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The "Lost Decade" for Venture Capital

Posted by: Michael Mandel on June 10

Paul Kedrosky just did a new report for the Kauffman Foundation entitled “Right-Sizing the U.S. Venture Capital Industry.” Paul’s main point—the VC industry needs to shrink to match the pool of opportunities:

It seems inevitable that venture capital must shrink considerably. While there is no question that venture capital can facilitate some forms of high-growth entrepreneurial firms, its poor returns make the asset class uncompetitive and at risk of very large declines in capital commitments as investors flee this underperforming asset. While any estimate is subject to much uncertainty, it seems reasonable—based on returns, GDP, and exits—to expect the pace of investing to shrink by half in the coming years. We should also expect a continuing sharp decline in the amount of money invested in information technology, a maturing sector with declining capital requirements in its remaining innovative segments. Capital will continue to grow in other areas, including clean technology, but the sector must shrink its way back to health if venture capital is to provide competitive returns and secure its own future as a credible asset class and economic force.

Paul (who runs the immensely successful Infectious Greed blog) points out, quite correctly, that

ten-year venture performance will almost certainly turn negative at the end of this year when the bubble venture exits of 1999 are excluded. As a result, the venture industry’s current returns are already challenged and set to become considerably worse.

The question is why. Paul gives several reasons, including:

the venture business itself might be structurally flawed, with the core markets that made it successful—information technology and telecommunications—now mature and delivering sub-standard returns, while new venture-ready markets have not emerged.

I would go even further. I think the disastrous ten-year stretch for venture capital closely reflects the innovation shortfall. The VCs did precisely what they were supposed to: Invest in high-risk technologies which were supposed to pay off in the 5-7 year time window, such as biotech, MEMs, fuel cells, and so forth. Unfortunately, they ran into a giant negative coin flip—everything was delayed a lot longer than they expected. Thus all the money-eating startups, and the general reluctance of VCs to stick their neck out.

But this explanation for the VC lost decade opens up another question: Do we need less venture capital, as Paul suggests, or do we need more? Or do we need another type of innovation funding, better suited for businesses which still need to do a lot of cutting-edge research?

“Venture capital never designed to take a company ten years into the future,” Gary Pisano of Harvard Business School told me a few weeks ago. Pisano makes a distinction between engineering-oriented high tech, like information technology, and science-oriented high tech, like biotech. Venture capital works well for the first type, because the difficult science has already been done and the time to market may be a few years. But biotech companies are still doing research, with a much longer time to market.

Pisano suggests that we set up the equivalent of a minor league for public companies, like the NASDAQ used to be before it got big. “It’s almost as if we need a quasi-public equity market which is regulated differently,” says Pisano.

Not an easy question.

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Reader Comments


June 10, 2009 02:46 PM

Still peddling that biotech/MEMs saw? How much VC money was actually put into those sectors, as opposed to IT? I'd guess that the VC money put into IT dwarfs biotech, MEMs are a joke. VCs are actually horrible even for engineering-oriented high tech, as most of their money goes there already. I've already sketched out why this in previous comments, let me repeat. VC was a small cottage industry that had some big hits with capital-equipment intensive industries like semiconductors or PCs. However, once online startups were the next big thing, the money flowed into VC with the boom hype and a lot of idiots rushed in. It seemed to temporarily work, before the bust showed that they were all variations on Ever since, they keep busting their heads into the wall with the same model that doesn't work, dumping money into idiotic startups like offerpal or wordpress. That's because they never deployed the proper monetization model, micropayments, and online startups are much more idea-driven than past tech. Rather than trying to find some magic technology and dumping $30 million into it, the best investing model for online startups is seed, making a ton of small bets on promising ideas and teams. Of course, it would help if the VCs had some clue on what was technically promising, but they're usually just aged financial jockeys trying to make one last big score. Investors, particularly the idiot VCs who rushed in during the last boom, are too stupid to figure all this out so they keep burning their limited partners' money, until the LPs finally realize this and pull out. As for biotech, there's no magic wand for early-stage research and I certainly don't know enough about biotech to offer any inkling of the right model. ;)

Mike Mandel

June 10, 2009 05:25 PM

Ajay:: I focus on biotech because VCs poured an enormous amount of money into the area--$35 billion between 1998 and 2007. Add in medical devices and healthcare, and you get almost $65 billion in venture capital money going into the health area, without the payoff that everyone expected.

