Last night it was announced that the Administration and Congress had reached an agreement to extend the debt limit to 2013, avoid a U.S default, and begin to reduce the federal deficit. This agreement likely will be voted on by the Senate and House over the next 36 hours and is comprised entirely of spending cuts. It does not include any proposals to increase taxes, including carried interest.
However, the agreement does create a small bi-partisan, bi-cameral committee that will examine further ways to reduce the deficit -- including tax reform. Once the agreement is passed and the composition of this committee becomes clear, we will understand more regarding how the Committee could impact the venture and entrepreneurial communities. We anticipate that all areas of tax reform will be on the table ultimately -- carried interest, capital gains, partnership and corporate tax structures will likely be addressed in the coming months. The NVCA plans to work with the Committee and to advocate for our long held position about the importance of encouraging long-term investment. We will keep everyone up to date as developments occur.
Today the NVCA and PwC issued the Q2 MoneyTree VC investment numbers based on data from Thomson Reuters. Upon first glance, the second quarter fuels the fodder about a new Internet bubble - with the highest level of Internet investment in a decade. Here at the NVCA we continue to assert that the excitement around the social media space remains healthy -- perhaps a bit frothy -- but healthy nonetheless. Consider the following:
- The level of Internet investing this quarter was driven by 5 large deals which made up 25 percent of the quarter's Internet investment dollars. These rounds were exclusively expansion and later stage deals going into mature companies, which during the 2000 bubble may have already been public. Venture capitalists are nurturing these companies for the appropriate amount of time rather than exiting too early.
- The level of Internet investing in Q2 was $2.3 billion dollars into 275 deals. At the height of the "real" Internet bubble in the first quarter of 2000, venture capitalists invested $13.6 billion into 977 deals. There is a huge difference.
- Only 40 percent of the Internet deals completed in Q2 were first rounds - the remainder were follow-on, suggesting momentum in existing portfolios. Milestones are being reached and these companies are moving forward.
- Anecdotally, there are much fewer "me-too" companies being funded this time around. Inevitably there will be a shakeup and fall out because we still live in a Darwinian world, but we aren't seeing the level of copycat companies that we did in 2000. Venture capitalists are savvy enough to know that ultimately there will only be three or four winners in each category.
The Internet category is not the only sector that appears "bubbly" this quarter. Life sciences (biotechnology and medical devices) also saw an significant increase to $2.1 billion dollars into 212 deals. But again, a deeper look into theses numbers shows the majority of this investment is in expansion and later stage deals, suggesting that venture firms are focused on sustaining their existing portfolio companies in a still challenging exit market.
As I remarked in the press release, the money raised by venture capital firms in the last three years does not support a bubble theory -- at least in the same way we experienced one in 2000. The venture industry has raised far less money than it has invested over the last three years and this level of investment can not continue unless more dollars are raised in the coming quarters. In fact, the industry would be better served if a bit more money flowed from institutional investors to a broader array of firms -- not less.
Our Monday meeting in July is with Ketan Patel, Principal at New Venture Partners where he focuses on corprorate spinouts, enterprices security, mobile media and security, ad-hoc wireless networking, and communications. Having joined New Venture Partners in 2006, Ketan previously worked in a variety of operational roles in the semiconductor industry, encompassing startups and large multinational corporations including Cavium Networks, Inc. where he was part of the technical sales and marketing organization responsible for the commercialization of the industry's first 10Gbps in-line security processor. Ketan holds a BS, magna cum laude, in Electrical Engineering from North Carolina State University, an MS, cum laude, in Electrical Engineering from the University of Illinois, Urbana-Champaign, and an MBA from the Tuck School of Business at Dartmouth. His current investments include: GainSpan, Intelleflex, and TimeSight Systems.
Ketan Patel, Principal, New Venture Partners
From which industry sector do you think we will see the most innovation in the next 2 years?
Mobile security. The existing security paradigm is arguably broken, as evidenced by the multitude of high profile attacks on seemingly secure enterprise and government institutions, and does not scale well for mobile devices. Consequently, innovations that result in new security paradigms that leverage the unique attributes (such as location awareness) of a mobile device while addressing the scalability challenges of the mobile environment will be interesting. There are at least two key rules that apply to security: 1) Hackers go where the people are…they look for scale, and 2) Hackers go where the money is. The growth of smart-phones, the introduction of various mobile payment systems, and the latent value of personal information that people store on their cell phones leads me to believe that mobile security is going to get a lot of attention in the next two years.
2011 is the year of ....
Acquisitions. As the economy recovers, we have seen our large corporate partners that have been building up cash reserves increasingly looking to deploy that cash to buy companies and technologies that present them with growth opportunities; presenting startups with interesting exit opportunities.
The biggest threat to the US venture capital industry is ...
Depressed returns in the asset class.
What is your favorite book of the last year?
Against The Gods: The Remarkable Story of Risk by Peter L. Bernstein. The book is a deceptively easy read that outlines the evolution of human risk perception and resultant human behavior.
Name a venture-backed company you are not invested in but wish you were.
