Although venture capitalists in the past decade to invest more than ever could, depression reigns in the industry. Is the Venture Capital Business Broken? Not necessarily – if the industry understands that there has been a structural, not cyclical change.
Summer 1996: venture capitalists from Silicon Valley put a few million dollars in a start-up, Juniper Networks, will produce the telecommunications equipment. Three years later, and some funding is Juniper Networks, which has become the first product ready to go public. At the end of the first trading day, the company’s whopping five billion dollars. Nine months later, their stock market value has increased tenfold. The profit for the investors: 10.000 percent.
At this time other investors put their money also one with a promising networking startup: Procket Networks. The sum is much greater than before at Juniper Networks. Around 300 million finally come together in several rounds of financing. Procket Networks is also three years after the founding of the stock market, though still without product. But the spark does not ignite: 2004 IT – equipment supplier Cisco, a leading network infrastructure hardware and Cisco Certifications provider acquires company in an emergency sale. This time the investors get out only a fraction of the capital employed by them.
The crucial difference between the two stories lies in what happened in 2000: the New Economy bubble burst. In retrospect shown herein but also the difference between the images of the Venture Capital (VC) has received in the 1990s, and the harsh reality of today. Ten years ago, venture capitalists seemed almost to be alchemists: Which start -up and touches it, turned it into pure gold. From this magic is not much left.
Since 2004, the average five-year yield fluctuates around zero. Spectacular IPOs are now a rarity, even though venture capitalists are still investing billions of dollars a year in new companies. Fred Wilson of Union Square Ventures takes as no bones about it: “Venture capital funds have earned throughout the last decade basically no money.”
Of course, the investor, this development has not left cold. On the contrary, the search for reasons sometimes resembled a masochistic self-flagellation. This is now the global economic crisis. Very hard to put Matrix Capital – founder Paul Ferri in 2006 in the Wall Street Journal: The VC industry has not “economically viable business model “more. A year earlier, Yankee Group founder Howard Anderson in Technology Review the “Farewell to the venture capital had proclaimed. Finally, when the company last summer and asked Polachi Co. about a thousand investors: “Is the Venture Capital business is broken? “It affirmed the half. Given the key role played by the venture capital to fund American innovation, this response is dramatic.
Of course, such disappointments are inevitable. Boom and crash has been in the VC industry, since it arose in the 1950s. Harvard economist Josh Lerner writes in his new book, “Boulevard of Broken Dreams”: “Groups have [repeatedly applied] enormous sums that they built it unwise – either at start-ups that would never actually have capital may have, or promising Founders, which they gave too much.”
The crashes that follow such excesses solve capital, mostly from an abyss of pessimism. Thus published about Paul Comper from the University of Chicago in 1994 a study entitled “The Rise and Fall of Venture Capital”, shortly before the New Economy boom began. Given two Stock exchanges quarrels in the past ten years and an erratic stock market – normally the exit option for venture investors – it would be a surprise if the mood was not somber.
And yet, to believe: that the problems of the industry would evaporate if the economy picks up again, would be a mistake. In fact, it is in some factors, have made huge profits so rare to structural changes, not cyclical. The VC scene will therefore have to adjust.
On the one hand, the cost to start a company and make successful: In the IT sector as they are, thanks to open- source software, globalization of engineering technology, plenty of available bandwidth and cheaper infrastructure fallen drastically – according to estimates by Fred Wilson since 2000 ‘at least’ by a factor of ten. The business has given more leeway because they are no longer relying as strongly on debt. Same time, sectors such as IT, Telecoms and Technology, where investors were particularly important, getting on in years and do not grow as fast.
Moreover, create the value that companies in sectors such as social networks, for the time being not “monetized “is. The benefit to the user results not dollars. Today’s generation networks will naturally assume that everything on the Internet must be free. Those who hope that it is a lucrative customer base as well as the IT departments of companies, is mistaken.
Whether IPOs ever again be the gold mine that they once were, is also an open question. 2009 only 13 were funded with venture capital firms to go public. In 2004 the figure was still 94, at the height of the New Economy boom in 1999 did 271st at that time, Twitter and Facebook would have gone virtually certain to go public. But do not make use of two companies so far a move to do so.
The problem lies on both sides: it requires strong entrepreneurs do not like it used to IPOs, but the investors do not even that. A listed company is now harder than ever to lead: The regulatory framework is extensive, the greater pressure from shareholders and the stock market, at least in recent times, more susceptible to fluctuations. Moreover, the determination of emission rates is now far more rational than before. This is a crucial factor, because venture capitalists have pulled out the most money from IPOs.
Howard Anderson holds the solid evaluation of start- ups for the core problem of the investor sector. “The whole market has become more mature, “he says.”This is not bad per se, but for investors already, because we love irrational markets. They facilitate the outrageous profits; you need to make this business work. “However, there are exceptions: the Battery manufacturer A123 Systems – In the way Anderson invested – got together with its IPO in the fall of 2009 380 million dollars.
