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The VC industry is great catalyst of job and GDP growth in the U.S. Only, it has a major problem on its hands: it is going to shrink considerably over the next few years. The challenge is that investors like pension funds, college endowments, and wealthy families allocate a certain percentage of their money to the VC industry (e.g. 3%).

Now 3% of investments in 2008, before the stock market, real estate, and other categories crashed was a larger number than 3% of investments today. Unlike publicly traded equities, VC investments are very illiquid so what was 3% in 2008, with portfolios lower overall, might represent 5% of the portfolio today. Thousands of investors needs to shrink their VC allocation down from 5% to 3%, and that’s going to result in many VCs going out of business.

Here’s the number one thing the VC industry would like to do to save itself:

The VC industry should make an across-the-board cut of 30% to all internal company valuations.

Internal company valuations are required to report back to the investors but in reality represent a guess at the company value since the companies are private and the valuation is but a range. After cutting the valuations internally and reporting the new values back to the investors (that’s not a tenable conversation or legal) the investors’ portfolio allocation would back inline.

Since the portfolio allocation would be back inline investors can put new dollars into VC as the rest of the portfolio grows. As it stands now with a significant overallocation to VC, investors are going to allocate even fewer new dollars (or none!) to VC for a period of time until the existing dollars plus new dollars equals the desired percentage of the portfolio.

This strategy won’t happen but would be the number one thing the VC industry as a collective could do to save most of the size of the industry.

What else? What do think of this idea on how the VC industry could help itself?

There’s an interesting phenomenon that takes places with startups looking to raise money: the startup is more valuable on day one than on day 100. Naturally, you’d think that working over three months on a business would make it more valuable, but for startups with no operating history a clean slate makes it easier to paint a big picture on this new, valuable business. You see, after 100 days, the entrepreneur should have launched the product or service in a minimum viable manner, have prospects and (hopefully) customers, and be well on his/her way to making money.

The strange disconnect occurs when the company starts generating revenue and has paying customers. Now, with real numbers, an investor can start doing projections and come up with a model for how the company will grow and be valued. Almost always this results in a company valuation which is less than the pie-in-the-sky value assigned to the business on day one.

So, if you’re raising money, and have a track record (required to raise money in Atlanta for an idea-stage startup), think hard about how the value of the business is likely to be higher at the beginning when you don’t have real-world data.

Two weeks ago I was at Jimmy John’s in Buckhead near my house and there was a sign on the wall with a parable (see photo I took from iPhone to the right). Here is the story titled How Much is Enough:

The American investment banker was at the pier of a small coastal Mexican village when a small boat with just one fisherman docked. Inside the small boat were several large fin tuna. The American complimented the Mexican on the quality of his fish and asked how long it took to catch them.

The Mexican replied, “only a little while.”

The American then asked why he didn’t stay out longer and catch more fish?

The Mexican said he had enough to support his family’s immediate needs.

The American then asked, “but what do you do with the rest of your time?”

The Mexican fisherman said, “I sleep late, fish a little, play with my children, take siesta with my wife, Maria, stroll into the village each evening where I sip wine and play guitar with my amigos, I have a full and busy life.”

The American scoffed, “I am a Harvard MBA and could help you. You should spend more time fishing and with the proceeds, buy a bigger boat, and with the proceeds from the bigger boat you could buy several boats. Eventually, you would have a fleet of fishing boats. Instead of selling your catch to a middleman you would sell directly to the processor, eventually opening your own cannery. You would control the product, processing and distribution. You would need to leave this small coastal fishing village and move to Mexico City, then LA and eventually NYC where you will run your expanding enterprise.”

The Mexican fisherman asked, “But, how long will this take?”

To which the American replied, “15-20 years.”

“But what then?”

The American laughed and said that’s the best part. “When the time is right you would announce an IPO and sell your company stock to the public and become very rich, you would make millions.”

“Millions?” asked the fisherman, “Then what?”

The American said, “Then you would retire. Move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evening, sip wine and play your guitar with your amigos!”

(Author Unknown)

 

 

A few nights ago we saw the movie The Social Network and really enjoyed it. One of my favorite anecdotes came when the characters were debating the potential of Facebook. I’ll paraphrase the story without giving away too many details of the movie. One of the main characters poses a question to the founder of Facebook: Have you ever seen a photo of a fisherman with 14 trout caught in one day? Of course he hadn’t as fishermen like to show off the pictures of a giant marlin. The character’s point in the movie was that the entrepreneur needs to decide if Facebook is going to be a trout or a marlin.

There’s no right or wrong answer but I think it’s important for entrepreneurs to think through the question of what they want to be in the future.

What else? What are your thoughts on the trout vs marlin question? What did you think of the movie?