In January, Jerry Neumann wrote a long and detailed analysis of his view of the VC industry in the 1980’s titled Heat Death: Venture Capital in the 1980’s. While I don’t know Jerry very well, I like him and thought his post was extremely detailed and thoughtful. However, there were some things in it that didn’t ring true for me.
I sent out a few emails to mentors of mine who had been VCs in the 1980s. As I waited for reactions, I saw Jerry’s post get widely read and passed around. Many people used it as justification for stuff and there were very few critical responses that dug deeper on the history.
Jack Tankersley, a long time mentor of mine, co-founder of Centennial Funds, and co-founder of Meritage Funds, wrote me a very long response. I decided to sit on it for a while and continue to ponder the history of VC in the 1980’s and the current era we are experiencing to see if anything new appeared after Jerry’s post.
There hasn’t been much so after some back and forth and editing with Jack, following is his reaction to Jerry’s piece along with some additional thoughts to chew on.
It is good that Mr. Neumann begins his piece in the 70’s, as that era certainly set the table for the 1980’s. You may recall I got into the industry in 1978.
The key reason for the explosion in capital flowing into the industry, and therefore the large increase in practitioners, had nothing to do with 1970’s performance, early stage investing, or technology. Instead, it was the result of two profound regulatory changes, the 1978 Steiger Amendment, which lowered the capital gains tax from 49% to 28%, and the 1978 clarification under ERISA that venture capital investments came within the “prudent man” doctrine. Without these changes, the 1980’s from a venture perspective would not have happened and the industry would have remained a backwater until comparable regulation changes stimulating capital formation were made.
Secondly, the driver of returns for the funds raised in 1978 – 1981 was not their underlying portfolios, at what stage, or in what industries they were built. Instead, the driver was the 1983 bull market. The Four Horsemen (LF Rothschild, Unterberg Tobin, Alex Brown, H&Q and Robinson Stephens) basically were able to take any and everything public. Put a willing and forgiving exit market following any investment period and you get spectacular returns.
So contrary to the piece, it wasn’t VC were good at early stage technology, it was that they had newfound capital and a big exit window. For example, my firm at the time, Continental Illinois Venture Corporation, the wholly owned SBIC of Chicago’s Continental Bank, had many successful investments. Some were Silicon Valley early stage companies, such as Apple, Quantum, and Masstor Systems. I handled CIVC’s investments in the latter two (in fact, I also “monitored” Apple as well). Take a look at the founding syndicates of each:
|Masstor Sytems (5/1979)||Quantum Corporation (6/1980)|
|CIVC||$ 250,000||CIVC||$ 200,000|
|Mayfield II||$ 250,000||Sutter Hill||$ 790,000|
|Continental Capital*||$ 250,000||KPC&B II||$ 775,000|
|Genstar**||$ 275,000||SBE+||$ 700,000|
|S & S***||$ 225,000||Mayfield III||$ 500,000|
|BJ Cassin||$ 75,000|
*Highly regarded private SBIC, **Sutter Hill Affiliate, ***Norwegian Shipping Family, +B of A’s SBIC
What is striking about these syndicates is that nobody had any meaningful capital, which forced syndication and cooperation. CIVC’s only “competitive” advantage was its ability to write a check up to $1 million. In this era, the leading VC firms such as Mayfield, Kleiner, and Sutter Hill (all shown above), rarely invested more than $1 million per company.
When we syndicated the purchase of the Buffalo, New York cable system, we literally called everybody we knew and raised an unprecedented $16 million, a breathtaking sum in 1980. As dollars flowed into the industry, cooperation was replaced by competition, to the detriment of deal flow, due diligence, ability to add value and, of course, returns.
