Monday, March 30, 2009

Has Venture Capital Matured?

Have the information technology/web industries matured to the point that traditional venture capital no longer makes sense for them? More below the fold.

In a recent blog post, Fred Wilson discusses the rather dismal average returns seen in venture capital over the past 10 years (especially once you factor out the late 90s bubble and Google).

In his post, he muses that

entrepreneurs in the web sector have done a great job of figuring out how to build companies on much lower capital needs and we also have a vibrant angel and early stage (pre-VC) market developing. So it may be that the real problem is that there is simply too much money looking to get put to work in the VC asset class (certainly that is true in information technology)

My belief is that the relatively lower venture capital returns being seen in the IT sector are emblematic of a maturing industry. Many of the technology fields that powered the VC boom over the last two decades are now relatively mature industries. The PC, the internet, cell phone technology, Web 1.0, even Web 2.0 in many ways. It is precisely because the industry has matured that web/IT startups need a lot less capital to get going. It has become very cheap to buy computers, host servers etc. And the ubiquity of the internet and web 2.0 has made getting the message out about a product/application easier and cheaper than ever (if you can overcome the signal to noise issues).

I think that the rise of the micro VC niche is more a symptom than a cause of this. Companies, need less money to get traction in the IT sector and so financing sources have evolved a model that allows them to make money by making smaller investments. However, the flip side of this is that the mega funds have gotten so large that they can't put enough capital to work in the really disruptive corners. In addition, competition among the mega funds for the few start-ups in this sector that both are exciting and need a lot of capital drives down returns. There will always be room for the talented VCs in the IT sector, but the shakeout seems to already be under way.

As I have posted before, there are simply too good of returns that can potentially be realized in other less mature sectors (cleantech/biotech/nanotech) and other less mature geographies.

For example, the trend of many VCs in the US moving away from traditional computer and information technology and into cleantech, biotech and medical devices.

Moreover, right now home run returns can be visualized in India and China. (Although very few have materialized to date.) And investments are often being made in sectors that sound foreign to the VC world of the last 9 years, such as in education, hardware manufacturing and infrastructure. (Much different than web 2.0, SaaS and the cloud). However, when you take into account the massive and growing middle classes in India and China, these investments have the potential for the kind of explosive growth that a VC is looking for.

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