Peter Rip of Leapfrog Ventures in the US last week started a series of posts on the evolution of the venture capital model from a US perspective. The first post is a great backgrounder which sets out how the venture capital cycle has worked over the last 40 years and gives the main reasons it will change. As he says most of it will be obvious to people who know the industry well, but for those new to it there will be some interesting insights.
Here I briefly summarise what he says and comment on where things are different in Europe. Assuming his later posts live up to the quality of the first I will do the same as his series progresses.
- VC is a hits business – fund returns are driven by a few big wins
- Success breeds success – entrepreneurs want to work with VCs who have had hits, so top name VCs have enduringly fantastic franchises (Sequoia, KPCB)
- For the last 40 years the VC industry has repeated the following cycle:
1) high returns attract more capital to the asset class
2) competition increases and returns fall
3) capital becomes scarce, returns go up and the cycle begins again
- The cycle won’t repeat again due to globalisation, abundance of capital across the cycle, IT is now mainstream and much cheaper, enterprises have a reduced appetite for risk (making it more difficult for start-ups to sell them innovation)
- The UK VC has only existed at any scale for ten years (less than that on the continent) so we have been through the cycle once
- That cycle was EXTREME – encompassing the March 2000 bust and ensuing nuclear winter
- There is still a scarcity of capital here so the cycle may repeat again – funds raised by limited partners in Europe fell c90% 2000-2005 and the last couple of years have been a great time to invest
- The ultimate winners are not yet clear – although there are some leading candidates
- I suspect that European VC returns are not as hits driven as they are across the pond – for reasons that I think are structural there are fewer mega hits and more 3-4x deals (this is a complex issue which to which I don’t have space to do justice here, suffice to say that our returns are lower over here and we need to eliminate the gap)
That makes the climate a little easier over here – as a result European general partners haven’t felt the same need as many of our US brethren to make risky departures from their business models and go to India or China or enter new sectors like Cleantech.
I look forward to the next posts in Peter’s series, but my feeling is that whilst there is change afoot in the VC industry here it won’t be as dramatic as in the US, mostly because capital isn’t as abundant.