A Slightly Different Perspective

I’ve been reading a bunch of posts recently suggesting that the VC model is broken. But guess what? It’s always been broken. As Jeff Nolan points out in a short and sweet post:

there is a permanent structural imbalance in VC that simply doesn’t
change and serves to exacerbate the amplitude of the swings from good
times to bad. There are maybe a dozen VC firms that generate the bulk
of returns, a handful of “individualist” firms that simply chart their
own path to good success, and a whole bunch of followers that get
slaughtered. This was the case in 2001 and it’s the case today.

Jeff’s truth has been the story with the venture capital asset class for the entire 22 years I’ve worked in this business and probably for long before that. Jeff and Matt’s posts were inspired by this presentation that Adeo Ressi of TheFunded gave at HBS recently.

TheFunded – Canarie

View SlideShare presentation or Upload your own. (tags: lp vc)

I don’t buy most of Adeo’s arguments in his presentation but I am not going to critique it. Most of what he says is old news. The chart that TechCrunch picked up in particular is not news and I don’t even think its right. LPs have been telling me that the VC industry has been cash flow negative for years.

Clearly there is too much money and there are too many firms in the venture capital business. The same is true of every asset class I follow. I was at a hedge fund annual meeting yesterday and they predicted a huge number of hedge funds will go out of business in the next 12 months. I think the same will be true of private equity, real estate, and a number of other asset classes.

The venture capital business is changing if you look closely. Many of the biggest and best firms are slowly but surely turning their attention from information technology to energy technology (ET). Not all of them will be good ET investors and the firms that don’t navigate that transition well will struggle. Firms that continue to focus on IT have largely turned their attention to the web where capital requirements are lower and technology and IP barriers are non-existent. Many firms are struggling with these realities and they may decide to throw in the towel on IT. The VCs who came of age in the glory years of IT venture capital in the 80s and 90s are getting older and quite a few have stepped back or retired outright. While it is certainly true that there will be new firms and new VCs who pick up the slack, the reality that money is harder to come by and may stay that way for years will likely force the venture industry to get smaller not bigger.

But be careful what you wish for. We will get a better, more efficient venture capital industry that produces better returns for investors from all these changes. But we may also get less capital for entrepreneurs. Just like there aren’t thousands of great VCs, there aren’t thousands of great venture capital investment opportunities. When the industry is flush with cash, entrepreneurs are the beneficiary. When it is not flush with cash, entrepreneurs will feel it too.

Adeo is seeking "less funds and better funds" and I think he’ll get that wish. But he’s also looking for "more deals and equal treatment". The law of supply and demand suggests that we are likely to get less deals and worse treatment, at least in the short term.

Good entrepreneurs are crafty and will figure out how to navigate this new reality. They’ll do what they are already doing, which is to figure out how to bootstrap and build a business without VC, or they’ll wait longer to tap into VC. In the web sector, that’s a very good approach and I recommend it to every entrepreneur I meet with. In ET and biotech, it’s harder to do that and a tightening of the money supply there is a bigger problem.

The other big factor that nobody is really talking about is the globalization of startup culture and venture capital. The capital that gets invested into venture capital firms and our portfolio companies is increasingly global and will become more so. And the investment opportunities are equally global. Everyone is focusing on what’s going on in Silicon Valley and to a lesser extent the rest of the US startup scene. But what is going on in China and India and other parts of the world is truly mind blowing. And I think we’ll see non-US startups producing a significant, if not majority, of the investment exits within the next ten years. Much of the "sky is falling" prognostication is focused on Silicon Valley and misses the big picture.

So in the wise words of Pete Townshend, "venture capital is dead, long live venture capital."

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