How does that compare to other areas? Well, it depends on whether we include the bubble years of 1999 and 2000 or not. Including the and telecom nonsense of the bubble years, biotech and health-related startups make up roughly 17% of VC investments (by dollar). If we omit the two bubble years, biotech, medical devices, and health make up 25% of VC investments. Another cut: From 2003 to 2007, biotech, medical devices, and health make up almost 30% of VC investments. This is where the VCs made their big bet for the future.


June 10, 2009 06:03 PM

The return of the corporate research lab, or, more likely, more university research?


June 11, 2009 04:32 AM

Mike, however much money was stuck into biotech, you know that much more was stuck into IT and that it's the real laggard. Basically ignoring IT in that article, while focusing on biotech, was not a good assessment of our problems. I must say I'm surprised by how much money has been dumped into biotech (according to this data-, since most of it probably shouldn't have been put in and has had predictably weak results. Why would one exclude the bubble years? The fact is that dot.coms had a bubble where people expected them to deliver great things in short order, nobody ever had such high hopes for biotech and with good reason. Just because the bust showed that most of that money was invested badly doesn't mean the promise was false. I suspect we will look back on the last 15 years without micropayments as lost years someday soon, where much more could have been have done but wasn't solely because of sheer stupidity. Getting back to VC, the fundamental problem is that they have no idea what they're doing and they will continue to lose money until the LPs wise up.

Mike Mandel

June 11, 2009 05:19 AM

I'm going to get to IT next. It poses a different set of issues for the economy.


June 11, 2009 07:04 AM

Maybe I should have read the surprisingly short, linked pdf before commenting: he has a great graph in there that shows exactly how IT has dwarfed healthcare VC over the years, also fascinating seeing the actual numbers on how VC capital skyrocketed during the bubble. Glad to hear you'll get to IT next, looking forward to what you dig up. In looking for info on who exactly are the moron limited partners who put money into VC, I found this great expose that details why money keeps getting dumped into VC and lists some examples of how that money is frittered away - If you follow tech funding at all, you know that those dumb investments are the rule, not exceptions, which is why I stopped following startup news last year. I think one main reason large venture investments fail in IT is that most of it goes to salary, not equipment. I suspect that good teams can only be grown organically, that one can't pump the steroids of VC money in and get there faster, perhaps explaining the dysfunctional character of VC-backed IT companies. Perhaps the VC model once worked when most of the money went to capex like semiconductor fabs or PC factories, but it has assuredly not worked for intellectual labor-intensive IT, which is another reason I believe seed is the better investing model.


June 11, 2009 09:48 AM

1) I am struck by the VC concentration on IT and, lately, on green energy. (See Kedrosky, p.6) Why so little on manufacturing, or on conventional energy? The oil industry seems to find lots of new things to invent, but it is not a field for VCs. (I have some knowledge of this general area because of involvement in coal, which has been a research-light area, and which has promising possibilities.)

2) Bob Cresanti, when he was at Commerce, talked of the "valley of death" -- the stage at which companies were too big for friends/family funding and too small to interest VCs. Kedrosky comments (pp. 2-3) that the fastest growing small companies do not get VC funding; he draws the conclusion that they do not need it, but another possibility is that these are the survivors of a Darwinian process, and that other companies might succeeded too if funding had been available.

