By Igor Sill*
Venture capital investing is in the midst of a revival and change. It is certainly creating a different story from its past based on Wall Street’s new-found appetite for venture-backed technology companies.
To many investors, the silver lining in 2011 was Wall Street’s initial public stock issuance of venture backed Linkedin, Groupon, Pandora, Zynga, Zillow and Impreva shares.
After languishing for years since the global financial crisis, Eurozone concerns, poor governmental economic policy and with continued stock and bond market volatility, a revitalized initial public offering (IPO) market has begun registering healthy returns for venture investors. Existing venture capital funds are being deployed, new funds are being raised and investor allocations to venture capital and private equity are on the increase. As a result of the recent strong IPO market, startup venture capital and private equity have garnered renewed investor interest. These alternative asset investments continue to deliver positive returns at a better rate than public market indexes such as NASDAQ or S&P which delivered 0% in 2011. It’s nice to have intrinsic investment alternatives with the ever-changing capital markets.
The tremendous success of venture capital funded Linkedin’s public market debut is still fresh on investor minds. LinkedIn shares skyrocketed to a high of $92.99 per share from its opening of $45., establishing a market value of $8.9 billion, virtually overnight. Zillow climbed 80% percent to $35.77 on its first day of trading. Zillow joined other recent IPOs such as LinkedIn, Renren, Yandex NV and HomeAway in gaining at least 49% in first-day trading this year. Another venture backed internet company, Imperva, went public at $18 and its shares now trade around $35, giving it a market capitalization of $800 million. Zipcar jumped 66% over its IPO price on first day of trading. Investors are flocking to those few Internet offerings after some have far outpaced the average gain of about 7% in all Wall Street IPOs in 2011, according to data compiled by Bloomberg. The technology sector led on trading volume with 44 companies going public this past year and many indicators suggest that the momentum prospects are strong as we enter 2012.
Venture capital, IPO, M&A opportunities
Other high valued IPO candidates in the pipeline include Facebook, Twitter, Yelp, Kayak, ExactTarget, Glam Media, InfoBlox, LivingSocial, Rocket Fuel, Craigslist, ProofPoint, Vocera, Angieslist to name, but just a few. An interesting trend, however, is that these newly minted IPOs all issued a very small percentage, ala 10%, of the total outstanding shares, making it difficult for the average investor to purchase significant amounts. Most anticipate this trend to continue into 2012′s IPOs.
As of result of the market’s volatility, a new perspective on venture capital is broadening the view of this alternative asset class. Discarding the old rules, a new era of angel investors (now referred to as Super Angels), Startup Incubators, Pre-IPO mutual funds and Microfinancing groups are re-inventing the start-up funding arena while enjoying venture-like returns. As a result, the traditional venture capital model has moved more towards the later stage funding arena. Many start-up founders and entrepreneurs are seizing new funding source opportunities by utilizing the breadth and depth of expertise that successful Angel investors, former entrepreneurs-turned-investors, incubator communities, ala Plug & Play Tech Center, pre-IPO mutual funds, ala Denver-based Keating Capital, well organized micro-financing groups, ala MicroVenture Marketplace and independent professional venture investing advisory firms provide.
Venture industry outperformance
Traditionally, the very best venture funds have consistently out-performed the industry and, of course, it’s everyone’s aim to invest in the top decile of these funds. The California Public Employees’ Retirement System’s (CalPERS) best performing 2010 invested fund achieved an impressive 154% IRR. After all, some of the most successful public corporations such as Apple, Amazon, AOL, Baidu, BusinessObjects (SAP), Cisco, Compaq (HP), eBay, Genentech, Google, Hewlett-Packard, HomeDepot, Informix (IBM), Intel, Linkedin, Microsoft, Netflix, Netscape, NetSuite, Oracle, Salesforce.com, Skype (Microsoft), Starbucks, Sun Microsystems (Oracle), PayPal (eBay), Yahoo, YouTube (Google), Zynga and privately-held Facebook, were all financed by venture capital funds. The investors in these venture funds realized significant healthy returns while Facebook’s investors continue to realize tremendous value appreciation.
Understanding which tech market sectors are most likely to outperform, coupled with gaining access to exploit those opportunities are a critical component of the investor’s decision making and research process.
Next-generation technology growth segment: cloud-based, software as a service
Potential high-growth market segment examples would be the emergence of cloud computing, software-as-a-service (SaaS), virtualization, cybersecurity, open source, Artificial Intelligence, mobility and financial software technologies. These are major, disruptive tectonic shifts occurring in the global IT ecosystem. Market researcher, Trefis estimates that the cloud-computing market stands at about $65 billion and is projected to grow to more than $300 billion by the end of 2018.
Existing public technology companies, ala Amazon, Cisco, Citrix, EMC, Google, HP, IBM, Microsoft, Oracle, Salesforce.com, etc., are recruiting a new set of next-generation, innovative start-up companies as technology “partners.” Some of which will find their way to becoming public traded companies over the next few years.
Some examples of startups that may have crossed that risk chasm include: 3Leaf, BlueWolf, Cloudscale, CloudSwitch, Cloudberry, Eucalyptus Systems, Good Data, iCloud, Nuxeo, Quantivo, Quora, Palantir Technologies, Palo Alto Networks, Parallels, ParaScale, ProofPoint, Savvis, ServiceMax, SoundCloud, SnapLogic, Zoho, to name but just a few. Some of these promising startups are partnering with public traded technology companies, but have extended their customer base to an entirely different, much larger market segment.
Technology’s self-renewing cycle of new wave innovation continues, driven mostly by cost improvements, easier use and vastly greater efficiencies. The SaaS subscription model of recurring revenues provides predictable visibility into cash flow, growth rates and a substantially profitable business, generally achieving a premium company valuation. Of course, not every cloud based and SaaS start-up will become a successful investment. Great investments in large growing markets have to be coupled with exceptional management teams, disruptive competitive advantages along with a business model that leverages that advantage. Great management teams are generally a sign of exceptional business opportunities. If the opportunity wasn’t truly extraordinary, those talented individuals would be focusing their efforts elsewhere.
Consistently successful returns are achieved from those investors who diligently study, identify and recognize disruptive technologies and start-up management teams on the leading edge. These startups tend to focus on building companies at the forefront of market forces creating outstanding growth and exit opportunities.
Joining a supportive Angel investors network, doing your homework up front and placing your bets wisely in innovative startups can result in significant healthy returns whether through an IPO, merger or acquisition. Investing in private issues are, by their very nature, a long term higher risk, illiquid asset class, and of course, past performance is no guarantee of future results.
*Igor Sill is a Silicon Valley venture capitalist and founder of Geneva Venture Partners. Igor manages his own angel investment fund at Geneva Venture Management and is also a Limited Partner in Goldman Sachs Investment Partners, Benchmark Capital, Norwest Ventures, Granite Ventures, The Endowment Fund and ICO Funds. Igor resides in San Francisco, CA and has 23 years of tech investment experience.