On the other hand there are early signs that will be re-thought in the industry. Tim Draper of Draper Fisher Jurvetson (DFJ) argues even know that “the next eight to ten years, the grandest venture capital in years of history.” However, he sees the innovation drivers no longer there, where they had so far: DFJ invests primarily in Silicon Valley is no longer, but also in China, India and Vietnam.
Although would still invest a lot of investors in IT, “because they have always done it that way,” Paul Kedrosky criticized by the Ewing Kauffman Foundation. But not a few put their money now in the media, education and even in the financial sector on where to ground- breaking innovations, technical change and thus leads to potential profits.
But it would not be enough if investors only changed the sector and the region. The real problem is simple: there is too much venture capital and too many venture capitalists, as the industry really are profitable as a whole could. $ 200,000,000,000 it manages, more than twice as much as in 1998. Most of them invested in the past decade 20-30 billion dollars per year.
At the level of individual funds, the combination of huge amounts of capital and falling start-up costs, the fund ” muscle packages made, “as Anderson puts it: who controls $ 500,000,000, cannot go into little too many holdings, even if they would make economic sense because the partners do not have time to oversee hundreds of start- ups.Among other things, more and more investors than to be seen once and join in later financing rounds.
In the absence of a new financial bubble new companies currently have no chance to earn a profit, which makes an investment volume of 20 to 30 billion U.S. dollars lucrative. Wool enter the industry sustainable profits, should the annual investment volume and the funds managed only once to be halved, argues Kedrosky. And Wilson acknowledges that his optimism returning for the new decade, the industry “to the size and the Constitution, which they had in the late eighties and early nineties.
Interestingly, this diagnosis is not particularly controversial. Most people in the VC industry believe this is because too much money. However, it is like with transport: Everyone thinks there are too many cars on the road, but nobody wants to switch to public transport. While in most industries, competition is forcing the weak in the knees, sorting out the Venture Capital takes longer because it’s not like the stock market works: When you get doubts about his investment, you cannot get off easy. The partners, which invest in venture capital funds are long-term, binding commitments one to support payments to the shareholders who manage the fund.
Regarding the innovation is both the great strength of venture capital: Instead of relying on quick profits, it can afford to build companies. On the other hand by a “huge latency arises in the system, “as Wilson puts it. Although has developed a more reasonable balance between the capital stock and the potential rewards, it takes time until the “underperformers “are driven out of business.
This indicates that the VC industry still has some weakening years ahead. Even though this is not good news for investors, it must not be a problem for the economy as a whole. The peculiarity of the debate is that everyone is still convinced before, early rounds of financing are important for innovative companies.
It’s not about whether venture capitalists to create additional value: History shows that they have driven innovation, even if many entrepreneurs strike up a lament. The scientist Thomas Hellmann and Manju Puri have found in a study by Silicon Valley companies that venture capital -funded companies have brought products to market faster and more of an “Innovator “strategy pursued. In an analysis of patent data could explain Josh Lerner turn, that the VC- dollar ” three or four times “as much effect on the innovation process were as in-house spending on research and development.
Thus, if venture capital is equally necessary and useful, why is it then plays a role of a social standpoint, whether there is too much of it is? Ultimately we are interested not so whether or enter big profits for investors are well paid. The idea is to create new companies and innovations are financed.
One of the basic wisdom in this business is that you do not profitable innovations can detect in advance (which is why it is important that in the VC portfolio a few hits, make up the bad investments).
If the VC industry is shrinking healthy, which has perhaps even more important for them than for us all? For, as says Tim Draper: “There is never enough for investors, entrepreneurs or money for new ideas.”Although some investors put too much money on me-too software companies or failed cleantech companies have, would it have been better they had put it into any debt borrowings from banks, which led to the financial crisis?
However, there are arguments that a too bountiful venture capital industry is not good. First, since investors will receive a certain percentage of the invested money, they can, given the billions that come into play each year, live well even if the investment leads to nowhere. Not a good condition for linear investors.
The ” muscleman “problem is also important: if too much capital leads to one an increase in later financing rounds, decreases the value that can be added by the investment. Equally likely is that broad portfolio, because of the fund size to ensure that the oversight diminishes the performance of each company. This may interfere with entrepreneurs, but the results show by Josh Lerner, that the supervision by venture capitalists has an important role by enabling VC- financed firms are more innovative.
Since there could be no coincidence that the excess supply of venture capital to a period falls, in which only two VC -funded companies have a real difference: Facebook and Twitter. Perhaps it is also the industry as a whole has been a while too well.
This is changing now, and that’s good: the financing with Venture Capital in 2009 fell to 17.7 billion dollars, 40 percent less than last year. Even if it hurts, it is better to get investors; the industry will again find a reasonable size. It is extremely unlikely that the pendulum swings back too far – so that it at once is not enough venture capital. The lure of large profits will remain so. And as before, is more venture capital with successes such as Juniper Networks – and before that associated, for example, Cisco, Apple and DEC – as with failures like Pocket Networks.
Venture capitalists are always very self-confident as well as entrepreneurs: they believe that they can identify potential profits, and realize that others miss. This may for investors and entrepreneurs may not necessarily be good for us all against it already, because is a constant cash flow guarantees in new business. Venture Capital must be a more rational business – but rational may not be the business.