SF Venture

Boxing & Boards

I started boxing about two years ago, a few years late for professional rank. I was introduced to a former heavyweight, Seamus McDonagh. Seamus started boxing at an early age, winning All-Ireland amateur titles, before emigrating to New York in 1983, where he won the U.S. Golden Gloves tournament. After turning professional, he won 19 fights with 14 k.o.'s and reached a World ranking of 10. He later fought Evander Holyfield in Atlantic City for a shot at the world title. After losing that match, he retired from boxing. He ended up running a small business in San Francisco. He hadn’t touched the gloves in a dozen years and was intrigued at the idea of talking about the sport again.

Seamus is a charismatic man. A local paper did a profile on him that captures his preserving spirit.

SF Weekly Article On Seamus McDonagh

I thought it would be cool to try boxing. While I tried Karate briefly as a teenager, I have always dreamed of being able to really fight. After one session, I found boxing the toughest workout I’d ever tried. This was after successfully completing three San Francisco Marathons, hiking the John Muir trail and climbing three 14,000+ peaks in the few years prior.

I was quickly hooked. The toughest part wasn’t throwing punches while dancing around for an hour or two. The challenge was to keep punching in the ring while somebody was punching back. The fear of getting hit still causes me to tense up, which is much more tiring. I forgot to breathe. I forgot to move. Then I got hit.

I initially put a heavy bag in a spare room. The nice part of the sport is that it’s cheap. The world’s best, leather Everlast bag at 150 pounds is only $500. After that, there’s not much to buy other than tape and gloves.

Last year, after a decade without a dedicated boxing club, the 3^rd Street Gym opened up in San Francisco’s Dog Patch. Two young professionals want to revive the sport in San Francisco.

Third Street Gym - San Francisco

I spent most of my first year of training learning to thow a left jab.  A good punch comes from your legs and whips through your body.  Speed creates the force.  I quickly found out that my back wasn't ready to dance with the punches and started seeing a sports chiropractor. I moved to yoga and pilates to build flexibility and core strength.  Bulky muscles don't work, so I stopped lifting weights after a routine of many years.  After many sessions, I started to feel I was getting my balance right for boxing. 

My first sparring match was with Miguel. Seamus picked him out in the gym. Why, I’m not sure. I went 3, 3 minute rounds. I didn’t fall down. I didn’t stop punching. I didn’t throw up. I did end up with a bruised rib and a very slick looking black eye. It turns out Miguel used to fight smokers in the Marines. While he was out of shape, he still weighed 200+ pounds compared to my 165 pounds. The adrenaline was amazing. I wanted another fight. My wife and colleagues were convinced I was crazy, which was hard to argue.

Unfortunately, my first few black eyes coincided with the process of getting my son into private school in San Francisco. It was difficult to explain to the headmaster in one school, who eventually declined to accept my son. I promised my wife I’d stop sparring until after school started. Fortunately, my son is happy in Kindergarten and I’m back at it.

I have a lot to learn from Seamus.  My plan is to have Seamus teach my son and daughter the art of boxing. Seamus has already had a few sessions with my son, but we’re waiting to make sure he can understand it is for self-defense. My hope is that they can build confidence through boxing that helps them avoid the need to fight. I didn’t find that physical confidence until I was an adult.

What does this have to do with venture boards? Probably not much, but I like boxing. I do note that one of the toughest things that board members face is fear. Frequently, it’s fear of confronting a CEO who may not be working at peak efficiency. Many times the founding CEO has done an amazing job taking round after round of punches from perspective customers until he knocked down the first one. That some maniacal stubbornness may not work as well when the company and the board expand to require formalities of process. Most board members fear the disruption of change. I’ve learned that the key is to keep moving, whether in the ring or on the board.

The Venture Capital Overhang is Gone and a Shortage is Looming

By our calculation, the Venture Capital overhang is gone. With the recent wave of new funds being raised, we’ve seen comments of concern from the media and other venture capitalists that miss the math. Looking at industry data as of the end of 2004, we estimate less than $10 billion is still available from funds raised around 2000, with most of that probably needed for reserves and not available for new investments.

There seems to be general confusion about how to figure out how much money is really available for new investments. Some overhang calculations take the gross amount of money raised over a period and simply subtract investments, calling the remainder overhang. This calculation does not subtract fees and expenses. It also does not factor in the investment reserves for future rounds.

So, let’s review the math. According to Venture Economics, Venture Funds in aggregate raised approximately $300 billion from 1993 through 2004, with $105 billion in 2000 alone.

