Every once in a while, you read something and you agree with what the author is saying. As you read, you can hear the resounding “yes” that accompanies the comprehension of the text. What doesn’t happen as often is the experience of where you find yourself physically nodding your head in agreement. Well, that is exactly the experience I had when I read Alan Patricof‘s piece in the NY Times DealBook: Another View: V.C. Investing Not Dead, Just Different.

Alan is the founder and managing director of Greycroft Partners, and he clearly has a lot of years of experience to make this analysis. In meeting and chatting with some of the veterans of the venture industry the one thing that I’ve  consistently noticed is that there are a lot of smart people in the business. I haven’t had the pleasure of meeting Alan, but his column certainly resonated with me.

In essence, Alan’s column gets to the core of why I started K9 Ventures, and does a wonderful job of explaining why and how Venture Capital needs to change. He makes the case that because of the changes in the public markets and what it takes to take a company public, those exits are going to be far and few. Therefore, venture capitalists need to change their models. The change can be one of two things, either you focus in the early stage and in that case you have to have a smaller fund and expect to get smaller exits (my strategy) or you can move upstream and go for the later stage opportunity (which is where I would argue most of the well known funds are headed, for example, KP is raising a total of $1.25B).

Though the whole article is well worth the read, I took the liberty of excerpting the key paragraphs here:

… I believe that the paradigm has changed for the venture business. We can no longer realistically expect the same kinds of absolute returns that were achieved in the past through a quick turnaround from start-up to liquidity through an I.P.O. Rather, I believe that most of the companies that venture capitalists are funding today will find an exit through merger or acquisition. And if we expect to achieve a return in a reasonable time frame of three to five years, we are probably looking at a sale price of $20 million to $100 million. This is the valuation range where most young companies are being acquired.

To compensate for these lower gross return expectations, we must establish initial valuations, usually in the single digits, that can provide an adequate multiple return and internal rate of return. Inevitably, this suggests that a true venture capital firm should be reverting to smaller-scale funds and restricting individual investments in early-stage companies to accommodate the realities of the exit opportunity. Larger funds can focus on later-stage growth opportunities that can absorb greater amounts of capital where there still exists the possibility of taking companies public in a timely manner.

I’ve bolded the key statements in the excerpt that had me nodding along as I read Alan’s article.

VentureBeat just blogged about some new statistics published by Thomson Reuters and the NVCA in this post: Venture fundraising: Going, going, gone?.

Here is the most damning/shocking excerpt from this post:

Venture capital funds raised only $3.4 billion in the last three months of 2008, according to new data from Thomson Reuters and the National Venture Capital Association. Unsurprisingly, this is a big drop (about 70.9 percent) from the same period in 2007, when venture firms raised $11.7 billion, and also a substantial decline from the $8.4 billion raised in Q3 of 2008.

In my previous post, A Time for Change in Venture Capital, I’d guess-timated that a 50% reduction in the total money going into venture capital is not inconceivable, but a 70% decline is even more severe. I would still hazard a guess that Q4 2008 was by far the worst economic time for venture fund-raising — primarily because the LP portfolios were so battered that no one was really in the mood to talk about new commitments to venture (and even especially given that the returns on venture capital have been nothing but disappointing for most LPs). Depending on how 2009 shapes up, chances are that the 2009 numbers will perform better than the 70% decline for Q4 2008. Very curious to see how this year plays out for the venture industry.

Jason Mendelson, co-founder and managing director of Foundry Group has a brilliant (brilliant in the sense that I agree with it 100%) guest post on VentureBeat: FAS 157 is stupid. It is a must-read post in which he discusses the new accounting rules (FAS 157) in effect regarding valuation of portfolio companies in the venture industry. Jason makes the point loud and clear about the “stupidity” that this represents.

In a well-intentioned but thoroughly misdirected effort to correct the accounting practices that occurred in cases like Enron, legislators and regulators have succeeded in doing little more than making the system even more obtuse, arcane, onerous, and, of course, “stupid.”

Peter Rip, General Partner at Crosslink Capital recently authored a post on his blog EarlyStageVC that has been getting a lot of attention. Peter’s post “The Coming Venture Capital Boom” presents a view that is hard to find these days. I had a mixed reaction to Peter’s comments. To a large extent I agree with him that there will be another boom in venture capital. After all, the industry does move in cycles and the boom and bust cycles are essential for survival of the ecosystem. This was best described in a quote by Kanwal Rekhi, Managing Director of Inventus Capital Partners: “A recession is like a forest fire. It frees up resources for the newer generation of companies.”

So I agree with Peter that there will be another boom coming in venture capital — it is inevitable. I would add though that before that boom happens, and before venture firms can benefit from this upcoming boom, there need to be some changes. The current environment provides enough momentum and incentive for a change in the venture capital industry. It is my opinion that there needs to be a clearer distinction between which firms are doing “early-stage” deals and which firms are doing “growth-stage” deals. The practices in venture have evolved but the nomenclature for stages of deals has not — for example, is Series A really the first round of funding for a company? Not any more.

Peter also makes the case for “great restart and late-stage opportunities.” Though that may indeed be the case, there are more companies that will go under because they cannot raise new capital and their existing backers do not want to participate. There will be some companies that may go through a restart; but a restart is really a softer way of saying re-cap. The re-cap benefits the new investors that come in and do a downround, but it is very demoralizing for the entrepreneurs and the team. Downrounds might be an opportunity for VCs, but they’re not fun.

I do agree about the separation of the wheat from the chaff in this economy and an overall improvement in the quality of entrepreneurs and startups. The Darwinian nature of the environment makes sure that only those who are truly commited and devoted to making their companies succeed will persevere. I also agree with the rest of Peter’s comments, especially his three points regarding the silver lining.

I’ve maintained that “It is never a bad time and always a good time to do a startup.” Doing a startup is hard regardless of when you start and it is only “Insane perseverance in the face of complete resistance,” (:Jack Thorne) that can make a startups succeed. There will be another boom in Venture Capital — it will just be after we get through the current environment and hopefully change for the better. In the meanwhile, there are still good companies out there and there is still money out there for those good companies.