What Matters: February 2002
Timing is Everything: What's New in Venture Capital
By L. Robert Johnson '63
When I meet someone and they ask me what business I am in, I say "early stage venture capital." They often respond "Oh, things must be really bad right now!" Well, that depends. Just like in real estate, there are buyers' markets and sellers' markets.
Right now is a terrific time to be investing in new companies. Many venture investors are busy with triage—deciding which of their portfolio companies to keep alive and which to let go under. They often don't have the time, or the emotional mind set, to be making investments in new young companies. So there is less competition among venture investors, meaning that more sensible, even attractive, valuations are available.
This sort of boom or bust has been going on for a long time. For example, the crunch of 1974-1975 led to few companies getting funded. This meant that only the best ideas and teams got funding. As a result, a few years later there were some major success stories, and many institutional investors raced to invest in new venture funds and ventures. As a result, too many weak (and "me-too") ideas got funded. Many of these failed, and returns to investors suffered. Many institutional investors pulled back from making new commitments to venture funds and ventures. Money became scarcer, and fewer ideas and teams got funded. And so on. The cycle is about 12 years, plus or minus. Any of us who have ever been exposed to Jay Forrester's System Dynamics ideas understands the feedback loop and time constants of investment returns and institutional decisions to invest. As with most things, Timing Is Everything. And if you can't control the timing, then what happens is very dependent on luck.
Why talk about this? Because there is a human cost of entrepreneurialism that isn't often described. We hear many stories of how people got rich, making those entrepreneurs sound brilliant and far-seeing. We rarely hear about how luck was a factor. This makes us think that an entrepreneur who fails is simply less capable. And the entrepreneur often feels the same way. His or her spouse may too. And friends and acquaintances do. And the business magazines reinforce this view. Often it just isn't so.
Three examples—two companies for whom the events of September 11 were a death sentence and one for whom major new opportunities opened up. I won't name them, but the stories are true.
The first is a company that provided web-enabled call center services on an outsource basis to high tech and services companies. The company had grown steadily over its five-year life and was able to attract venture capital in the fall of 2000 to support an aggressive growth plan. The company built a second center, which was ready in early 2001, but never opened. Demand had begun to fall. It fell steadily throughout the spring and summer, and the company successfully contracted to half its former size. Then came September 11. Demand fell by 50% again. The company couldn't cut its expenses for computer and telecommunications hardware far enough to stay afloat. The venture investors lost all their money; the founders lost all their money and their jobs. This company was "OBE" (Overtaken By Events). In fact, this company would have been luckier if it hadn't been able to raise the venture money and expand its fixed costs when it did. (Timing Is Everything.)
The second company had provided software for property & casualty insurance companies for years. It recently developed a suite of web-enabled systems to support all the myriad forms insurance companies use in quoting, selling and processing car and homeowners' insurance. The business had grown rapidly during the e-business boom, but management had successfully downsized it when the "e-bubble" burst. Then came September 11. Property & casualty insurers were reeling. They stopped spending money on outsourced development of business systems, along with a lot of other things. This company was able to cut its expenses to the bone, but there was only enough business left to support a skeleton crew. This company, too, was OBE.
The third company manufactures all sorts of infra-red cameras and imaging systems. These products have been used in military and high-value commercial applications for years. Silicon technology is enabling costs to come down rapidly, making many more commercial applications feasible and attractive. The business has been growing rapidly. Then came September 11. Military and homeland security demand took off—on top of already strong demand. Are these entrepreneurs smarter and more capable than the others? Maybe, maybe not—but they certainly are luckier.
It is often said that Americans are much more tolerant of business failure than many other cultures. That is what makes it okay to leave your job at Big Company and strike out on your own. In the nineties, it was even chic. If you fail, you won't be "banished." You won't be honored, but you and your family will not have to move away. Nonetheless, many entrepreneurs, a driven and ambitious lot, certainly feel like failures.
I think it would be a fine thing for us all if we realized the importance of timing and luck in these matters. The winners, the also-rans and the losers are all worthy players—some are smarter than others. At least as important, some are luckier than others—at least for now.
About the Author
L. Robert Johnson earned his SB in physics from MIT in 1963 and an MBA from the Harvard Business School in 1965. He began his investment career with Kidder, Peabody & Co. in 1966 as an analyst following the electronics and computer industries. He moved to Donaldson, Lufkin & Jenrette, Inc., in 1969 and gradually became more involved in venture and private equity investing and less with public companies.
Johnson became a General Partner of the Sprout Capital Group, DLJ's venture capital arm, and managed the group for several years before leaving in 1981 to try his hand at being an entrepreneur. He co-founded Angenics, Inc. with an MIT and a Harvard professor and served as CEO until 1988. When the company was sold, he went back to the venture world and formed Founders Capital Partners to invest in early-stage technology-based businesses in the Boston area. In 1999, he moved the focus of his investment activities to Santa Barbara, California.
Johnson is currently a director of West Pharmaceutical Services, Inc. (NYSE), and he is chairman of the board of HealthBanks.com. He has served on the boards of numerous public and private companies in the past. He is also a former director of the National Venture Capital Association and a former governor of the National Association of Small Business Investment Companies.
He currently serves MIT in several capacities. He is a member of the Corporation, chair of the Physics Visiting Committee, a member of the Biology Visiting Committee, and president of the Association of Alumni and Alumnae for 2001-02. He earlier served as the chair of the ad hoc committee that precipitated the establishment of Alumni Network Services (ANS), now known as the Infinite Connection.
What Matters is a guest opinion column written by a different MIT alumnus or alumna. The views expressed are entirely those of the author and do not necessarily represent the views of the Alumni Association or MIT. Interested in writing a column? Email whatmatters@mit.edu.
