Saturday, January 24, 2009

More Gloom and Doom on Venture Capital

In my first post on this blog, I speculated that although the popular press has a gloom and doom perspective on venture capital fundraising, in practice, there are plenty of factors that give me hope for a strong year.

Interestingly, it appears that the John S. Taylor, Vice President of Research at National Venture Capital Association, agrees in part with my thinking. In an interview he did with Venture Capital Experts on 1/21/2009, he echoed and amplified many of my sentiments.

Q: The NVCA released data in October 2008 that indicated institutions that invest in venture funds put less money into fewer funds in the third quarter of 2008. In fact, 55 venture capital funds raised $8.1 billion down from 83 funds that raised $8.6 billion in the same period the prior year. What do you believe the factors are that are contributing to this decline, and do you see the trend continuing?

A: There are conflicting dynamics happening here. Investment trends would suggest larger funds going forward. For example, international deals and investments in clean technology, medical devices, and biotech call for larger deal amounts and therefore more capital to launch the companies. On the other hand, there is a stronger downward force. The institutional investors who invest in alternative assets in general are tapped out. Venture is regarded as a good place to invest for those LPs which can, however, many cannot. For example, say that you are an endowment manager and you target 10% for alternative asset investment with 4% of the total going to venture capital. Assume you invest and attain this balance. Then the public markets which drive the other 90% fall in value by 40%. The portfolio is now over-allocated to venture capital. Because of this denominator effect, many LPs simply cannot commit to any such funds at this time. Compounding this effect is decreased liquidity in institutional portfolios having to cover the capital calls already committed to over the next several years.

If new capital were more plentiful would VC firms take it in? That's not clear. The industry has already shown great restraint post-bubble. Existing funds last longer. Capital efficiency is the name of the game. These days $10 million buys you more "runway" than it did a year ago. It buys much more than it did during the frenzied period of the bubble.

Just because there is less money going into venture capital funds, does not mean that there is not plenty of money out there -- many funds are sitting on large amounts of dry capital. Further, the trend is toward a greater number of smaller funds and a few very large funds, with not the large number of medium sized and large funds that have been common recently. This may mean that the absolute dollars raised is decreasing, but it does not mean that there are not deals being done.

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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.