The Future of Venture Capitalism

Fred Wilson on the changing nature of Venture Capitalism - GigaOm:

Firstly, it doesn't make money any more:

Wilson said that since the mid-1990s institutional investors have poured $30 billion into the venture capitalist business every year, but venture capitalists have only been able to figure out how to generate good returns on half of it. (Actually, venture capitalists haven’t seen that much money flowing in since 2007, according to the National Venture Capital Association, which notes the recession dramatically lowered investment.)

“There’s two times as much capital in the venture capital business today than we, the professional investors who make up the venture business, can actually put to work intelligently,” he said. As an asset class, venture capital has not beat the public markets on a consistent basis since the mid-1990s, he added.

Secondly, new money is coming in from new sources (I suspect this may be the cause of the above problem):

In the past five years, the amount of angel investment has grown fivefold and more international funding is also entering the startup sector, particularly from Russia and the Middle East, Wilson said. The growth of crowdfunding (made possible by the recently-passed JOBS Act) will further flood the startup market with new capital. If every American family gave just one percent of their investable assets to crowdfunding, he said, $300 billion – or ten times the current amount invested in the sector – would come barreling into venture capital. (That seems to be a pretty big assumption but, regardless, the point is well taken: crowdfunding stands to dump a huge amount of new money into startups.)

Fred's view of where VC is going are:

(i) Given all the new pools of funding, he said, it doesn’t make sense for VCs to continue aggregating capital. And considering the industry’s inability to generate returns on more than half of the current investment in venture capital, he added that the allocation aspect is another area ripe for rethinking.

(ii) Still, he continued, VCs, can keep on adding value as board members, advisors and resources on exits and governance.

(iii) Going forward, VCs have a few options on the table, including becoming more selective, shrinking, halting investment of instutional capital or taking more equity for the governance and advisor services they provide, Wilson said.

(iv) But one of the more compelling ideas he floated was building a business on top of crowdfunding.

“If these crowdfunding markets really do develop into these vibrant markets… maybe the answer is to leverage that capital and do something interesting there as opposed to going out and raising money from the institutions,” he said....And, as a last resort? Quipped Wilson, “We can just retire.”

Only those that were in it before 2000 can retire comfortably by the looks of it though

In his own blog, Fred notes his talk was picked up wrongly as the "death of VC"

I can assure you I never said anything about the "death of the venture capital business" in my talk. The venture capital business is not dying.

My talk was a rumination on the forces at work on the venture capital business today and the changes that may be required to remain relevant and profitable in this new world. The talk was provocative and "out there" but it was not a eulogy.

Defitely not the death. More the circle of life....seems to me that rather than a paradigm shift in VC, another very plausible explanation is that too much new money is flooding in chasing too few opportunities - in other words what we are seeing is good old Bubble behaviour as people start to become irrationaly exuberant again. Then we will have a bubble, then a burst, then it will all flood out again.

That new startups do not need the same funding as the olde style ones is a truism - but all that has done in the last few years is increase the number of boot-strapping startups in the primordial soup. You can't seem to move these days without tripping over another newly set up incubator (more shades of 1997....).

Update - just saw this from Fred Destin on Kernel - Europe is playing out differently:

European venture capital is out of favour with LPs. Even the word seems toxic: I know of one fund who dropped “venture” entirely from its pitch, focusing its messaging on “growth capital for technology companies”. Struggling venture capitalists have to first convince hesitant investors that Europe is a good place to put their cash before they can talk about the relative merits of their particular fund. It’s tough when you have to evangelise your region before you can even get into your own story.

Ironically, the best new initiatives end up relying on public money. The wonderful Passion Capital initiative is one such example. The European Investment Fund (EIF) is seen as the great white hope anchor investor you need to get. (I used the word “ironically” because during the Great Internet Bubble the EIF stood behind a gazillion regional fund alternatives, most of which produced disastrous results.)

In this case it's governments rushing in while Angels fear to tread