Quality Over Quantity: National VC Expert Mark Heesen, David Jones Jr. Discuss How Louisville Fits in VC World

Business First of Louisville, January 8, 2010, by Terry Boyd

National venture-capital expert Mark Heesen put a sharp spin on his talk Wednesday to the Venture Club of Louisville.

The venture-capital scene is nothing like it was back during the booming ’90s, or even before the recession.

Thank goodness.

Nationally, the number of deals and the amount of venture capital pouring into deals is down dramatically, said Heesen, president of the National Venture Capital Association, an Arlington, Va.-based association that directs policy and research initiatives.

Conversely, the quality of venture-capital firms and entrepreneurs is rising in a more competitive national landscape of innovation, he said.

Despite the recession, venture capitalists funded 1,211 new companies in 2008.

So how does a small city such as Louisville play in this ultracompetitive world?

David A. Jones Jr., founder, chairman and managing director of Chrysalis Ventures LLC, the largest Louisville-based venture-capital fund, joined Heesen for a question-and-answer discussion about venture capital. Their remarks have been edited for space purposes.

Business First: Are there any cities comparable size in to Louisville that have become venture-captial/private-equity centers?

Heesen: “If you look at a city like Minneapolis, it’s a city that years ago said, ‘We have an expertise in medical devices because (the Mayo Clinic) is not that far from us. There are some good companies that have a large presence here, so we’re going to work off of our internal expertise, and that’s medical devices.’

“Today, if you’re a medical-device company, you’re going either to California or to Minneapolis. If you’re looking for good people, that’s where you’re going to look. They’ve been able to create a niche market that’s very important to Minnesota and Minneapolis, itself.

“The second city I’d say is Salt Lake (City), which isn’t there quite yet but has made rapid strides to become a center for entrepreneurial activity. The reality is, ski slopes help. Venture capitalists can see great companies, have a house in Park City and get in and out on a direct flight.”

It’s funny you should say that, because we lack almost every one of those things. We lack flights. We have life sciences, but so does everyone else. We lack mountains. We lack immigrants.

Jones: “Maybe the way to frame it up is, just as there’s been an effort at capital formation, there’s been a now more than a decade-long effort to make the city friendlier (to immigrants), and I think it’s bearing fruit.

“We have things that appeal to people … moderate housing prices, a great parks system, places for biking and outdoor activities. We don’t have mountains, but we do have other things.”

What makes you most optimistic right now? Or are you optimistic?

Jones: “It’s a little schizophrenic. The scale of the problems that have resulted from yesterday’s success are so large.

“Most of the cost in the American medical system, most of the money is spent caring for diseases that result from smoking or obesity — chronic diseases.

Obesity is “a result of the incredible success in the agricultural industry in making calories really cheap. Calories are super cheap, and the result of that is, people are way heavier than they were. I believe there’s a tremendous (investment) opportunity … in figuring out how to help people.

“How do we make ourselves healthy in the modern world? I think there’s a health care services and health care information opportunity there that’s tremendously exciting.

“Another issue is, we’re all drowning in information. Maybe Google will dominate 100 percent of that. Maybe that game is fully mature and done. But probably not. It’s only been identified as a problem for a decade.

“We have a company called Digitalsmiths in our technology portfolio. They index video on behalf of Paramount Pictures (and others), and it’s all about helping people find the content they’re looking for (and) helping the owners of content monetize content where so much is sloshing around.”

How can the city help the VC community help employment in Louisville, help raise household income and all of the things that need to be done economically?

Heesen: “You need to have an entrepreneurial community before you have a venture-capital community. We’re followers, not leaders. The entrepreneur is king, and you always have to remember that.”

Jones: “Absolutely right. We’re infrastructure.”

Heesen: “As an economic development person, you have to say, ‘What can I do to stimulate the entrepreneur?’ And is that working with colleges and universities in a collaborative fashion as opposed to what has traditionally been the case in many cities at loggerheads, competing with each other as to how to get technologies out into the marketplace?

“Silly things like, how do you get the Kentucky venture capitalists to come see the Kentucky Derby or UK basketball game? … They may stick around and do deals.”

Jones: “We have two deals in our portfolio that are Derby-related. We invited people to town and brainstormed a company idea we’d been working on. One is still in our portfolio — Laboratory Partners … (which) employs 1,400 people in Ohio.

“If I could wave a wand, education would be absolutely No. 1. It’s a community problem that only 45 percent of the people who start at U of L get their degree within six years. That’s a huge waste of effort.

“The time for excuses is over. It’s ridiculous that the University of Louisville and the University of Kentucky both think of themselves as sports franchises rather than educational institutions.”

Is there a perpetual tension between entrepreneurs and venture capitalists?

