Reinventing Venture Capital

Posted by: Spencer Ante on June 11, 2009

Yesterday, as part of his work as Senior Fellow at the Kauffman Foundation, blogger Paul Kedrosky released a report, “Right-Sizing the Venture Capital Industry.”

Now, I couldn’t agree more that the venture capital industry needs to reinvent itself. That was the theme of my recent feature in BusinessWeek, Super Angels Shake up Venture Capital. But I was a little surprised by the way that Kedrosky went out of his way to diss the venture capital industry’s role in nurturing innovation, even though I know the Kauffman Foundation has a bit of an anti-VC bent.

“The industry has become conflated with entrepreneurship in the popular imagination as well as in policy circles, with the result being a widespread and incorrect belief that venture capital is a necessary and sufficient condition in driving growth entrepreneurship,” writes Kedrosky.

Kedrosky’s big data point? Of the 900 companies on the Inc. 500 list between 1997 and 2007, he reports that only 16% received venture capital backing. It’s an interesting data point. But to then argue that “venture capital and entrepreneurship are separate phenomena,” as Kedrosky does, seems like an overstatement to me.

Obviously, most new companies do not require venture capital but the ones that do need it play a hugely important role in the economy because they tend to be the ones that grow the biggest and create the most value. Think Google, which got a $25 million injection of venture capital at a key moment in its evolution. Without that money Google might have never become Google. There are many examples like this.

The rest of the report tries to figure out why venture capital performance has been poor lately and suggests how the industry will reshape itself. The upshot? The industry must shrink, perhaps in half in the coming years.

I basically agree that the industry needs to shrink. That’s pretty much what I argued in my super angels feature. The industry has an inversion problem: Fund sizes have gotten bigger while the capital needs of companies have shrunk. $500,000 is the new $5 million, as super angel Mike Maples said in my story.

Will it shrink in half? Maybe. Maybe not. All I know is that it will get smaller and that’s a good thing for the industry and for the economy. An excess of capital ends up wasting money and the scarce time of entrepreneurs, and drives up valuations to unhealthy levels.

The more important issue to me is that the industry needs to develop new models to finance and nurture innovation that fit today’s capital-constrained economy. Super angels will be part of the answer but it won’t solve the whole VC problem.

My colleague Mike Mandel blogged about this issue, making the point that science-oriented VC requires more money and a longer time frame to come to fruition. I think he’s right. And I’ve heard many VCs who invest in clean tech make this point.

Another big issue: Without an IPO market, there needs to be a new type of capital market that helps young companies finance their growth once they graduate beyond venture capital.

- Spencer Ante also publishes the Creative Capital blog. Click here to see more.

Reader Comments

Alex Salkever

June 16, 2009 4:07 AM

Spencer, another key point in the report was the VC Funds have actually underperformed the Russell 2000 over a 10 year window. That's pretty damning evidence. Also, with regard to Google needing that $25 million to become Google, there is no casuality and never will be. VCs will never be able to prove it was their intervention and capital that fostered innnovation. Not to say it isn't true but its always going to be open for discussion - a much harder discussion if their returns continue to lag.

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Bloomberg Businessweek writers Peter Burrows, Cliff Edwards, Olga Kharif, Aaron Ricadela, and Douglas MacMillan, dig behind the headlines to analyze what’s really happening throughout the world of technology. Tech Beat covers everything from tech bellwethers like Apple, Google, and Intel and emerging new leaders such as Facebook to new technologies, trends, and controversies.

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