Venture Capital

In the United States in the Boston area a number of venture capital firms started up to fund and grow local businesses: Greylock, Matrix, Battery, Polaris, Accel, Advanced Technology Ventures, Charles River Ventures are all examples.

In the New York City area was Venrock, Rothschild, Union Square, Bessemer as examples.

In the San Franciso Bay area was Kleiner Perkins Caufeld Byers, Sequoia, Andreesen Horwitz, Menlo Ventures, Canaan, et al.

As an asset class, venture capital was able to return 60% Internal Rate of Return from 1980-200, far above the 15%-20% of the S&P 500 Index, and this led to venture capital funds attracting larger and larger sums of money.  In 1980 a typical top tier venture capital fund would have $50M assets under management in a given fund; in 2000 a typical top tier venture capital fund would have $500M assets under management in a given fund.

This led to a sea change in motivations: if the fund was $50M a 2% annual management fee was $1M, and if the fund returned $250M then the fund managers received 20% of that or $50M, so the bulk of the compensation was tied to the success of the fund in finding profitable investments. If the fund was $500M, 2% annual management fee was $10M, and if the fund lost $50M in a particular investment it was a small fraction of the fund assets, leading to very different behavior by the fund managers than before.

From the 1980s to 2005 significant venture capital funding went into hardware and hard science ventures.  The end result was the buildout of megabit and gigabit per second networks around the world, and this plumbing permitted the proliferation of software businesses (more on this in a moment).  MoneyTree, a volunteer survey of venture capital funding has been in existence for decades; every quarter venture capital funds are asked to disclose what investments were made that quarter in what companies at what valuation.  From 1980 to 2007 over 24,000 companies received venture capital funding, and yet 13,000 returned ZERO, while 3,500 did a stock floatation or Initial Public Offering and that paid for all the remaining companies and then some.  This is NOT for the faint of heart.

Bart was engaged with the creation of the optical networking equipment company Ciena in 1994, and with the optical networking component company JDSUniphase in 1992.  He was engaged with roughly twenty odd startups in this time period, the most well known was Tegic that became acquired by Nuance and offered predictive text entry that is found in the software on over one billion mobile phones around planet Earth today.

Software as a business involves far less technical risk than hardware: given enough time and money, a software package can be turned into a viable product, and the manufacturing of additional copies is straightforward and relatively risk free, unlike hardware.  The main issue in software is finding a solution to a compelling need, and creating a viable business model to monetize this concept, and so from 2005 onward the bulk of venture capital funding went into software and away from hardware.

The innovation of software as a service had a major impact on venture capital funding.  Prior to this, software was sold as a license: a customer would purchase a license typically for five years, and would pay an annual service fee for updates and support equal to 20% of the purchase price.  This led to significant money being received by the software supplier as each license was sold, and led to software firms typically being funded to reach positive cash flow for $20M-$30M over a period of three to five years.  With software as a service, initially the customer pays a monthly fee, perhaps $100 or less, and this includes service and support; the end result is that far less money is received until the number of customers reaches ten times or more that of the license model, and in order to reach positive cash flow $100M-$150M has to be spent over five to seven years.

Currently there are estimated to be several thousand venture capital funds, excluding crowd sourcing activities, in the United States, with the top fifty venture capital funds enjoyed returns of 60% per year, year in and year out.