Jones: “Your question is, ‘Should capital be cheaper?’ If the company is mature enough and has an impregnable position, there’s never been a better time to borrow than today.

“But all the small companies are saying, ‘The banks aren’t lending.’

“There’s a cycle to the price of capital. Venture capitalists … we can blow it by being too greedy. But at the end of the day, the price of capital is a math problem. The pension funds, the unions and state employees who put in a chunk of money and universities who provide another chunk of money, they need X-percent return to pay their retirement benefits. You put that into the model of venture capitalists, and it comes out with a target number.”

Wealth managers are jockeying for position on the prospect of the return of prosperity. Is there a similar expectation for a flood of deals in the VC sector?

Heesen: “There’s been a lot of talk. I was getting frankly a bit aggravated the last quarter of 2009, hearing from lawyers and investment bankers, ‘We see so many companies that are going to be registering to go public. We can’t fight them off, there’s so many companies!’

“Show me the numbers.

“Have we seen an uptick in (Securities and Exchange Commission) registrations? Yeah, but we’re at 29 (up from 13 last year). But 29 does not make an open, vibrant IPO market.

“I think we have to be brutally realistic about where we are. Right now, I think we have the opportunity to be able to put out very solid, venture-backed companies into the public market in the first half of this year. But it will be by no means a flood of companies going public.

“I think the second half is a more optimistic period for the venture industry as a whole. I think you’ll see more companies going public. And more importantly, I think the stable stock market over the past couple of months will breed more companies that will go public and go beyond their opening price.

“Of the 13 (IPOs) last year, nine are above their opening price. That’s not a bad number. That stability is more important than anything else.

“I get very concerned, particularly, about investment bankers — and I know they have a job to do and they’re trying to sell. But they’re selling a recovery that’s coming much faster than I see it coming.”

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‘The tourists have left,’ Heesen tells crowd at The Venture Club of Louisville

What follows are selected remarks by Mark Heesen, president of the National Venture Capital Association, during his Jan. 6 address to The Venture Club of Louisville.

• This is one of the best times to get in the venture-capital game, Heesen said. The recession has cleared out many of the less attractive deals, leaving solid entrepreneurs and investors with more realistic expectations.

“The tourists have left,” Heesen said.

• The number of U.S.-based, venture-capital firms dropped to 882 in 2008 from 1,027 in 2006.

Capital under management dropped 30 percent during that period to $197 billion from $278 billion, according to data he presented.

Total venture-capital investment, which peaked at $103 billion in 2000, was $12 billion during the first nine months of 2009.

Venture-capital funds cannot work without institutional funds from colleges, retirement funds and insurance companies, Heesen noted.

Managers at firms that can’t raise that money “are looking for another line of work. But it’s a net positive because the strongest firms survive,” he said.

“We’re seeing fewer firms,” Heesen said. “It’s a Darwinian process.”

• Since the economic downturn started, there are fewer ways for entrepreneurs to fund their concepts.

It’s more difficult to fund startups with second mortgages, savings, friends and family and by charging multiple credit cards up to the limit.

Investors who once were casual about investments now are more serious.

“One guy told me, ‘I used to make these deals without my wife’s approval,’ ” Heesen said. “Entrepreneurs looking for money have to go to a lot of places.”

• There are only about 2,000 venture-capital firms in the United States. But one in 10 people work for a company that began with venture-capital backing. “We’re the ones out there creating the jobs,” Heesen said.

• Heesen sees several promising emerging sectors for venture-capital firms and investors, the most promising being clean energy, whether it’s wind, solar or clean coal.

“There’s huge potential because we’re looking at fundamental, dramatic change,” he said.

Investors should look at the potential and see that the industry is ripe for “disruptive technology,” funded by venture capital, Heesen said.

A clean-energy technology breakthrough will be “the next Google, the next eBay and the next Genentech. It will be a great test case for venture capital,” similar to past successes in bringing life-science and information-technology sectors to maturity, Heesen said.

• Initial public offerings are down dramatically and might not be the most popular exit for entrepreneurs.

After the wild stock markets swings of 2008 and 2009, the number of IPOs has dropped to 13 during 2009, raising about $2 billion, from 86 in 2007, raising $10.3 billion.

More entrepreneurs might eschew IPOs because they don’t want to deal with attorneys, banks and other complications that IPOs require.

Rather, they might prefer acquisitions that allow them to get out of the business quickly and start a new one.

“The brass ring is no longer solely an IPO. People are saying, ‘I can get acquired, and that’s a great thing.’ ”

• Immigrants are an enormously important part of the venture-capital community, Heesen said. Half of the venture-backed firms in the United States were founded by people who came here from overseas, he said.

“If (an émigré) is willing to learn a new language and leave his country, he’s an entrepreneur from the get-go!”

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