Ventures sees big problems for the venture capital sector. For him the problem is too much capital and the nagging problem of liquidity. Rip argues that smaller investments make sense because $60M buy-outs can still be had 2-3 years from a startup. Whereas, there are very few $200M buyouts. So when VCs invest $60M in a startup they face slim odds of getting that back.

Rip's math is clear:
"To make a modest venture return on a $500M fund, you need to generate $1B. Assuming you own an average of 20% of companies at the exit, you need to create $5B of shareholder value. If the average IPO valuation is $216M (per VentureOne, according to a WSJ article last week), that means you need 23 IPOs in a portfolio of 30 companies. The math worked when venture funds were $200M and exits were $500M. It doesn’t work when the numbers are reversed."

While we agree with Rip's observations, we might add that we think it's likely that there will be another growth spurt in tech IPO and M&A. In fact, we suspect that's why investors continue to pour money into VC firms - they don't want to miss the next bubble that rewarded so many risk-takers.

Read - Traditional Venture Capital Sure Seems Broken - It's About Time (Peter Rip - Early Stage VC)