‘Walking dead VCs’?

Venture capitalists are facing renewed criticism, but this time from a different angle: they are accused of having battened down and tightened their hatches too quickly during the last tech crash (2001-2003). This had scared away many would-be entrepreneurs back into the safety zone of corporate labs and a regular monthly pay-check.

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It was not helped by the fact that those who had already taken the step to do their own start-ups during this period had great difficulty in raising any seed or first round funding and had to make many personal sacrifices. VCs are now left with a very limited gene pool from which to hit some home runs.

Many of these VC funds are reaching the end of their natural life and are desperate to show some real kickers and positive returns. The situation is further exasperated by the fact there still remains a large overhang (unspent money). Instead of relying on their traditional networks, most of which were weakened during the recessions, VCs are getting out of their offices more often and now are seen at many events, looking for late stage deals. There is now a scramble to find late stage deals, especially fabless chip companies, which can show them positive IRRs over a reasonably short period of time. As a result, valuations are now getting out of kilter again.

The light touch (some commentators say ‘no touch’) AIM market further complicates the picture, as some companies can bypass the traditional late stage R2/R3 VC round and head straight for the AIM market, even if sometimes they cannot show any functioning products or respectable revenues prior to a listing.

With the better than expected return for early stage funds, after being in the doldrums for many years, there is renewed interest in early stage deals. Unfortunately, like the AIM market, many weak start-ups are getting funded by less experienced investors on the basis that the fundamentals will be sorted out some time in the future by buying in outside IP, new management teams or even acquisitions.

The chances are that these start-ups will suck up a lot of cash and fail to deliver the most important fundamentals, i.e. customers, revenues and positive cash flow.

Some of the funds have started raising their new funds before the first funds have shown any positive signs or proper results; lack of reliable data on portfolio performance is further complicating the picture. By the time the data are compiled and results better understood, the funds are already co- investing from the next fund. This will complicate any cleaning up of the portfolio in the future. They are hoping that they will score one or two big hits which will buy them time to clean up the portfolio.

Many VCs are taking an in-ordinate amount of risk to make up for the lost time and some may be on the verge of the last few strokes before they finally admit defeat.

There was a time when the VCs talked a lot about ‘the walking dead’ portfolio companies, but it won’t be long before we start talking about ‘walking dead VC funds’ as well. This trend is already showing up in the U.S. market, and no doubt given some time, it will show up in Europe. Watch this space.

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