Here Come the Cloud and Gaming Funds (And Other VC Trends)

Venture capitalist William Quigley, managing director of Clearstone Venture Partners, will release his State of Venture Capital in America today. The 20-year-industry veteran details a VC community at a crossroads and poised for comeback after a rocky decade. But only the strongest firms survived the shakeout. While there were 712 active technology investors at the start of the decade, only 313 remained in 2009.

We caught up with Quigley at his Santa Monica office and asked the VC to explain to us just what the heck is going on in this cooky market and hand over some advice for internet-based startups looking to attract the remaining VC players.

Q. The U.S. economy has grown nearly 50 percent since 2000, yet there are half as many venture firms in existence today as there were in 2000. That’s pretty shocking. What’s the effect of that contraction on the market?

A. Well, our entire asset class was pretty much abandoned over the last decade. But it’s actually great for those of us left standing!  We have half as many firms as we did as ten years ago. We also have far fewer assets under management than we did ten years ago — $225 billion in 2000 versus $179 billion in 2009. What that tells me is the venture market is really poised for some really great returns. Whenever there is less capital it will generate a better return.

Plus, there are far fewer venture capitalists, and especially far fewer experienced venture capitalists around today. The angel markets have been deployed, but I don’t think there is a substitute for an experienced VC within your company who has weathered multiple IPOs and can assist when M&A heats up. The ones who are there are going to win big.

Q. Venture capital fundraising has been in long decline. Your report shows fundraising peaked at $83 billion in 2007. In 2010, that figure was down to only $12 billion. So there are fewer VCs and less capital floating around. But this is somehow a good environment for startups?

A. Its terrific environment for this reason! As a startup guy, if you are looking to raise capital with half as many VC’s, but these firms are hungry. If you have a good idea it will get funded. But because the market isn’t out of control, ten of your marginal competitors won’t get funded.  The entreprenuers with the best teams will win. The fact that there is adequate capital but its not overflowing means there is some discipline.

What the VC like in markets like this are companies with innovative ideas targeting new markets, with strong management teams. Of course, this isn’t true across the entire tech sector. If you wanted to get your optical networking company funded right now, you would have a real hard time. In cleantech, those companies are definitely facing uncertainty over federal funding possibly drying up and now those companies are finding it harder to get funded. But if you are in sectors like mobile, gaming or cloud, you are most certainly finding wind at your back.

Q. The 1990s were all about the IPO. Public offerings are finally on the upswing again after a long dry period. Traditionally, the market has turned its nose up at the historically less profitable Mergers and Acquisitions.  But that’s changing, right?

A. We are in a very strong M&A cycle and its going to be very profitable. The larger more established companies have finally convinced themselves that they need a footprint in these sectors, which is leading to a bidding up of the values of these businesses. We had a very narrow group of buyers in the middle part of this decade. But that’s all changing now that these very large private companies like Zynga and Facebook and Twitter are buying up startups. It’s  added a whole new group of buyers to the market. We are entering a cycle with all these private companies that almost act as public companies. Meanwhile, these sales produce a nice virtuous cycle where companies get acquired and capital is released back into the market for more startups.

Q. We’ve all heard mobile, social and cloud is where the next cycle is focused. And your report details all three categories. But where do you think the biggest opportunity for growth lies?

A. The gaming sector really excites me right now because it takes into account two giant dislocations. We as VC’s love when a market is undergrowing great change and that industry is shifting from packaged console-based gaming and going to a free-to-play model. We also need new monetization models. There are opportunities for startups offering new payment gateways. After all, if you’re a gaming company you can’t go to American Express and say can you manage the back end on this. There’s also opportunity on the virtual goods marken. Also, a lot of the dollars currently spent on traditional advertising are migrating to gaming. Businesses are beginning to understand keeping customers engaged on their website is easier if something entertaining is being offered.

Q. You predict the mobile, social, and cloud cycle will last for the next ten-year cycle. Do you see new catagories of funds arising from this trend?

A. Oh, definitely. One of the biggest changes will be the rising importance of sector-focused funds.  Partners can get so much smarter about an industry when you are hyper-focused.  We already have tasted this. Of course, we have dozens of clean tech funds. And the industry just saw its first iPhone fund and the first Android-only fund.  I think you have to move so quickly in today’s market you have to be sector-focused to exploit the trends.  While we don’t have them yet, I’d expect cloud and gaming funds to do very well.

Q. So where do you have any areas of concern?

A. Social Media is certainly getting out of hand. I get worried when the valuations people are assigning a company are based on an increasing number of assumptions. Investors have shifted to being more optimistic because of this shining icon called Facebook. If Facebook is worth this, than my company which is like Facebook is worth that. It’s the danger of the also-rans. And hopefully venture capital will not make the mistake of falling for it.

Q. Any closing advice for startups. What are the money people looking for now?

This is the time to think big. In the current climate where optimism is increasing, I would say to have as much ambition as you can. This is not the time to pull your punches. Look at the biggest markets and address as wide a piece of that market as possible. We have moved from the point where entrepreneurs were awarded for conservatism. This phenomenon where angels were rewarding companies for pulling in your ambition and bringing your company to profitability right away are over. There is ample funding now to go big.