CIVC had a number of highly successful non-technology investments made in the late 1970’s timeframe, such as:
- LB Foster: Repurposed old train tracks
- JD Robinson Jewelers: The original “diamond man” (Tom Shane’s inspiration)
- National Demographics: Mailing Lists
- American Home Video: Video Stores
- Michigan Cottage Cheese: Yoplait Yogurt
- The Aviation Group: Expedited small package delivery
- JMB Realty: Real Estate Management company
None of these companies fit Mr. Neumann’s definition of the era’s venture deals and each generated returns we would welcome today.
For many years preceding 1999, the 1982 vintage was known as the industry’s worst vintage year. Was this a function of “too much money chasing too few deals” as many pundits claimed? Not really; it was a result of an industry investing into a frothy market at higher and higher valuations in expectation of near term liquidity, and suddenly the IPO window shutting, leading to no exits and little additional capital to support these companies.
Mr. Neumann’s post also misses the idea that it was a period of experimentation for the industry, This time period saw the rise of the industry-focused funds and the advent of the regional funds. Many of the industry funds were wildly successful (in sectors such as media communications, health care, consumer, etc.), while none of the non-Silicon Valley regional firms were long-term successful as regional firms. Some regional firms, such as Austin Ventures (in Austin, TX) did prosper because they subsequently adopted either an industry or national focus. The remainder failed as a result of the phenomenon of investing in the best deals in their region which typically were not competitive on a national or global scale. Just imagine doing Colorado’s best medical device deal which was only the 12th best in its sector in the world.
Some additional observations include:
- Many of those quoted in the article such as Charlie Lea, Kevin Landry, Ken Rind, and Fred Adler, were all very well known in the industry. However, none were based in the Silicon Valley and are probably unfamiliar names to today’s practitioners. I knew them all, because we all knew each other in this era.
- “By January 1984, investors had turned away from hardware toward software.” This isn’t true. Exabyte, one of Colorado’s hottest deals, was formed in 1985; Connor Peripherals (fastest growing company in the history of technology manufacturing, four years to $1 billion in revenue) raised its first round in 1987.
- “By 1994 the big software wins of the 1980’s were already funded or public.” This isn’t correct either. A good example is Symantec
- “Ben Rosen, arguably the best VC of the era”. While Ben may well have been among the best, in the early 1980’s Ben was brand new to the industry. He was a former Wall Street analyst with no operating or investment experience, who became a VC by teaming up with operator LJ Sevin. Even many newcomers with little real experience were quite successful.
- Silicon Valley firms also did many non-tech deals. Sequoia followed Nolen Bushnell from Atari into Pizza Time Theaters (and according to legend, did well). I well remember being in Don Valentine’s office as he waxed poetically about his new deal, Malibu Race Track. Unfortunately Reed Dennis of IVP did not do as well in his Fargo, ND-based Steiger Tractor investment!
- “Venture capitalists’ job is to invest in risky projects.” This statement is scary to me. We should be risk evaluators, not risk takers. We should invest where our background and instincts and due diligence convince us the anticipated return will far exceed our evaluation of the risk. There are five key risks in any deal: Market, Product (a/k/a technology), Management, Business Model, and Capital. Taking all five at once is crazy. Most losses happen when you combine Market and Product risk – take one, not both, and take it with a proven entrepreneur.
- “The fatal flaw of the 80’s was fear”. I strongly disagree. Instead, it was the result of virtually no liquidity windows after 1983. As mentioned, the industry also experimented with new strategies such as industry focus funds and regional focus funds. Some worked; some did not. Also in the 80’s, the megafunds were created (at the time defined as $100 million plus); the LBO sector outperformed venture through financial engineering; asset gatherers, such as Blackstone, were created. The biggest Wall Street crash since the Great Depression (October, 1987) shocked us all. “They don’t talk about the 80’s”; if true, maybe it’s because the period cannot be simplified.
The 1980’s proved there is more than one way to “skin a cat”. Early stage technology may be one; but it is not the only one and may not be the best one, then or now. My advice to a venture capitalist, then, now or later, is simple: Do what you know, do what you love; build great companies and over time you will succeed.