A Conversation with InterWest Partner Keval Desai

VC

An Exciting Era for Investors in the Age of Innovation

At the Red Herring Global 100 this past December in Los Angeles, Keval Desai, a partner at InterWest Partners, discussed where to invest in 2012 and beyond at a
keynote roundtable, together with George Coelho, managing director of Good Energies. Afterward, Red Herring had a chance to discuss with Desai about venture capital’s unique opportunities in the evolving digital age, why high price valuations for companies like Facebook and Groupon may be worth more than just a bubble, and the challenges facing the venture industry for the next decade.

RED HERRING: Why is this an exciting time for venture capital?

KEVAL DESAI: There’s no shortage of innovation. We are in a very fortunate era if you think about what’s happened in the last 15 to 20 years in terms of the history of the Internet. When Netscape came along in 1995, every business, small or large, started to create a website for their users. That was less than 20 years ago, but guess what, five or seven years ago, social networking came along, and all these business retooled what they do for the social Internet. Just within the last two years, those businesses are now retooling for the third time what they do for the mobile Internet.

From an investment perspective, it’s a dream come true. How often do you get three shots at the goal within the span of 20 years? I think it’s fantastic. As a result of this retooling of the Internet, there are opportunities at every single layer, which is why you see such a profusion of entrepreneurship and startups in the industry.

RH: Do you think there’s a bubble bulging in venture capital? Do you think brands like Facebook and Groupon are worth their high evaluations, or will investors be left holding the bag in these deals?

DESAI: Somebody said a bubble can only truly be seen in hindsight, so honestly I don’t know if there’s a bubble. In terms of Groupon and Facebook, I am still very much a believer in those businesses. If you think about their long term growth prospects, Facebook has 800 million users, which is still only about 10 percent of the world’s population. As big as it is, even Facebook has room to grow. Groupon has changed the way local businesses interact with users. They’ve had hiccups, but so has every company trying something innovative. If they can respond to customer feedback and improve, who’s to say Groupon won’t be around for the next 20 years?

Every human being is going to get connected to the mobile Internet, so the market is huge. As a result, these valuation benchmarks may turn out to be their own benchmarks for a connected world.

RH: As a third of the world has Internet, 5 percent has smartphones, what roles can VCs play in setting the table for the technological sphere?

DESAI: Access to technology has a huge role to play in every aspect of society, from how elections happen to creating free markets to just providing basis in transparency and truth, which has positive ramifications. If you look at what’s happened in the Middle East, major societies have gone through fundamental transformation fueled by technology.

Venture capitalists take a huge risk in investing in technologies that don’t have any near term business model or commercial ROI capabilities. Take even Twitter. Still today, people argue whether it’s a valuable business enterprise that’s profitable or not, but there’s no question that Twitter has been a transformative platform for changing society, and it’s a venture funded company. One can only imagine if there would be a Twitter without the venture capital.

RH: What do you see as the greatest challenges facing venture capital in the next decade?

DESAI: Early stage venture capital is about identifying truly disruptive ideas and giving them enough capital to see the light of day and get into the mainstream. The challenge for venture capitalists is to focus on identifying and funding those few rare diamonds in the rough, as oppose to funding companies that are already working. The role of early stage venture capitalists is to invest in companies nobody else would touch with a 10 foot pole. You have to find the next Larry Page and Sergey Brin or the next Mark Zuckerberg.

The second challenge is to ensure we provide returns for our limited partners. Venture capital is a risky business that only make sense if there are appropriate rewards. We’ve seen the troubles with that over the past year. If the public markets don’t open up, we have to find innovative ways to create liquidity for our LPs, whether M&As, the public market or what have you. We have to be creative at providing returns, or the whole machine comes to a standstill.

RH: We’ve seen the venture capital world consolidate into fewer but bigger funds. How do you see this affecting entrepreneurs and what kind of an ecosystem does this mean for startups?

DESAI: My view is that it’s a relative phenomenon. If you look at the absolute number of funds, there are still plenty. The dollars available for investment in venture capital are still pretty high, and have trended higher and higher over the last 20 years. Relatively speaking, we are probably seeing a consolidation of venture firms compared to what was prevalent three years ago, but I think that’s good. Fewer firms with higher quality investors who have the time and experience to help entrepreneurs build great companies is better for everybody.

I don’t see the overall activity of venture capital decreasing systematically. True, as the public markets remain closed for a long period of time, it might change the equation because VCs and entrepreneurs need liquidity to get the business going. But even in a dark day scenario where public markets are not available for liquidity, you see things like second markets and other platforms that provide alternative liquidity. In the long term, I remain bullish about the venture industry.

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