The future of venture capital

Over the weekend I had been thinking I would post today on the health of the venture capital industry and then when I read in the FT this morning that the US venture capital sector faces an shake-out and investment cut my mind was set.

The FT was reporting on Venture Source data (previously reported on Venturebeat) that shows 2008 was a disastrous year for exits in the US.  There were only 6 or 7 IPOs the lowest number since the 1970s, and there were 325 trade sales, the lowest number since 2003.

At the end of the day venture capital is about dollars out over dollars in, and if the dollars out fall then eventually the dollars in have to go the same way – so the FT is right to predict a shake-out in the US.  Dixon Doll, founder of Doll Capital Management and current chairman of the National Venture Capital Association (US equivalent of the BVCA) put it this way (from the FT article):

“There’s been far more money paid into our industry than being returned.”

When he is saying that it is very clear that the industry needs to get smaller.

The good news for Europe is that the shake-out has been underway for years now and is hopefully largely over.  Piecing together bits and pieces of data my best guess is that there has been a 70-80% contraction in European Venture Capital since the bubble burst in 2000 and in contrast with the US my strong belief is that this market is now under-funded and we should therefore be set for a period of growth – at least over the medium term.  Any pointers to hard data on this topic gratefully received.

The second point I want to make is that this is just a cycle.  Peter Rip wrote a great post on this point a couple of days ago and in it he said:

This year is going to be tough. The destructive firestorm of leveraged, momentum investing has destroyed much of the forest.  But the forest will begin its renewal because Life Goes On, and with it ingenuity, entrepreneurship, and innovation.

and:

So why am I so sanguine about the prospects for venture capital as everyone seems to sound the alarm about Recession, the lack of capital, and the fear gripping the markets? It is simple:

  1. Venture capital returns are predicated on scarcity of risk capital.  It has been all too abundant. That will change.
  2. Many good businesses will be left on the beach as the rest are washed out to sea – the remaining VCs will invest in them and both the entrepreneurs and VCs will get rewarded as the survivors gain market share and become successes in the economic recover.
  3. The economic recovery plan of the new Administration will be massive and favor investments in productivity-enhancing growth sectors like information technology and energy technology.

He is talking about the US, and as noted above risk capital is already scarce in Europe.  Further, our governments will come through with their own stimulus packages – remember the £1bn for UK starups from before Xmas? and just this morning I was reading of David Cameron‘s plans to create a generation of world beating green startups in Britain.

  • Hi Phil – I agree with most of what you say – many companies will find ways to go without raising venture – but there will still be lots that want to use additional capital to scale more quickly, and the venture industry will continue to service them – over the medium term anyway. It is very difficult to say anything for sure about the next twelve months. I also agree that we need more smaller funds.

  • A nice optimistic view there Nic but I have to disagree. In this kind of market, the good businesses are those that understand how to cut their cost bases and strive for profitability as quickly as possible. They are the entrepreneurs and companies who won't actually need to raise any VC once they are on this path and will instead seek out Angel investments and smaller amounts of cash to tide them over for any cashflow dark spots.

    Any company that has raised VC all ready should have enough to see them through to profitability or the VC's who originally invested will sink a bit more cash into it if it's going the right way. I don't see any VC's making any new investments in new companies for a long time now as they hardly did this when times were good anyway!

    Let's face it – VC's need to be become smaller, more dynamic in levels of investment, and stop being scared of risk. In fact – 2009 / 2010 are the years of the angel investors!

  • I agree with your points, but every bust is followed by a boom – and booms will make people leap into the VC pool. So while the current situation is clearing out many, as soon as those good businesses “on the beach” have exits, if those exits are high profile, you will see all kinds of people “becoming” venture capitalists again. The problem is that after the tech boom of the 1990s and early 2000 anyone with a pile of cash decided they were a VC. Being a venture capitalist is more than just being some rich dude, To do it right you really do need the experience and the skills – but the lure of the big pay out and the “sexy” nature of calling oneself a VC will always bring too many into the pool when times are good.

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  • Hi Phil – I agree with most of what you say – many companies will find ways to go without raising venture – but there will still be lots that want to use additional capital to scale more quickly, and the venture industry will continue to service them – over the medium term anyway. It is very difficult to say anything for sure about the next twelve months. I also agree that we need more smaller funds.

  • webtogs

    A nice optimistic view there Nic but I have to disagree. In this kind of market, the good businesses are those that understand how to cut their cost bases and strive for profitability as quickly as possible. They are the entrepreneurs and companies who won't actually need to raise any VC once they are on this path and will instead seek out Angel investments and smaller amounts of cash to tide them over for any cashflow dark spots.

    Any company that has raised VC all ready should have enough to see them through to profitability or the VC's who originally invested will sink a bit more cash into it if it's going the right way. I don't see any VC's making any new investments in new companies for a long time now as they hardly did this when times were good anyway!

    Let's face it – VC's need to be become smaller, more dynamic in levels of investment, and stop being scared of risk. In fact – 2009 / 2010 are the years of the angel investors!

  • I agree with your points, but every bust is followed by a boom – and booms will make people leap into the VC pool. So while the current situation is clearing out many, as soon as those good businesses “on the beach” have exits, if those exits are high profile, you will see all kinds of people “becoming” venture capitalists again. The problem is that after the tech boom of the 1990s and early 2000 anyone with a pile of cash decided they were a VC. Being a venture capitalist is more than just being some rich dude, To do it right you really do need the experience and the skills – but the lure of the big pay out and the “sexy” nature of calling oneself a VC will always bring too many into the pool when times are good.

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