Zynga. They drove a business model innovation (vs. a technical innovation) in the gaming industry that has upended the classical model of game/content creation, game delivery, and monetization.
Name a practicing VC from another firm who you admire and why?
Larry Finch at Sigma. His endurance in the Venture Capital industry is simply amazing. He has had tremendous success over three decades in Venture Capital, yet retains a tremendous excitement and passion for building great companies and helping entrepreneurs. Larry’s energy towards Venture Capital is truly inspiring.
This week, two significant developments occurred with respect to NVCA’s clean tech priorities. First, the Senate Energy and Natural Resources Committee passed the Clean Energy Deployment Administration (CEDA) as part of a larger package of energy issues. CEDA has historically been a bi-partisan issue, but the political dynamics on the committee have changed significantly and the pressure to cut spending forced all the Republicans, except Ranking Member Lisa Murkowski (R-AL), to vote against it. We are disappointed that an issue that has been supported by both Republicans and Democrats has fallen victim to partisan politics, but we are very pleased nonetheless that it passed the committee and Chairman Bingaman and Ranking Member Murkowski are steadfast in their commitment to get CEDA done this Congress. NVCA is putting together a coalition of interested organization to help drive support for CEDA among the broader Senate. Some of the groups may include TechNet, the Chamber of Commerce and NAM.
The second clean tech development just occurred this morning when the House passed the Energy and Water Appropriations bill. This is the bill that funds important programs at the Department of Energy, like ARPA-E and the DOE Office of Science and Energy Efficiency and Renewable Energy. The good news on ARPA-E is that yesterday Rep. Adam Schiff (D-CA) introduced an amendment that passed which would increase funding for ARPA-E from $100M (which is the amount Committee appropriated) to $180M. In the process, we even had to defeat an amendment offered by Rep. Jeff Flake (R-AZ) to defund ARPA-E, and other amendments by Rep. Paul Broun (R-GA) that would decimate many of the programs that NVCA supports.
This funding is a significant accomplishment as most programs are seeing their dollars cut rather than increased. Many NVCA members were helpful in efforts by signing letters to Congress and getting portfolio companies to engage on this issue. NVCA members also participated in meetings on Capitol Hill in support of ARPA-E and CEDA. Thank you to all those who supported these initiatives. Our efforts paid off.
There is still much work to do on CEDA and ARPA-E, but these are very positive steps in the right direction.
On July 7, the House Energy and Commerce Subcommittee on Health held a hearing, entitled PDUFA V: Medical Innovation, Jobs, and Patients. The purpose of the hearing was to lay the groundwork for reauthorizing PDUFA V (Prescription Drug User Fee Authorization, which Congress must pass by September 2012) and highlight other areas in the FDA regulatory process that should be addressed including impediments to medical innovation. The House Energy and Commerce Committee has jurisdiction over FDA regulation and FDA user fee re-authorization for both drugs and medical devices.
Jonathan Leff, Partner, Warburg Pincus and NVCA Board Member, testified before the Committee that the U.S.medical innovation ecosystem is in jeopardy and life sciences venture capital is experiencing an alarming decline. The primary reasons? Cost, time and risk involved in developing new drugs and biologics have increased to unsustainable levels and, as a result, vital risk capital is being diverted to other industries and other countries. He noted that while many factors have contributed to this situation, a changing regulatory environment at the FDA is the most significant and that the FDA has become much more risk-averse in approving new drugs than they have in the past.
He emphasized that while protecting patients is an essential element of what the public expects from the FDA, so too is enabling the timely development and availability of new therapies. Finding the right balance has tremendous implications for U.S. leadership in medical innovation.
Mr. Leff asserted that these problems can be addressed but Congress should act now to:
- Strengthen FDA’s mission statement to reflect the importance of innovation;
- Expand the Accelerated Approval Pathway into a Progressive Approval System for new drugs that offer significant advances;
- Empower FDA to weigh all evidence, in the context of the disease being treated, in assessing benefit versus risk in new drug approvals;
- Fully detail the FDA’s benefit-risks calculus when denying or delaying approval in favor of collecting more data and;
- Ensure the FDA is provided with the resources it needs to accomplish its mission.
Janet Woodcock, Director, Center for Drug, Evaluation and Research, FDA, also testified and defended the speed of the FDA approval process citing 20 new drugs approval in the first half of 2011 and saying this rate is much faster that of our European counterparts. She also stated that FDA is approving two-thirds of first round drug applications. Paul Hastings, President and CEO, OncoMed, testified on BIO’s behalf and the National Health Council and Friends of Cancer Research also testified where there was a consistent theme that FDA’s benefit-risk decisions are negatively impacting the drug development and approval process.
Several members on both side of aisle indicated a willingness to examine the issues that Mr. Leff raised in his testimony, which was often quoted when members questioned Janet Woodcock about FDA’s impact on drug innovation.
These recommendations are consistent with both NVCA/MedIC and BIO’s FDA reform priorities which can be found on NVCA’s website. You can also watch the entire hearing by going on the House Energy and Commerce Committee’s website.