Jan
31
12



Where We’ve Been & What’s To Come

Venture capital appears to be defying reason. On one hand, early stage fund raising has declined 48% year-over-year. On the other, there’s a start-up boom. Everyone, it seems, is starting something. And in Silicon Valley valuations are astronomical. What’s really going on?

Venture capital isn’t as attractive an investment as it used to be. 10 year median cash-on-cash returns fell 36% in the 2000s (1). In response, LPs have retrenched. For the past 3 years, venture fund raising has fallen below the 20 year median of $17.2B (2). As a result, today there are 31% fewer funds and 26% fewer venture capitalists than at the peak in 2000 (3).

Startup gestation times have never been longer. The median times to IPO and M&A have more than doubled since 1998, jumping to nearly ten and seven years respectively (4). Additionally, the IPO market is constricted. Over the past 20 years, 97 venture backed companies have gone public annually. Since 2001 we have averaged an anemic 36.

We’re observing a correction in the venture market.  LPs have pared allocations to venture funds and pursued firms with established track records. Since 2005, the average dollars committed to the top 25 venture funds varied between 7% and 57%. In 2011, these 25 firms raised 72% of all new investments.

Faced with longer holding periods, fewer winners and concomitant higher exit values at IPO or acquisition, VCs have concentrated bets, moved up market and invested in select growth-stage companies planning an IPO in 12 to 24 months at heady valuations.

If recent performance benchmarks are any indication, this strategy is rewarding investors handsomely. 10 year venture returns have hovered at 2.6% while trailing 1 year returns have jumped 10x to 21% (1). At least on paper, investors are gaining momentum.

With returns growing, VCs will continue to put money to work. Innovation has rarely occurred in as many different sectors as today. Mobile phones are changing consumer. SaaS software is disrupting the enterprise market. Data center innovation is driven by virtualization of the stack. And new consumer companies, whether gaming, curation or ecommerce are fueled by the massive distribution power of social networks.

However, the looming risk of the European debt crisis will surely temper these investment trends. The correlation between venture backed IPOs and stock market performance has grown much stronger over the past 30 years (5).  As a result, raising capital will be a tale of haves and have nots. Rapidly growing companies will have many suitors, while late bloomers and slow-growers will face a challenging fund raising environment.

Nevertheless, the industry won’t change too much. After all, VCs are always game to find the next great entrepreneur building the next big thing.

(1) Cambridge Associates
(2) VentureSource
(3) NVCA
(4) NVCA
(5) Redpoint Research