The Future of Venture Capital

This week I graduated from the Kauffman Venture Fellows program.  It was a proud day for me and my mentor in the program, Will Rosenzweig.  The Kauffman Fellows program is designed to develop future leaders of the venture capital industry and share best practices in entrepreneurship and innovation. Since its creation 14 years ago, graduates from the Kauffman program have collectively made $6 billion in venture capital investments, creating hundreds of new companies, which generate $15 billion in annual revenues, and have generated 50,000 jobs.

The subject of this posting is the makeup of my Kauffman class, the topics we discussed at yesterday’s Affinity Graduation Day and how these portend to the future of the Venture Capital industry.  With 29 Fellows, my graduating class is the largest and most diverse class of Fellows in the history of the Kauffman program.  The fellows represented venture capital firms from 10 different countries and 8 different US states.  These included the traditional innovation regions of San Francisco, Boston and New York, high growth, emerging economies like China, India, and Brazil, and countries with nascent venture capital industries, such as Mexico, Italy, and the Palestinian Territories.  The fellows also represented a broad range of venture capital investment models from Incubation to early stage Angel and Micro VC, to traditional VC, to Secondary Investors and Venture Philanthropy.

This amount of geographic and investment model diversity is relatively new for the Kauffman Program.  As the chart below shows, for the first 8 years of the program all the Kauffman Fellows were based in the US, and 80% worked in San Francisco and Boston.  In the last few years, only 60% of the fellows were US based and only 40% worked in San Francisco and Boston.  It was announced this week that the 2011 incoming class of Kauffman fellows will continue this trend and be the first class with less than 50% of the fellows working in US based firms.

This growing diversity reflects the fact that venture capital and entrepreneurship is now intrinsically a global business. For example, even though my firm, Physic Ventures, invests exclusively in US based companies, nearly half our portfolio has business activities in Europe or Asia.  These include manufacturing products in China, performing R&D in India, and outsourcing software development to Eastern Europe. This is a profound change for the Venture Capital industry.  When the Kauffman program began in 1996, most VCs only invested in companies within an hour’s drive from their office.  Entrepreneurs and service providers were clustered close by and beta customers were also local.  These days, the global reach of the internet, the low costs of outsourced R&D and manufacturing, and the emergence of entrepreneurial talent around the world means that, while venture investing remains mostly a local activity, every startup needs to have a global perspective from day one.

In additional to geographic diversity, the other key topic of yesterday’s graduation day was the growing diversity in how companies are financed at inception and new ways for VCs to exit investment positions to return capital to their LPs.  I moderated a panel where Blair Garrou described the successful Micro VC model that his firm, DFJ Mercury, has developed for investing in capital efficient, early stage IT and science companies.

On the same panel, Eugene Song from W Capital described the rapid growth of secondary funds who purchase both individual investments and subsets of portfolios of direct investments.  In the last few years, this secondary asset class has grown from a niche asset class to deploying over $10B in 2010.  This growth in secondary transactions is driven by the need for alternative ways to monetize investments in an era when it is taking more time for US ventured-backed companies to reach an exit.  In 2010 the median time from first investment to IPO reached 9.4 years, the longest on record.  When compared with an equivalent time to exit of only 2.6 years in China, it is easy to understand the current enthusiasm to invest in Chinese funds.

Saed Nashef

Finally, I want to take a moment acknowledge one of the many exceptional people in my Kauffman class.  Saed Nashef joined the Kauffman program two years ago with the goal of starting a new venture capital firm in the Palestinian Territories.  Like many of my classmates I thought this was an admirable goal, but in the dark days of 2009 when half the venture firms in silicon valley couldn’t raise capital, I doubted many LPs would be willing to take the risk of investing in a first time fund, located in the West Bank.  Well, Saed proved us all wrong and earlier this year, Sadara Ventures announced it had raised $29MM and is open for business, making its first investments in West Bank based IT firms.  Saed was selected for the 2011 Jiff Timmons award for Entrepreneurial Leadership by his classmates – a most fitting and deserved award for someone who embodies the very best of the Kauffman program and is an inspiration to us all.