Shake it to the left. Shake it to the right.

Shake-out in the industry. Who is right?

We recently had a run-in with Mark Heesen, NVCA President, over how to determine the scale of the shake-out going on in the venture capital industry.

Now, it is never a good idea to get into a data dust up with Mark. He has more facts about our business at his fingertips than just about any other human. Still, we enjoyed the banter, not because he was wrong, but because we think we were both right.

In the 2007 NVCA Yearbook (perhaps the best product this side of Lunesta to ensure nocturnal tranquility), it was revealed that the number of US venture capital firms rose from 395 in 1990, peaked at 946 in 2001, and has now declined to 798 as of 2006. So, the long-awaited shakeout in the venture industry is occurring. Correct?

We agree, but we think those numbers dramatically understate the reality. That drop of about 15% of the firms in existence in 2001 misses what we see as a much more profound number. That is the number of active venture capital firms. Given the ten-year nature of partnerships, one may hang on in this business for a long time, doing follow-on rounds in an existing portfolio, while not really being in the game.

So, we focus on a different metric. We look at the number of firms that have made a new investment in the last 12 months. To us, if you have not found at least one new deal in that time, there is a high probability you have indeed been "shaken-out" and are simply playing out the cards in their hand.

In 2000, there were 1156 different venture firms that made at least one new deal. In 2006, there were only 597. This is more like a 50% drop, not just 15%! We think that is the big, so far unwritten, story. The US venture industry has been cut in half. That certainly qualifies as a major shake-out.

There is one more piece of data we found interesting, and here we and the NVCA are completely in synch. The average size of the most recent fund raised by the venture funds in 2006 was exactly double that of 2000. The 2000 funds came in about $100M, while the 2006 funds were at $200M.

So, how does this square with the well-reported shrinking of venture funds from the bubble vintage? The story is: Those mega funds were the exception, even though they were very noticeable. There were a gaggle of new funds of the bubble era under $100M. Most of them have died (see shake-out), with a few succeeding and increasing their scale. Since 2000, and particularly recently, there has been a flight to quality.

So, the second unwritten story of the bubble was not so much the billion dollar funds that cut themselves back, but the hordes of small funds that messed up the market by investing in the seventh company in a given space, failed, and then quietly went away.

The venture capital industry is healthier today than most people realize, given the magnitude of the shake-out already behind us.

Shake it to the left. Shake it to the right.

Shake that battery. See if it will light.

Sometimes the most interesting investment opportunities are basic technology components. This is certainly true in the wireless space.

While doing due diligence on several wireless deals this year, the innovation that sparked the most interest with handset vendors, wireless industry experts and seasoned Wall Street analysts was self-charging batteries. Every person we interviewed was eager to learn more about the technology.

Why the enthusiastic response? Batteries have not been able to keep pace with the power requirements for applications on cell phones and other portable devices.

One Wall Street analyst commented, "I have been looking for battery alternatives for a long time. I tried a fuel cell battery as a beta test a few years ago. It burned up on me. If self-charging technology can perform as promised, I see no major competitive threats on the horizon."

The biggest market opportunities will be at "both ends of the bar bell" -- high-end phones and low-end phones.

For smart phones and power-hungry multimedia devices, extended battery life is a big issue. One analyst's response was, "This area is very exciting. Speaking as a 'Road Warrior' who does a lot of international travel, I would be willing to pay an extra $50 to have a cell phone that didn't have to be charged. It would be great for my iPod too. Not only is it a hassle having to carry several power cords wherever I go, but overseas I need adapters for all of them. When I go to South Korea, the hotel gives me a cell phone with 2 batteries and a power cord. It's always a worry that I will run out of battery power when I need it most."

Ultra low-end phones for developing countries will be an even larger market segment, when the batteries reach the right price point. Battery life is the #1 handset problem, especially in rural areas where there is limited access to electrical outlets. Wireless phones have become the primary communication tool in areas where it is too expensive to lay cables for wire-line phones and Internet access.

Assessing the market opportunity for a new deal is only the first of many key questions during the due diligence process. But it's a great first step when industry experts offer to introduce a start-up to major handset vendors and say, "This has IPO potential."

It's Back to School Time - Lesson Learned

What better time than now to review a hard-learned lesson from the past, before everyone puts their planning hats on for 2008.

Loyal readers of this newsletter (you are out there, aren't you?) will recall our solemn mantra to our portfolio companies:

• Make a plan that you can make
• Then, make that plan

So easily said, but so hard to do.

There are a couple of absolutes we've discovered that give startups a greater chance of making plan. One of the most overlooked is to follow a smooth hiring ramp, rather than a step-function one. We are always taken aback at the number of firms that build into their assumption set a model that has all new employees hired in the first three months of the year. And this is planned for even in the face of the well-known "Google effect" of industry leaders (Google among them) sucking up all the top talent by waving enormous amounts of money in the air. That makes hiring any lump of real performers almost impossible.

Any firm that assumes all its engineers or sales people can be added in a group at the start of the year, in order to produce critical products or revenues, is setting itself up to miss plan. Better to smooth the hiring flow and lower the expectations. Because the truth is, even if you could hire all those people at once, training and inculcating them into the organization takes up time and energy from others already hard at work.

While some wise startup managers at least plan for a ramp up of productivity from new employees, we have yet to see a plan that ever factors in the loss of productivity from distracting all those already in place. A more gradual influx of new talent dramatically mitigates that problem.

A graceful hiring plan is a key component to a plan you can make.

We just love it when former successful entrepreneurs of ours decide to recycle themselves. All the "team" risk comes off the table, and the wisdom quotient goes way up. We recently financed such a project, Altus Networks in Seattle, a firm led by a number of the senior executives who delivered our largest win ever when we backed them in WatchGuard (NASDAQ: WGRD).

Altus is staying rather stealthy for the moment, so we can't reveal too much. But given the lineage of the founders, you might expect something revolutionary in price-performance aimed at SME (small to medium enterprise) computing.

OVP did most of $1M seed round in Altus. Chad Waite has joined the board of the company, backed up by new OVP partner Mark Ashida. A full Series A round is planned for 1H 2008.