Silicon Valley Venture Capitalist Confidence Index

(Bloomberg ticker symbol: SVVCCI) Third Quarter 2012

(Release date: November 1, 2012)

Mark V. Cannice, Ph.D. University of San Francisco The quarterly Silicon Valley Venture Capitalist Confidence Index (Bloomberg ticker symbol: SVVCCI) is based on an on-going survey of San Francisco Bay Area/Silicon Valley venture capitalists. The Index measures and reports the opinions of professional venture capitalists in their estimation of the highgrowth venture entrepreneurial environment in the San Francisco Bay Area over the next 6 - 18 months.1 The Silicon Valley Venture Capitalist Confidence Index for the third quarter of 2012, based on a September 2012 survey of 31 San Francisco Bay Area venture capitalists, registered 3.53 on a 5 point scale (with 5 indicating high confidence and 1 indicating low confidence). This quarters index was up slightly from the previous quarters confidence reading of 3.47. Please see Graph 1 for trend data.
Graph 1

Trend line of Venture Capitalists' Condence

over the last 35 quarters

5 Confidence Index 4.5 4

3.5 3

2.5

Time

Publishing a recurring confidence index of professional venture capital investors is intended to provide an on-going leading indicator of the overall health of the high-growth new venture environment. Questions about this study or related topics should be addressed to its author at Cannice@usfca.edu.

The Silicon Valley Venture Capitalist Confidence Index is sponsored in part by:

Silicon Valley Venture Capitalists confidence in the future high-growth entrepreneurial environment in the San Francisco Bay Area rose slightly in the third quarter of 2012. The modest increase followed a significant decline in confidence in the previous quarter and suggests a possible stabilization in confidence at a level somewhat lower than its nearly nine-year average. Although the Index edged higher, the venture capitalists who responded to the Q3 survey pointed to concerns over stubbornly high valuations despite recent venture-backed public market disappointments such as Facebook, Zynga, and Groupon, and despite the overall performance of the venture asset class. Furthermore, funding available for life science ventures continues to be limited, and macro economic and political uncertainty are affecting investments across industry sectors. Notwithstanding these concerns a number of this studys participants reported a positive sentiment assured that Silicon Valley remains the epicenter of technology innovation and new venture creation where trends in analytics and IT infrastructure are providing opportunities for well managed ventures that solve enterprise issues. In the following, I provide many of the comments of the participating venture capitalist respondents along with my analysis. Additionally, all of the Index respondents names and firms are listed in Table 1, save those who asked to remain anonymous. Despite concerns about the broader economic and political environment, a number of the responding venture capitalists to the Q3 survey reported positive sentiment, concluding that as positive technology trends continue, they will be developed in Silicon Valley. For example, Tom Baruch of formation | 8 confirmed continued dominance of the Bay Area as a source of innovation and entrepreneurship throughout the entire world. And Jeb Miller of Jafco elaborated, saying Silicon Valley remains the epicenter of the three most compelling market opportunities in technology, the mobile internet, cloud computing and big data. The IPO market remains open for high quality issuers like Palo Alto Networks and the strategic exit environment remains healthy as legacy vendors put their cash to work acquiring innovation. Similarly, Jon Soberg of Blumberg Capital shared I am very bullish on the opportunity for high-growth venture in the next few years because we are seeing incredible growth trends in mobile and social online commerce and major changes in enterprise software as well. A renewed focus on value creation with strong management in new ventures along with an improving exit market have helped support optimism. Shomit Ghose of Onset Ventures explained Investors and entrepreneurs alike have experienced their Back to the Future moment and refocused on building companies that solve real problems rather than building the Next Big Thing social network. Were seeing lots of interesting start-ups who are marrying disruptive new technologies with disruptive new business models. And Sandy Miller of Institutional Venture Partners reported With some solid recent tech IPO successes, the market seems to have moved on from the initial shock of the disappointing Facebook IPO. Private valuations remain pretty high but the quality of the companies we are seeing is impressive with a large number of scaled rapidly growing companies with great CEOs and teams. So we have a balanced market between investors and companies which is the healthiest environment. And Bob Pavey of Morgenthaler Ventures added It was already improving and QE3 will stimulate the stock market a little more. In fact, the number of venture-backed IPOs and capital raised was approximately double that of the year earlier quarter.2 Rising sectors that rely on the development of emerging technologies also point to opportunities. Dan Lankford of Wavepoint Ventures observed growing interest in smart grid, energy efficiency, and energy demand-side deals. And Bob Bozeman of Eastlake Ventures suggested that the breadth of opportunity is improving. Igor Sill of Geneva Venture Management shared I see pockets of opportunities in the current venture capital environment given some of the positive signs of economic rebound from where we were just three years ago. Prospects for the M&A markets are promising as
2