Since 1993, $325 billion has been invested. Looking year by year, the rate of investment has kept pace with the capital raised. The investments from 1993 through 1999 are also partially funded by money raised prior to 1993. In order to take into account the lag due to a 4-5 year investment cycle, we have chosen to only subtract the investments since 1999. Since 1999, $262 billion has been invested. That leaves $30 million for fees, expenses, reserves, and new investments.

I estimate fees and expenses at 10% on average over the lives of the funds during this period.  I observed that most of the 1999 and 2000 funds invested money very quickly, reducing average fund lives. In addition, most funds will reinvest fees and expenses to the extent possible. We expect many observers will be surprised to see that as much as $30 billion has been paid for fees and expenses. This leaves an effective overhang of only $8.5 billion.

I was recently quoted regarding these calculations. 

Business 2.0 Article On VC Overhang

Whatever money is still available, almost all 1999-2001 funds are at the end of the contractual period allowed for new investments, so most of this is likely reserved for follow-on investments. After 4-5 years of investment, a reasonable number of companies created during this tough market are reaching revenue, allowing liquidity during the second half of 10-year fund lives.

Follow-on investments can keep weak companies operating artificially, creating continued competition in the markets in which these companies operate. In terms of competition, the good news is that the dropout rate has increased. In the last five years, we have seen estimates that roughly 5,000 venture-backed companies have either been acquired or gone out of business. While there are still a few thousand companies that may languish and not achieve liquidity, the competitive climate for private companies is allowing more revenue generation, profitability and liquidity.

Is a new overhang developing? Most venture funds will have raised new funds in 2004 or 2005. New funds are significantly smaller than funds raised in the last cycle. In the aggregate, the $18 billion raised in 2004 was less than the $21 billion invested in 2004. These levels are well in line with long-term averages.

More importantly, exit values exceeded money invested in 2004.  Accourding to Thomson Venture Ecomonics and the NVCA, the total value of disclosed M&A transactions jumped to $15 billion in 2004, up from $8 billion in 2003.   As many deals are not disclosed, the real number was even higher.  IPO values of $11 billion brought the aggregate exit value to $26 billion in 2004.   

Recent venture data highlights that prices have recovered from depressed levels, mostly justified by higher exit values, but we have not seen prices rise significantly on average.

We have seen some isolated price increases in mid-to-later stage deals starting around the end of last year. We view this as partly a function of 1999-2001 vintage funds needing to make their last investments in order to avoid refunding fees for capital committed but not drawn.

Looking to the 4-5 year new investment cycle for vintage 2004/2005 venture funds, we see very healthy market conditions. As discussed, the dollars available to invest are significantly lower than recent years. Increases in IT spending are justifying the creation of higher quality private companies. Financial markets are supporting increased M&A and IPO activity at higher prices. The net impact should be a positive venture returns.

Investment has kept pace with fundraising for the last 11 years

The LBO Bubble

During the last five years, Leveraged Buyout Funds, LBO funds have boasted favorable returns compared to public and venture market returns. This has caused a flood of new capital into large, mid and small market LBO firms. According to Venture Economics, LBO funds raised $46 billion in 2004, compared to Venture funds raising $18 billion. Given the run up in public market prices and this glut of new capital, it’s hard to imagine how LBO can go in any direction but down.

M&A Trends Boost Prospects for Venture Returns

According to Venture Source, median prices paid in 2004 for Venture-backed companies have returned to the $40 million level, up sharply from $22 million in 2003. This is based on 376 transactions reported. This compares favorably with an average of $22 million raised prior to M&A. It took longer, over 4 years, for those companies to reach exit, on average.

We see a healthy balance of supply and demand to fuel more M&A activity at even higher prices. On the supply side, more private companies are nearing or reaching profitability with revenues that can be attractive to public companies. Public companies have richer stock currencies and a need to buy growth by adding new technologies to exploit existing distribution.

The Next Network Effect - Software

Failed Internet promises have made us jaded, but it remains a trend that keeps on giving. The nature of big markets is that it typically takes a few generations of trial and error to make technologies easy enough to use for the majority. There are all kinds of We now take the Internet for granted, which is typically a sign that a real market has emerged. We are seeing the network effects of mass connection to the web. We now depend on the Internet for basic communication.

The spike in availability of broadband and wireless access is enhancing the Internet’s value. Right now we have the promise of getting text, video and voice over any network. Of course, we’re not there yet, but convergence is creating a powerful network effect. We will demand more services in more places, enabling real business growth

We still have problems with the wired world. We assume that most major software applications will be a pain to install, implement and maintain. Even successful enterprise deployments have created massive data pools that are barely being used. More applications are being simplified and improved to allow Web access. Linux and other open standards are helping. We may also get to the point where we start to take for granted that software works easily. When we reach this point there should be a significant network effect that dramatically boosts the software business. I would not be surprised to see breakthroughs over the next five years.