VCs will lose their grip on tech startups
COMMENTARY High tech and venture capital have been joined at the hip. Someone had to come up with the next new thing, and someone else had to invest so the idea could become reality. But there are some big changes coming in the markets, which will split traditional relationships into two parts. Entrepreneurs that can possibly get to an IPO will be in the driver's seat when it comes to VCs. Those who are unlikely will have to make their money the old fashioned way: Earning it, rather than earning out.
People will invest elsewhere
As McKinsey Global Institute just noted, there are a number of forces coming together that will "reduce the role of listed equities:"
The most important of these is the rapid shift of wealth to emerging markets where private investors typically put less than 15 percent of their money into equities (compared to 30-40 percent in many mature economies). At the same time, demand for listed equities in developed economies is likely to fall due to aging, shifting pension regimes, growth of alternative investments, and new financial regulations.
The issue of pensions is important because the massive funds they manage have been one of the great forces in equity investment. As the demographics of the workers shift to an older average, with more needing to draw on pensions, the funds will likely become more conservative and shift to bonds.
At the same time, there will be many companies that want to raise equity funds, particularly banks that must adhere to the new Basel rules for capitalization. Keeping more cash on hand will mean less to lend.
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Rise of private equity
Particularly for high tech, this is going to be interesting. More companies find that they can rely more on private equity markets rather than being public. You can see the concentrated shift by looking first at Groupon (GRPN), with its tumultuous road to an IPO, and LivingSocial, which is staying private as long as possible. (That actually isn't new: According to what the National Venture Capital Association told me earlier this year, companies are taking longer -- on the average of a decade -- to go public.)
With fewer investors, fewer companies will be able to go public successfully. But that has an ironic twist. VCs already feel the squeeze to get in on a few huge deals. That trend will likely intensify. That begins to put the entrepreneur in the driver's seat, because VCs won't be able to afford to get locked out of the opportunities.
Supply and demand returns to bite VCs
For evidence, look at Zynga, which will structure its IPO to give an unprecedented amount of concentrated voting control to CEO Mark Pincus, as Reuters reported:
One of Pincus' soccer friends said the reason he wanted more control was directly related to his experience at online tech services provider, Support.com, the first company he co-founded that went public, in 2000.Pincus has said that he was booted from Support.com, now known as SupportSoft Inc, after clashing with its venture capital backers.
"Mark's willingness to be ruthless is necessary," said the soccer friend, who did not want to be identified. "He learned that by getting burned by VCs and investors."
The important point is not that Pincus got burned, which is just another example of an old VC war story you'll hear from many entrepreneurs. What really should command notice is that Pincus will get his way with VCs.
As more VCs want to get on an increasingly shorter and yet more lucrative gravy train, the long-standing balance of power will shift. A few tech entrepreneurs will be in the driver's seat, because there will be a lot of venture capital demand for limited opportunities.
As for the technology companies not perceived as the hottest, it's going to get tough. Fewer opportunities for an IPO coupled with a possibly decreased amount of capital for bank loans (and you thought bankers couldn't become even more tight-fisted) will mean having to find ways to make companies make money from the start. In addition, companies will need long-term strategies, because there are only so many businesses that even such tech giants as Google (GOOG), Microsoft (MSFT), and Apple (APPL) can acquire. That will reverse the supply and demand balance, with plentiful numbers of entrepreneurs now competing for fewer spots. Exit strategies could get exceedingly tough to come by.
Erik ShermanErik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.
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