Down decade for VCs

As Mark Twain might have put it, the rumors of venture capital’s death in Colorado have been greatly exaggerated. But there are, well, some issues.

According to the MoneyTree Report from PriceWaterhouseCoopers and the National Venture Capital Association, Colorado companies closed on $610 million in venture capital in 2011 after bottoming out in 2010 when the state’s companies reported raising about $475 million.

While both the local and national year-to-year trends are positive, Colorado’s share of national venture-capital dollars has never bounced back to its dot-com-mania peak of around 4 percent in the halcyon days of 2000 ($3.8 billion of a nationwide $99 billion, according to the PWC/NVCA survey). In 2011, it was closer to 2 percent ($610 million of $28 billion), and more than 90 percent of that came from out of state. Companies based in Silicon Valley, meanwhile, attracted about 40 percent of all VC money invested nationally in 2011, $11.6 billion in all.

“Colorado has in some ways waited for the money to come to us,” says Steve Foster, president of the Colorado Technology Association. “It ain’t coming to us. We have to go out and get it. We need to have conversations with the East and West coasts. We need them to come here and dig some roots.”

Foster says the state’s tech sectors are flourishing, VC or no VC. “Colorado is a great place to start a company,” he says. “The momentum is building, the community is growing, and the excitement is running rampant.”

But all the excitement hasn’t necessarily translated into more funding for local startups. “It feels like we’re going backwards,” says Foster. “Funding is straggling in from different areas. Colorado is an extremely innovative and entrepreneurial state, but most of the funding is coming outside of Colorado. There are some great angel investors and super angels, but there are no substantial VC firms in Colorado.”

Brad Feld, a managing director at standout Boulder VC firm the Foundry Group, quibbles with the PWC MoneyTree numbers (largely because they’re self-reported, and many angel investments go unreported). He declared an email interview on VC in Colorado “a waste of energy” after two questions.

Maybe Feld is cranky because of his industry’s numbers: They pretty well stink. The average 10-year return on venture funds is careening toward negative 5 percent, as compared to around a roughly 4 percent positive for the S&P 500 during an anemic decade for stocks. There’s also a “best and the rest” stratification, with funds that have invested in big hits (like Foundry, with stakes in Zynga and other stratospheric startups), and then everybody else, including numerous zombie funds on autopilot until they mercifully unwind. Plus there’s been a major shakeout, with more than half of the country’s VC funds shutting down in recent years. Where there were more than 1,000 VC firms in the U.S. in 2007, fewer than 400 remain.

Seth Levine, one of Feld’s cohorts at Foundry, sees this shakeout as the last air escaping from the dot-com bubble. “Clearly the ‘average’ fund isn’t performing well,” he explains. “But we’ve known that for quite a while. And no investor wants to be in an average fund. Like a venture fund’s portfolio itself, performance in the venture industry is skewed very heavily to the very top performing funds. The best performing funds continue to perform well and outperform, even on a risk-adjusted basis, other asset classes.”

Still, it’s hard to sell limited partners on new funds with 10-year industry returns that are notably underwater. David Cohen of TechStars in Boulder has bucked the local trend by raising a new $28 million fund this year called Bullet Time Ventures II, a sequel to his Bullet Time Ventures, launched with $5 million in 2009. His advice to Colorado entrepreneurs looking for VC: “Get local investors involved before looking for out-of-state money.”

But here’s the conundrum. Local VC pickings have gotten a lot slimmer in recent years. Numerous Colorado-based VC firms have closed their doors or ceased investing because money has gotten much tighter in the years since the economic crisis of 2008. Venture capital under management in the state slid from more than $5 billion in 2004 to about $1 billion last year.

“We’ve lost a lot of our indigenous venture funds,” says Christine Shapard, executive director of the Colorado Cleantech Industry Association. Fewer Colorado-based funds translates to less out-of-state money, she adds. “So many VCs on the coasts want a local lead.” Shapard says that cleantech has fared well, raking in more than half of all VC invested in Colorado in recent quarters, but there’s a catch: “That’s all going to mature companies. I haven’t seen any early-stage investments, any A rounds.”

The Public Employees’ Retirement Association (PERA) of Colorado has put out feelers for a manager of a Colorado-focused fund, something Shapard hopes will catalyze outside investment. “The model is what Utah has done successfully,” says Shapard, referring to the Utah Fund of Funds, launched in 2003 with a charter of $100 million and augmented with another $200 million in 2008. This money is invested in VC funds with a condition that out-of-state funds spend a predetermined amount of time in the Beehive State. To date, the Fund of Funds has indirectly funded roughly 40 Utah-based companies to the tune of $250 million.

Shapard says Colorado needs to likewise “put money into venture funds and encourage them with a carrot and a stick to look at Colorado companies.” To its credit, the State of Colorado has dipped its toes in these waters by staking High Country Venture with $25 million in 2005 and another $25 million 2010. But Utah’s fund is about 10 times larger on a per-capita basis, and over the same time that Colorado’s venture capital under management dropped by 80 percent, Utah’s more than doubled. End result: As of 2010, Utah was ahead of Colorado.

