The good news is that venture investing grew in 2010 for the first time since 2007, according to the MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Assn. (NVCA). Venture capitalists invested nearly $21.8 billion in 3,277 deals last year, up from $18.3 billion in 2009.
The bad news: although more venture money is going out, less investor money is coming in, points out Michael Greeley, founder and general partner of Flybridge Capital Partners, a Boston-based venture-capital firm. Venture-capital funds raised only $12.3 billion in 2010, down from $16.3 billion in 2009, according to the NVCA and Thomson Reuters. That was the fourth consecutive annual decline and a far cry from 2006, when VC funds raised about $31.9 billion. All told, there were 157 VC funds in 2010, says the NVCA and Thomson Reuters, compared with 237 funds in 2007.
For Flybridge, which focuses on technology start-ups in the consumer, energy, health-care, and information-technology sectors, the shrinkage is a positive, says Greeley. “There are great candidates for us to invest in — almost every sector is being impacted by innovation — and fewer firms to compete against,” he explains. “It would be the golden age if not for the lack of liquidity.”
Given the shrinking pool of venture capital, CFOs will have to sharpen their presentation skills if they hope to obtain funding from selective VC firms. Greeley says he receives between 500 and 600 business plans per year and will ultimately fund 2 or 3 of them. Flybridge currently has about 55 portfolio companies, he says.
In a recent interview with CFO, Greeley discussed how finance chiefs can best capitalize on their meetings with VC firms, and why he would rather sell a company these days instead of taking it public. An edited version of the interview follows.
What should finance executives know about pitching their companies to a VC firm?
Some CFOs do it really well, others don’t. I have several pet peeves, and I’m amazed at how often these mistakes are made. One, I get frustrated when a CFO isn’t thoughtful about the capital intensity of a business. When I invest in a company, I’m really committing to invest in each subsequent round. When a CFO can’t answer “How much do you need to get to break even?” it tells me he hasn’t been thoughtful about how the business scales, its margins, and how profitable it could become. It undermines everything he says.
Two, I like to hear about unit economics — the cost and revenue per unit of product. One CFO who did it really well knew clearly how much his product cost, including sales and distribution costs, and how much he could charge for it. I really appreciate that.
The third thing I find disappointing is when a company pitches us and we say we’re interested, but the company is not prepared for the follow-up and supplemental materials we need. I probably meet with 150 to 250 companies per year, and if a CFO is not prepared to run a diligent process, it’s very quickly out of sight, out of mind. If the CFO can’t give you what you need in 24 hours, you’ve lost momentum. I’m quite critical of CFOs who run a bad process.
What do you look for in a CFO for a portfolio company?
We certainly will put in a VP of finance within the first year of investing; someone who can keep the books. But you want someone with good business insight, and who can run the back of the house [smoothly]. So we often put in a part-time CFO. Some of them are willing to juggle several portfolio companies, and they in a sense become a [venture capitalist]. They become very aligned with our business, because they have equity stakes and their time is valuable, so they don’t want to spend a year working on a company that’s not going anywhere.
Our best CFOs have tight relationships with service providers, like landlords and accountants, and can get things done quickly. If we need new lab space, they know exactly how to get to the landlord; if we need a discount on accounting services, they know exactly who to call at PwC. Most of all they’re great business partners, and they can think about things like pricing and selling strategies, how to position a product.
How can the lack of liquidity be fixed?
The Spitzer reforms [separating research and investment banking] have made it almost impossible to take a small company public, and that’s a structural dynamic that doesn’t get fixed easily. When you separate banking from research, it doesn’t make [economic] sense for banks [to underwrite those IPOs].
The good news is, the top 15 tech companies have more than $300 billion in cash earning basically nothing, so the large public companies that need growth will likely acquire it. The problem is, the venture industry grew so quickly that we funded way too many “me-too” companies, so when IBM wants to buy a company, there’s no shortage of look-alikes. Leverage is still very much with the larger companies.
Is a sale, rather than an IPO, a satisfactory outcome for you?
If you have a hugely differentiated product, you can make a reasonable amount of money in an M&A transaction. In fact, I would far rather sell a company for the certainty of cash these days than go public, because [with the latter] you’re in at least a six-month and maybe a one-to-two-year lock-up period. And given the reforms on Wall Street, those smaller companies tend to be ignored by analysts and trade at a discount. So you may be locked up into something that looks like a falling knife.
We do need the IPO market to come back to drive M&A valuations, though, because today you can’t say, “If you don’t want to buy us, we’ll go public.” That’s a very hollow threat. But I would far rather take cash today, even if it’s slightly less cash, than navigate a small-cap public company.