Thomson Reuters and NVCA Press Release, October 2, 2012.

strategic acquirers have excess cash to deploy, aka Oracle, Apple, Microsoft, Cisco, etc., and the IPO markets are healthy. Squares recent venture funding round of $200 million at a valuation of $3.25 Billion is a good barometer, with Starbucks among the investors. Sill added I just attended Salesforce.coms Dreamforce conference with over 100,000 attendees, up from last years 60,000. There are significant investment opportunities ahead in high growth IT sectors like cloud computing, consumer mobile, Internet, social media and payments sector, which give me a strong sense of optimism. Another VC contributor who provided comments in confidence saw opportunity based on 1. The number of proposals that we receive, 2. Monetization models that are becoming clearer although most of them are still dependent on advertising as the basis for their revenues, 3. The growth of local and mobile experience, 4. The growth of analytics to get better insights into consumer likes and dislikes, etc. And Jon Soberg of Blumberg Capital added Within the venture ecosystem, I believe the early stage will outperform because it is less subject to market swings, and the risk profile of early stage companies has decreased substantially relative to years past... Despite the aforementioned positive observations, concern regarding the capacity of the entrepreneurial environment to support high-growth ventures was voiced. Bob Ackerman of Allegis Capital indicated While the level and breadth of innovation in Silicon Valley are at close to unprecedented levels, there continues to be serious structural challenges developing in the ecosystem, including a shortage of engineering talent, high housing costs, insufficient experienced early-stage investment capital and a generally dysfunctional approach to Californias fiscal and regulatory challenges. Bill Reichert of Garage Technology Ventures explained The crush of new start-ups springing up here and coming from all over the world is incredibly exciting, and it is threatening to overwhelm the system's capacity to support them, despite the healthy recycling of funds back into the system from a continuing good pace of solid hits plus quick flips. The collapse of Zynga and Groupon, and the taint on the Facebook IPO, doesn't seem to have diminished entrepreneurial enthusiasm, but it creates a drag on the investor community. At the same time, the squeeze in cleantech has caused funding to dry up in most of the largest sectors. While we think that's an opportunity for us as investors, it does not bode well for entrepreneurs in those areas. To this point, the number of deals and total capital invested declined sequentially as well as year over year.3 Inflated valuations coupled with the weak Facebook IPO and the performance of the venture asset class also weighed on confidence. Elton Sherwin of Ridgewood Capital argued Many deals are overpriced, with poor risk adjusted returns. Deals that would have historically been priced at $5M believe they are worth $15 million Similarly, another venture capitalist respondent who requested anonymity noted lots of activity, but signs of overfunding at the early stage in many sectors, coupled with excessive valuations for late stage companies, while two other VC survey participants concluded, respectively, that the asset class has not performed, and the VC asset class appears to still be in question with many institutional LP's. Furthermore, John Malloy of BlueRun Ventures noted The Facebook IPO hangover is causing some short term skepticism here. National and international macroeconomic and political issues increased uncertainty. Elton Sherwin of Ridgewood Capital pointed to a presidential election, turmoil in Europe and a slowdown in China while another venture respondent echoed this concern, noting uncertainty caused by the US election cycle, slowing in China, and a situation in Europe that is continuing to make the exit environment choppy.
3

Price Waterhouse Coopers and NVCA MoneyTree Report October 19, 2012.

