As a venture firm founded during the last gasp of the dot-com boom in April 2000, San Francisco's Azure Capital Partners got a crash course early on about rough economic conditions. Today, founding general partner Mike Kwatinetz readily admits the firm made too many investments during its first year and was not focused enough on value.
But as a survivor of the tech downturn, Azure also knows that there are profits to be made during even the toughest times. Just last week Azure cashed in on an investment made during the dire post-Sept. 11. 2001, days -- a time when many considered the Internet to be all but dead -- when eBay Inc. acquired online payment service Bill Me Later Inc. for $945 million.
Kwatinetz says the firm is recalling both those lessons now as more clouds appear on the economic horizon. Although Azure has no plans to reduce the number of companies it invests in, it will be increasingly focused on what he calls "value venture investing" and may seek opportunistic later-stage investments in startups whose existing investors are unwilling to continue.
"We just won't pay an inflated valuation," says Kwatinetz. "There are deals that we don't do every year, where we like the company, but they are asking for too much." Entrepreneurs are optimistic by nature, he adds, and most are far too optimistic about their exits.
When Azure ran some numbers on recent exits, it offered a revealing insight into how excessive valuations could kill later returns. Of all startups that successfully completed exits last year, he says, the average proceeds tallied up to $110 million. It's harder to break out the the returns VC backers reaped from these deals since the funds raised varied from company to company. Still, Kwatinetz says its a sobering figure, which would equate to a return of about 2x for a company that had raised $40 million, after taxes and other costs get factored in.
As everyone in the VC world knows, a 2x return on investment is nothing to celebrate, given that will be offset by all the other portfolio companies that fail outright. Of course, many startups project eventual outcomes of $500 million, and some may achieve or surpass those goals. But Kwatinetz notes that VCs need to be mindful that companies that make such projections are including themselves in the top 1/10 of 1% of all startups.
For Azure, what's key is staying focused on an efficient use of capital and avoiding both the companies that appear too optimistic as well as some that may be realistic but just have large capital requirements. "I'm not saying we'll never fund another semiconductor company, but in the past four years, we haven't found one where we thought the large amount of capital needed was justified," he says.
The good news is that entrepreneurs will probably be willing to accept smaller valuations, and exisiting investors may chose to walk away from some startups with high valuations. "We'll be looking for situations where existing investors are unwilling to continue," he says. "We always see some of those in economic climates like this. We are not trying to be vultures, but we are looking for value." -- Andrea Orr
See Oct. 6 post on eBay's acquisition of Bill Me Later from Tech Confidential
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