Jim Linfield, the managing partner at Cooley LLP’s Colorado office in Broomfield and chair of the Governor’s Advisory Committee for Venture Capital Investment, testified to the state House in favor of a Colorado Fund of Funds earlier this year. The subsequent party-line vote quelled the possibility. “The Republican view is that it isn’t something the state should be involved in,” says Linfield. But over half of the states do have such a fund, he adds. “It’s unfortunate, due to the state’s fiscal situation, that we haven’t put any money behind it. It does put us at a competitive disadvantage to other states.”

Linfield dismisses the 10-year returns, noting that people who invested in the stock market in 2008 were undeterred by horrible 10-year numbers and consequently doubled their investment. The state would be wise to do the same, he says. “The best time to invest in the venture market is when valuations are depressed.”

Historically, venture capital has seen several boom-and-bust cycles. After legislation opened up the floodgates for pension plans to invest in venture funds in 1979, VC investments boomed for a decade before contracting and then booming again until the dot-com meltdown of 2001.

“Venture capital ebbs and flows,” says Brad Bernthal, an associate professor of law at the University of Colorado at Boulder and director of the Silicon Flatirons Center’s Entrepreneurship Initiative. “What’s been changing for Colorado is that regional funds have not regained favor among limited partners.”

Beyond the Foundry Group and its more national footprint, the cupboard is pretty bare in Colorado, says Bernthal. “And some of Colorado’s legendary venture capitalists are nearing retirement,” he adds, invoking the name of Centennial Ventures co-founder Steve Halstedt. “Where is the next generation of Steve Halstedts and where are they going to come from in Colorado?”

Steve Halstedt himself says the next generation is already in place, represented by Feld, Levine, Cohen and many others. He’s bullish on PERA’s potential investments as well as the state’s entrepreneurs. “Good companies in Colorado can still find out-of-state capital,” Halstedt says. “If you’d asked me three of four years ago, I would have been relatively negative. I think that’s changed.” The reason for the turnaround? “There’s been a general groundswell in entrepreneurial activity.”

“There’s always going to be space for smart money,” says Tom Frey, self-described futurist and executive director of the DaVinci Institute in Louisville. “But with the pace of business and the speed of change, the VC model has to adjust to get quicker turnaround on these deals. Plus, there are so many horror stories about dealing with VCs, entrepreneurs don’t want to go down that path.”

As a result, “There’s a lot of experimentation out there,” says Frey, namely TechStars-style “funded incubators.” Co-founded by Feld and Cohen, Boulder’s TechStars has been a smashing success, expanding into four cities beyond Boulder. Competition is stiff: In New York this year, 14 startups were selected out of 1,500 applicants. Many observers feel the smaller-stake, higher-touch model could be a template for the VC industry moving forward.

Crowdfunding is the other big buzzword. While only accredited investors have been allowed to invest in startups, many entrepreneurs would love nothing more than to harness the power of the crowd a la Kickstarter – but it’s illegal for a company with long-term plans that might include an IPO. Defenders of the status quo argue this keeps the fraudsters at bay, but the Jumpstart Our Business Startups (JOBS) Act that was signed into law in April will make it easier for startups and small businesses to raise funds, especially through online crowdfunding. Startups could conceivably look to Facebook and other social networks for funding.

CU’s Bernthal argues that small-ball crowdfunding might work for Internet and software startups – “There’s a saying in software that $500,000 is the new $5 million,” he says – but cleantech and biotech are more capital-intensive. “They need venture capital money to flourish. Without it, we’re going to see less activity in the state.”

Jon Nordmark, CEO of Denver’s, says his company landed funding via AngelList (, which uses the crowdfunding model to match accredited angel investors with startups. “It’s provided access to world-class angel investors,” he says. “We got money without even talking to people.” Nordmark says AngelList could help fill a local “void,” adding, “There should be more funds here.”

The CTA’s Foster doesn’t think Colorado needs to reinvent the wheel, rather just do a better job promoting it. “Ninety percent of Colorado’s problem is a PR problem. What we need is to tell the story of what is happening in Colorado. Boulder’s doing great, but it doesn’t end there.”’s Nordmark feels the entrepreneurial ecosystem in Colorado would get a much-needed boost from a big IPO. “You need startups to get good exits and you have to hope that people who benefit from those exits turn around and invest in new startups in the area,” he says, pointing to the beneficiaries of Microsoft and Dell who became angel investors as prominent examples. “That’s what makes Seattle and Austin so great. Denver’s got a little of that, but we need more.”

But without more VC flowing into the state, Colorado’s next big thing might just end up moving to Seattle or Austin before it goes public. Regardless, many insiders insist the golden age of VC is yet to come. For one thing, China’s cash reserves are far too vast for the country’s good, and the country’s central bank recently announced plans to launch a $300 billion investment vehicle focused on the West. There’s more where that came from, and negative 10-year returns or not, American venture funds still look like a relatively good bet.

Categories: Finance