In healthcare, continuing concerns over capital availability and the resulting impact on innovation were raised. Joe Mandato of De Novo Ventures noted a continued need to conserve capital for follow on investments, and a higher bar for new investments. He continued, stating, Life science funds have continued difficulty raising new funds. Also addressing health care investing, Mike Carusi of Advanced Technology Ventures, added that he is not sure things will turn around in 6 18 months, but I do believe they will get better in 18 36 monthsI believe things will get worse before they get better. However, those firms and companies that survive this very challenging period will be in the cat birds seat in four to five years when strategic acquirers are looking for innovation and have limited companies to choose from. It is in essence, ECO 101, the supply of innovation is going down while demand (from the strategics) is going up. I believe this will cause acquisition prices to go up (down the road). Again, things will be tough for the current crop of companies/VCs, but I believe the 2012-2013 vintage for early stage healthcare deals will be a very compelling one. And Lisa Suennen of Psilos reasoned that because investment in the VC sector has dropped dramatically and is being limited largely to firms that make exclusively tech/Internet investments, many of which neither improve national economic productivity nor have profitable business models, areas like healthcare are being rejected by LPs, who are reluctant to invest in longer liquidity vehicles like venture capital despite the incredible opportunities afforded by the changing economic structure of the healthcare industry. Suennen continued, As such, new firms can't enter the field, many established successful firms are dying, and critical areas of innovation are lagging or moving offshore. I understand that LPs must feel their investments will be profitable, but to entirely eschew the asset class is to miss the areas of opportunity that do exist to make a real difference in the national economy and prosper while doing so. In summary, despite concerns over the uncertainty from Europe and China, the presidential elections, inflated valuations, returns on the venture asset class, and a lack of funding in life science investing, confidence edged up on average among the venture capitalist respondents in Q3. While the aforementioned issues have made the entrepreneurial environment more challenging, venture capitalists, as Peter Fenton of Benchmark Capital shared, have to be optimists While much attention is now focused on the political environment and the upcoming presidential election, optimism may hinge on the expectation that either an Obama or a Romney administration will recognize, facilitate, and leverage the venture capital fueled innovation and business creation ecosystem in the Silicon Valley. For now though, capital commitments to US venture funds in the 3rd quarter of 2012 declined from the 2nd quarter of 2012.4 However, the number of new funds increased so the new capital raised was not as concentrated as in previous quarter. If this quarter signals a trend, capital for innovations that coincide with new venture creation may be restricted, but what innovations are supported will tend to stretch across more sectors and lead to necessary and unexpected new products. Ideally, though, political and economic uncertainty will decline in the coming weeks and months, and in this more predictable environment, pent up strategic decisions and investments will be made and provide a better context for the entrepreneurial and innovative ecosystems in Silicon Valley and across the country.

Thomson Reuters and NVCA Press Release, October 9, 2012.

Table 1 Participating Venture Capitalists in the 2012 3rd Quarter Confidence Index Survey Participant Alain Harrus Bill Byun Bill Reichert Bob Bozeman Bob Pavey Dag Syrrist Dan Lankford Debra Guerin Beresini Deepak Kamra Elton Sherwin IDG Ventures Igor M. Sill Jeb Miller Joe Mandato John Malloy Jon Soberg Lisa Suennen Mike Carusi Peter Fenton Peter Gardner Robert Ackerman Sandy Miller Shomit Ghose Standish OGrady Tim Draper Tim Wilson Tom Baruch Tom McKinley Anonymous Anonymous Anonymous Company Crosslink Capital 7 Capital Garage Technology Ventures Eastlake Ventures Morgenthaler Ventures Vision Capital Wavepoint Ventures invencor Canaan Partners Ridgewood Capital IDG Ventures Geneva Venture Management Jafco Ventures De Novo Ventures BlueRun Ventures Blumberg Capital Psilos Advanced Technology Ventures Benchmark Capital Wavepoint Ventures Allegis Capital Institutional Venture Partners Onset Ventures Granite Ventures DFJ Artiman formation | 8 Cardinal Partners Anonymous Anonymous Anonymous

Mark V. Cannice, Ph.D. is Department Chair and Professor of Entrepreneurship and Innovation with the University of San Francisco School of Management. The author wishes to thank the participating venture capitalists who generously provided their expert commentary. Thanks also to the attorneys of Greenberg Traurig for their on-going support of this research, as well as to James Cannice for his copy-edit assistance. When citing the index, please refer to it as: The Silicon Valley Venture Capitalist Confidence Index, and include the associated Quarter/Year, as well as the name and title of the author. The Silicon Valley Venture Capitalist Confidence Index is a registered trademark of Mark V. Cannice. Copyright 2004 2012: Mark V. Cannice, Ph.D. All rights reserved.