Wondering what happened to that looming shakeout in the VC
industry you were hearing about a few years ago? The VC industry
has weathered the storm and is now entering a new funding cycle
with increasing momentum.
There are currently two prevailing schools of thought on the
phantom shakeout. The first and more optimistic view holds that
fears were greatly exaggerated and the state of the VC industry was
never as bad as was rumored. "I never believed the doomsday
scenarios for the VC industry," says Mark Heesen, president of
the National Venture Capital Association. "We heard the number
of firms was going to be cut in half. Where we have seen a decline
is in the number of VC professionals. Because the fund sizes are
smaller today, VC firms don't need as many partners. As a
result, many partners have gone out and started smaller, regional
firms, so the number of firms has remained relatively
constant."
The second point of view holds that the bad investments from the
1999-2002 period have yet to work their way through the pipeline.
These supposed realists suggest that in another few years, when VC
funds that were started in 1999 or 2000 go out looking for new
funds from their limited partners, they won't find many takers
because their returns were so low. "When this happens,
it's going to squeeze firms out of the industry," contends
Rick Frisbie, founder of Wellesley, Massachusetts-based VC firm
Battery Ventures. "Today there is too much money relative to
the number of good investment opportunities for VCs."
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As with most debates, the truth lies somewhere in the middle.
What is clear is that the amount of capital in the VC industry is
down significantly from the bubble era. According to Thomson
Venture Economics and the NVCA, in 2000, the industry raised $106
billion. In 2001, that number dropped to $38 billion, and in 2002,
it plunged to $3.7 billion. But in 2003, the industry rebounded,
raising $10.5 billion. And in 2004, the industry continued its
resurgence, raising $17.6 billion.
These wide swings have forced some fundamental changes in the
way VC firms are structured and run. Venture capital has evolved
into a more mature industry with more procedures to follow.
"If you're going to scale the venture capital firm,
inevitably you have to have process," says Stewart Alsop,
venture partner with New Enterprise Associates, a Menlo Park,
California, VC firm. "It's not a bad thing because you
have to keep track of what you're doing. Venture capital
investing can't just be pure intuition. Process can get in the
way of actually making returns, but it doesn't have to."
So today, for better or for worse, many VC firms are becoming more
bureaucratic.
So what does all this mean for the entrepreneur? Since
there's a favorable climate right now for fund raising from
limited partners, the supply of VC capital available to
entrepreneurs will also increase. Says Heesen, "Over the past
six months, we have seen a marked change in attitude from VCs. A
lot of that is due to the fact that we have seen and will likely
continue to see good exits through the acquisitions market or the
IPO process. That, of course, is the end of the line for VCs."
So in the short run, it means a period of rising expectations, and
that's good news for anybody looking to raise capital. (For a
list of the top VCs for entrepreneurs, check out our 5th Annual VC
100 in the upcoming July issue of Entrepreneur.)
But in the longer term, it may cause problems for the industry
if VCs take in more money than is prudent. "We should have
learned the lesson of 2000, which was, If there is too much money
in the industry, a lot of it will end up invested in 'me
too' companies instead of important new technologies,"
says Heesen. "If we, as an industry, don't stay
disciplined, we could find ourselves in a situation where once
again there is too much capital."