Ajay's comment rings true: "Rather than trying to find some magic technology and dumping $30 million into it, the best investing model for online startups is seed, making a ton of small bets on promising ideas and teams." The question is whether the institutional structures, such as securities laws, facilitate this.


June 11, 2009 09:58 AM

1) The focus on IT and, lately, green energy, is interesting (see Kedrosky, p.6). Why the imbalance? Logic would dictate that VCs would seek out other areas, such as manufacturing, or conventional energy – the oil companies find lots to invent, and based on some personal involvement in coal, opportunities for innovation exist there as well.

2) When Bob Cresanti was at the Commerce Department, he talked of “the valley of death,” when start-ups become too large for friends & family funding and too small to interest VCs. Kedrosky (pp.2-3) says that few of the fastest growing companies got VC money. He interprets this to mean that they did not need it, but they could be the Darwinian survivors who managed to cross the valley, and that others would also have survived if money had been available.

Ajay’s comment seems right: “the best investing model for online startups is seed, making a ton of small bets on promising ideas and teams,” but why limit it to “online”?


June 11, 2009 12:55 PM

JVD: The goal of VCs is not to make promising and sustained investments, but the quick buck. The "exit strategy" is part of the deal from the inception. As dotcom has amply demonstrated, more often than not the exit strategy has been to sell an overhyped company to an unsuspecting public (IPO) and/or a larger corporate player (possibly competitor). That kind of hype cannot be generated with household names, i.e. "old economy business".


June 11, 2009 01:38 PM

Sorry for the duplicate post - I mistakenly thought the computer ate my first effort.

Cm - I agree about their motives, but I don't think it excludes businesses other than IT. After all, the Private Equity people took old names, loaded them with debt, and then sold them to an unsuspecting public.


June 11, 2009 11:32 PM

JVD: The PE business is conceptually different from VC. VC by definition will invest in "hot new stuff", or whatever is positioned as such. The V stands for "venture", as in "adventure".

Elliott Dahan

June 12, 2009 07:42 PM

The Risk Investing industry is divided into 3 distinct groups: (1) Seed/Startup; (2) Traditional VC and (3) Exit

They are systemically, operationally and attitudinally different. They have different metrics for acceptance and success; funding, oversight, sourcing, profitability and, most importantly, infrastructure.

The Seed/Startup stage creates and innovates.

The Venture Capital stage of the Risk Investing industry has a valuable place – to expand Seed/Startup companies with money for growth. In some cases, VCs do provide competent managerial talent and valuable business development partnerships, but the only constant provided by VCs is money. Money is the only element a VC provides that an entrepreneur cannot get from a Consultant, Board of Advisors or folks he/she really trusts.

The crisis is not in lack of IPOs or shrinking of the VC community. IPOs are dependent upon the marketplace. Too much money thrown at too many undeserving portfolio companies by too many VCs living on 2% management fees is the problem.

The shrinking of the VC community is certainly not a problem.

The crisis is in the ability to develop stronger Seed/Startup stage companies. The problem exists and is currently addressed by drive by mentor programs, summer camps and American Idol type reality shows. Two to four months of intermittent oversight and $10,000 - $25,000 in seed funding really doesn't do much for any venture beyond iPhone apps or Web gadget type items.

What is needed is a Public-Private For Profit dedicated effort to work with, support and compensate the Seed Infrastructure (Incubators, Economic Development Agencies, Tech Transfers). This infrastructure already exists and provides the efficient sourcing, screening and post-investment oversight needed to develop Series A worthy companies. What is needed is a dedicated effort that is not geographically constrained. What is needed is a thorough Virtual Incubation system that brings both Community and Collaboration to all elements of the total Investing community.

By dedicating a private/public collaboration to increasing the value and viability of early stage companies you are also increasing their valuation for their Series A round; thereby leveling the playing field with what will be a smaller group of Traditional VC funds.

Please review the powerpoint – The START Fund -

Elliott Dahan
Managing Partner
The Growth Group
Email elliott(a)

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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