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The Start Up – Venture Capital Disconnect

Great blog posting on PEHub today.  Venture Capital Right Sizing.

The post discusses how Venture Capital Funding is down about 70% and that is because of the lack of exit prospects.  So here are my two cents at least on how it applies to Digital Media:

1. Venture Capital funds are way too big.  VCs are incentivized to raise larger funds based on the economics of their take.  A 2% management fee and 20% carry – the bigger the fund the more they make.  This caused way too much capital to be deployed to this asset class.

2. Entrepreneurs should be focused on running capital efficient businesses.  They should raise the right amount of money to properly utilize the capital.  The problem with VCs with too much cash is that they need to invest large chunks.  They can’t manage too many investments at one time.  So they want to cut big checks.  The entrepreneurs are then enticed to take in too much money and have layered on some kind of Convertible Preferred that is ahead of them.  Meaning, if they dont’ properly deploy that capital, and if they ever exit, they will have a layer of investors to get through before they are paid.

3. Exits are going to be harder to get and a lot smaller in size.  As the PEHub post states, the IPO market for venture deals looks pretty bleak for a while.  So now you have to focus on M&A.  And according to a lot of investment banking and corp dev people I know, the sweet spot is going to be under $50 million and maybe under $20 million in deal size.  Acquirors now have digital media operations and just want to add.  They are not looking for super large transformative plays.  Can those deals still happen – yes.  But those bets are definitely not going to happen as often.

So where does this lead us for the entrepreneurs.  Run it lean, efficiently use your capital and expect lower exit numbers.  However, if you properly manage your cap structure your exit will still be very worthwhile.

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