Venture Capital: Money down the drain?

It was a glorious May day, her diamonds were sparkling, and we were at the Ritz, so it was hard to take her seriously. “I need to figure out how to make some money!” my very smart VC friend moaned. Huh. She’s one of the few women partners in a Silicon Valley VC firm; plenty of money there, right?

Well, yes, in a way. Plenty of VCs, plenty of money. But it turns out that my friend is right: not plenty of people making money.

Yes, folks, it’s true. VCs are not making money. The dirty little secret is out, and highlighted in lovely bar and line graphs throughout a recent report put out by the Kauffman Foundation. Indeed, over the past 10 years in the US, the returns on publicly traded small cap stocks, as measured by the Russell 2000 index, have beaten the VC returns. And the more recent VC returns are actually negative.

The venture capital industry has not always been a loser, of course. In fact, until about 5 years ago, the returns were healthy to very healthy. In fact, according the Kauffman report, in 2003 the trailing 5 year return was over 20%. Which is part of the problem. The high returns, combined with the period of incredibly good performance during the boom, attracted a huge amount of capital into the sector:  the total committed amount going up more than five times, in the space of one year.

Imagine: 5 times the capital. From less than $50 billion under management to over $250 billion.

Did the number of savvy teams and great opportunities increase by 5 times in the same span? Apparently not, if you go by the returns. Combine that with the fact that the VC’s favourite industry sector has gotten much less capital intensive over the past decade (it now takes about 30 seconds and $30 to launch an IT company) and the fact that the public, which happily gobbled up the shares of young, un-profitable companies in the past, now has a stomach ache, and the outlook for improved returns with this much money in the market is…how we say….pretty bad.

No doubt, venture capital has been very important to fuel the growth of some of the most important companies in the world – we know the names. Absolutely, it’s a vital asset class, and we welcome the growth of this industry in India.

But let’s also learn from the US….more is not always necessarily better.

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8 Comments

Filed under Start up funding, Venture capital

8 responses to “Venture Capital: Money down the drain?

  1. Fair point Laura and welcome to the world of blogging! It’s amazing what those little conversations in bars can lead to.

    In India it could be a larger problem with the difficulty most VC firms have in carrying out exits…

  2. Great start. And you are absolutely right on this one. The only little problem is that without the VC firms, the funding options are even more limited. Possibly part of the problem, but a problem we must find a solution to.

    • Laura Parkin

      Yes — need alternatives. Will be writing to that researcher at Kauffman (ref reply to Indus below). cheers, Laura

  3. Good points, Laura.

    While the “top” of the VC industry pyramid is weathering with the strong winds of changing world order; there is a movement at the bottom of the funding pyramid.

    This movement is supported by angels & new boutique funds who have grouped together and are doing the activities to keep the hopes alive for entrepreneurs and simultaneously keeping the traditional VCs out of the loop.

    I have opined on the same on my post titled Venture Capital Plus, Plus here http://www.khaitan.org/blog/2009/06/vc-venture-capital-plus-plus/

    Indus

    • Laura Parkin

      Hi Indus, I was trying to get to your blog — found your page, but couldn’t access the blog page. Alternative link? Would love to read it.

      Also, I agree that we need some alternatives to traditional VC’s and am delighted to see the growing Angel networks and seed-level funds in India. Lots of activity over the past 3 years. Hopefully these funders will invest beyond the more traditional VC sectors. This will require devising exits that don’t require the chain of VC funding.

      Also, the same Kauffman report updated a study of the Inc. 500 that was originally performed by Amar Bhide about 10 years ago.

      Turns out that of the 900 unique companies that achieved Inc 500 status between 1997 – 2007, only a small fraction recieved venture funding: 16%.

      I am going to write to the researcher who performed the study, to see if they documented the altnerative methods of funding used by the balance of the companies. We need as many examples of altnerative funding models as possible, even if some are not direclty applicable to this context.

      cheers, Laura

  4. Hi Laura,

    Great article; But VCs need to make money so that they put more money in other start-ups.

    There is a need to innovate either in product, philosophy, approach or business. One of the most interesting one on these lines I cam across was Husk Power Solutions (http://business.rediff.com/report/2009/jul/13/bihar-firm-bags-global-business-plan-award.htm) – innovation, need and clean-tech.

    Unfortunate but true- don’t you think that even the start-ups that were funded in India in boom-time were ME-toos & SiliconValley-clones. The VC favorite IT & Internet models have become easy to adopt or replicate., turn into commodity value quickly.

    Government does little to create any framework or policies to nurture entrepreneurship. What would you suggest?

    • Laura Parkin

      Yes, I agree — I do think there are a lot of duplicate companies out there. And I also agree that VC’s *do* need to make money, but the problem, at least in the US, is that there is too much money chasing too few deals, compounded with a terrible spell for exits, so VC’s are not making money. I’m suggesting that the overall supply of venture capital in the US needs to come down, in order to have the remaining VC’s be able to earn a return on their capital.

      re: government policies and investment
      I think would be great if the Indian government would focus on building infrastructure, I think…check out my blog “What Indian entrepreneurs need. Really.”

      BTW, I love Husk power — heard of them about a year ago. Love what they are doing. Need more of that type of company!

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