Tuesday, October 8, 2013

Tim Draper's Cycle of VC vs PE "The Draper Wave"

Tim Drapers graph coincides with what we know, that everything goes in a cycle. Aivars Lode

Why Now is a Great Time to Start a Company, be a Venture Capitalist, be an Angel Investor or Invest in a VC Fund – An Interview with Tim Draper, founder & Managing Director, Draper Fisher Jurvetson (DFJ) 

Draper: “After the bubble burst in 2000 we had ten flat years in venture capital. Then in 2008 the world came to an end and I thought  - Oh my gosh! We’re gonna be hit again! I then started to put perspective on it and thought - that just can’t be! It can’t be right, because eventually these things have to come back. So then I went back and started to analyze history and I went back to when my grandfather started venture capital on the West Coast in 1957. I tried to put this all into perspective. I created something I call “The Draper Wave”. Venture capital is not a cyclical business in the sense that it is a sine wave. It is, however, a cyclical business. It goes in waves that go opposite that of the private equity business. The way I describe that is that it comes up like a shark’s tooth (and there’s nothing ironic there) and then it comes down and then the PE business goes up like a shark’s tooth and then comes down while the venture business sort of goes flat.
There’s nothing scientific here, but the data and the emotional strength of the business does follow this. I don’t really know what happened when my grandfather was in the business from 57 to 65, but let’s assume he was trying to solve a big problem where there was a recession. What happens is after a recession people are out of work and looking for something to do. They say - well you know my boss wasn’t that good at what he did. I can do better. Or there’s an opportunity here that the company I worked for didn’t really take advantage of. So entrepreneurial ideas start happening and then venture capitalist come in. Then those entrepreneurs start employing people. Then jobs start to pick up, pick up, pick up and then there’s more and more venture capital. People start to see that these are great companies and they pour it on. Then it comes up to a crescendo and comes crashing down. From 65 to 74 the big companies became conglomerates and they bought other companies up and they fired half the employee force. That’s how they grew. They’d acquire and fire, acquire and fire and they made everything much more efficient. That was the roaring 60’s that went from 65 to 73 and then I think it probably got too frothy and then it came crashing down.
Then we had a recession in 73 / 74. Then people were looking for things to do and then the computer industry started and other interesting things happened. Between 74 and 83 we had a big boom in venture capital again where they employed a lot of people. It peaked in 83 with Arthur Rock being on the cover of Time Magazine and Steve Jobs on the cover of Time Magazine (for the first time) and then it came crashing down in 83. I joined the venture business in 85. The people who were the headliners during that time were the LBO folks. This was a new form of leverage that improved the efficiency of the system very much like the conglomerates did before. And they levered up, levered up, levered up until 1991 when we got the RJR Nabisco deal where they all bought in and then that came crashing down and the banks decided not to lend anymore. They had lent too easily and too crazily. Then it came down in 1991 and we had another recession.
Between 1991 and 2000 people began starting new companies again and that became the big Internet boom and that came down in 2000.  The PE business, which was really just the same thing as the LBO business between 2000 and 2008 came in and made more efficient all the inefficient companies that had been created during the 1991 to 2000 period. Then in August of 2007 that came crashing down with the credit crunch followed by a crash for venture capital in September of 2008 and we had another recession. And so now we are about three years into what I see to be a nine-year cycle. This is the cycle where people start creating new companies and then they start employing people and then there’s more venture capital and there’s even more and more venture capital. So I think it is actually an amazing time to start a business and an amazing time to be a venture capitalist. The angels have it right. They were funding these smaller businesses at just the right times. It’s all going to pay off very well for them. I don’t think we’re going to have another bubble until say 2017 or so. This means that we have plenty of time.” 

Romans: “Tim, right now there is more angel investing activity in the Silicon Valley and globally than ever before in history.  Accelerators are sprouting up everywhere spawning new ventures so the sheer number of companies being started and funded right now is higher than ever before in history.  At the same time, the dollar amount of money going into first round Series A venture capital financings is contracting.  How do you believe these companies will finance their businesses when the balance has shifted so much?” 

Draper: “What I was saying with the long history is that when there’s a need the investors fill in. Once they start making money in an area then they pile on and then it goes to a frenzy and then it comes crashing down. In this case the angels were very necessary between 2008 and 2011. The reason that you’re getting more angels than ever before is that in general the venture capital business is growing globally. You are going to have a lot more angels. You’re going to have a lot more entrepreneurial successes. You’re going to have a lot more businesses that take off because of venture capital. There will be more competitors worldwide and so the competition will be fiercer. But the markets are also bigger. And so I think everyone will benefit from more venture capital and more entrepreneurship. You will see each of these 18-year generations is going to be bigger than the last until it hits a steady state, which I think will be many generations out. Beyond the market growing right here in the Valley I don’t think there are many venture capitalists in East Africa. There are a lot of places in the world that don’t really have a lot of venture capital and entrepreneurship and so there’s still opportunity for growth there. By nature you will see a lot more angels now. I think you are asking where these new accelerator and angel backed companies will get there financing after three years when their angel funding has run out and they are looking for where their next round will come from. The next round will come from either angels that invest at later stages, venture capitalists or private equity or hedge fund guys that say – hey, I have to get into this because there’s an opportunity. I think where there are good companies there will always be funders behind them. Good companies are only limited by people’s imagination.” 

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