raising their next funds. So that’s one of the negatives of this part of the cycle, that the opportunities have receded somewhat to Silicon Valley and Boston.
X: Isn’t it inevitable that as the number of LPs investing in venture as an asset class shrinks, there will be a flight to quality?
Rory O’Driscoll: I dislike the term “flight to quality.” It’s more that there is a flight to the sure thing, and that is more likely to be an established firm. If Silicon Valley has 200 firms and it goes to 150, you barely notice. But if someplace has five firms and it goes to one, you really notice. It’s just more obvious in the regions, where a small absolute number of funds closing down really makes a lot of difference.
Stepping back, the industry massively overshot the amount of capital it could effectively use in 1999-2001, and it was above what the long-term number should be right up to and through 2009. We now think it has broken to the downside. Markets that overshoot by 10x are perfectly capable of undershooting by 2x. So it wouldn’t surprise us if there was an undershooting for the next two to three years—in other words, people putting less money into the business than the business warrants. You’ll see that in the fundraising figures initially, and then in the fundings. Money will be harder to raise for venture firms, and then harder to raise for startups.
KM: As a balancing trend, excluding cleantech and healthcare, entrepreneurs are a lot more efficient. Even for Facebook, initially building the company was very capital-efficient. More gets used in the later stages of actually scaling the business. There, companies can attract broader capital, from the likes of Microsoft or Google. So I don’t think the big successes will be starved for capital.
X: But is there anything that can be done to soften this “undershooting” when it comes to the regional venture capital picture? In places that Xconomy covers, like San Diego and Detroit, I think there would be a lot of concern that if the local venture funds go away, the local startups won’t getting the support they need.
KM: There may be more venture funds that are funded in Boston and Silicon Valley as a percentage, for a period of time. But I don’t know that that translates one-to-one to where the startups are. We have great company in our portfolio in Indianapolis, Exact Target, that just acquired a San Francisco company called CoTweet. It’s a big, $100 million company.
RO: You can definitely build successful companies in these places, and they will get a lot of money. For Exact Target, two of the board members fly in from California. One flies from Boston, and we’re happy to do it.
KM: But it is hard in places like Michigan. We are going to have the problem of undershooting, and there is no easy answer, because it’s the natural pendulum swing.
Seed investors and “super-angels” have been willing to come in, in certain areas. There is a group of next-generation, smaller funds operating in New Mexico, Colorado, Idaho, many of whom are really super-angels, who are looking for deals regionally. They are great people for us to pair with. We did work with the Angel Capital Association, from a policy standpoint, on