Sequoia Announces the New VC Reality

Matt Marshall of VentureBeat posted the Sequoia CEO presentation that is buzzing around VC circles and generating plenty of commentary. Putting aside the colorful graphics and the pointed 'cutting the fat' imagery, the presentation is excellent and right on the money. The new reality for entrepreneurs and venture capitalists alike is that we need to focus on building private companies that are cash flow positive while they remain private. The old 'build it and they will come", "technology first" approaches simply won't work in a liquidity constrained capital markets environment that is in major systemic flux. This does not, however, categorically spell 'Bad News' for the VC industry.

The first positive step is for VC's and entrepreneurs to recognize that Silicon Valley is not insulated from the capital markets-- the lag time between traded markets "Cause" and their "Effect" on the less liquid VC markets gives us the chance to make necessary changes to our business models before our portfolio companies go out of business.  At Levensohn Venture Partners we are proactively addressing the challenges as well as seeking out the opportunities created by the leveling of the old Wall Street while we wait for the New Wall Street to emerge (and it will).

Venture capital is all about capital formation, creating new jobs, and embracing innovation-- and these are essential elements of the capitalist engine that America must support to restore a new and lasting equilibrium to our economy. It is incumbent on the venture capital community to build companies which embrace fiscal discipline and can achieve positive cash flow organically. I also expect that we will see many more private to private mergers between existing VC-backed companies in growing technology markets in order to achieve scale and profitability.

ADDENDUM:

One of my Silicon Valley CEO friends made the following observation after reading this post:

Yes this is the time to be careful in how companies
spend - but it is also a time that good companies will be killed by
this type of scare tactic.  Many start-ups will see their revenue
impacted significantly by the economic downturn, but if the
fundamentals of the technology and business model are sound - this is
the time they need venture backers that will get them through the
downturn with some support and nurturing.  Arbitrarily deciding the
everyone has to get to profitability will create it's own death spiral
in many companies as they cut too deep to survive.  The venture firms
have the money to provide the cushion to get through bad times - they
shouldn't do it for everyone, now is a good time to weed out
investments that are mediocre - but it is also the time to support
those that have the potential to go on to do something great. 

I agree completely with this observation-- let's not forget that great companies are started during hard times and that we cannot abandon innovation and research in the name of cash flow.  To be clear, at Levensohn Venture Partners we will continue to make early stage investments as we do our part to help build the next generation of great companies.

Comments

[Charles Weller]

Please take "Cash flow positive" thinking to the next level with Prof. Rappaport of Northwestern's "Long Term Cash Flow" (LTCF) accounting metric that replaces "accrued earnings."

As you state, cash flow is the key.

For another, he shows that financial shennanigans will not be eliminated, no matter how much more regulation and regulators are added,until accrued earnings are replaced by LTCF as the key metric.

Best of all, LTCF is something the ordinary person can understand and use to take back control of their futures -- potentially very soon, thus restoring widespread hope for the future that is so urgently needed.

Why? For one, cash flow is something everybody understands.

For another, "long term" is a business question, not mathematical mumbo jumbo.

Again, whether a company will generate cash flow for the long term is a fundamentally different analysis than accrued earnings. Again this analysis is something many people can understand, especially using the business tools Rappaport proposes such as Michael Porter's. I've written a book with Porter for the antitrust community that includes not only his well-known 5 Forces tool, but two other tools he's developed that can be understood and used by anybody.

Mike's 3 tools, unlike any others I know of, can explain more than 80% of the differences between 134 countries GDP per capita -- aka cash flow.

The good news is the SEC has the legal authority to drop FASB rules, as it has already done in part and has a roadmap to do over the next few years.

Why doesn't the VC community lead the drive to change to Rappaport's LTCF? My paper exploring more of its truly thrilling implications is available on request.