Shrinkage—Expanded Upon….


Poor investment returns have had a similar effect to cold water – the VC industry is shrinking. As a follow-up to comments I posted this past weekend, I wanted to look deeper into recent fundraising data and see what other implications one might draw.

Since 1980 the VC industry has raised $495 billion across 4,333 funds or 1,670 firms (firms typically raise more than one fund). Today the industry is thought to actively manage right around $200 billion of capital and industry analysts estimate that there are about 770 active firms in the US today. There are 415 firms which are members of the National Venture Capital Association (where I am a board member).

VC funds tend to be fully committed within the first three to four years of being raised, although it may actually take quite a few years—upwards of eight to 10 years to be fully invested (because of reserves for follow-on investments in existing companies) and at least that long to be fully liquidated. Most VC funds have a contractual 10-year life. Firms are deemed active if they have raised a new fund in the prior eight years, per the NVCA.

In 2010 nearly $21.8 billion was invested in 3,277 deals but only approximately $12.3 billion was thought to have been raised by VC’s to invest—thus the shrinkage issue. Between 2007 and 2009 roughly 100 venture firms left the industry each year—in 2007 there were just over 1,000 firms—-not terribly surprising given the global economic meltdown. Perhaps a more interesting metric, though, is the number of funds raised; the high water mark in 2000 saw 635 new funds raised (six hundred and thirty five—over two per day not counting weekends), which declined to 157 in 2010. In 2000 all those funds invested in 7,970 deals – simply staggering.

More stats. Since 2004 more than $166 billion was raised by VC’s and $168 billion was invested (since 2005, $149 billion raised, $147 billion invested) so things seem to be in reasonable balance. The analysis is tricky because how long it takes to actually invest a fund once raised, but the industry has a nice ability to recalibrate itself quite quickly.

So as the economy recovers we would naturally expect to see the amount raised and the amount invested to converge – but we did not see that in 2010. In fact – other than for 2001 – we have never seen such divergence. What happened?

The venture industry this year reported for the first time 10 year returns data—which was quite negative—while expected, sent shockwaves through the LP community. As of September 30, 2010 the … Next Page »

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Michael Greeley is a General Partner at Flare Capital Partners, a healthcare technology venture firm. Follow @greels1

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6 responses to “Shrinkage—Expanded Upon….”

  1. Bob WilcoxBob says:

    So equity financing is an unsustainable method of funding startups, and the process of selection, as well as the method of company management practiced by VCs provides no evidence of success. But do older, larger, or more diversified VC firms correlate to better returns? Do smaller or larger investments yield better returns? Do late investments show success while seed investments destroy portfolios? Angels, joint ventures, and grants are alternatives for financing seed or A round. How does their their track record compare to VCs at the same stage?

    Our economy and our well-being depend on robust entrepreneurialism. It’s not clear that VCs are a good way to ensure entrepreneurialism, nor that they are always as bad at their job as this data suggests.

  2. Given all of the questions in Bob’s response I am not sure where to begin. Today the BBJ reported recent VC returns data which show meaningful improvement – and that returns continue to outpace publc indices. Trouble with aggregate VC returns are that no one can invest in that index – it does not exist. It is certainly true that top quartile VC managers very dramatically out perform the all other VC’s – so I would fundamentally disagree that “equity financing is an unsustainable method” to start and grow new companies. VC’s have provided capital to many of the corporate success stories of today.

    One thing I would point out is that VC’s are not alone in generating poor returns. Yes, we make investment decisions, decide which industries to focus on, which CEO’s we might like to back – but VC’s don’t build the product, sell to customers, hire management teams, execute on a business plan – we may influence those activities or express an opinion – but senior management at the end of the day is responsible for all of those activities. And doing that poorly generates bad returns. Blame needs to be shared.

  3. Michael,

    Excellent story. We are a Cleantech Open Finalist from 2010 and have built our business around biomass energy since 2008. The economy has been unfriendly but our approach has been to build an audience through social media. We currently have the world’s largest social network for gasification. This initial investment of time and resources into building a community has been the defining factor in our success selling bioenergy products.

    The CTO was an amazing experience and has helped us make it to the next level, but my impression of the V.C. industry is that it is simply too much of a lottery mentality, looking for these “black swan” events. There is no shortage of great ideas and willing markets that can produce cash flow positive businesses, but if they aren’t potentially valued at a billion dollars, they just get brushed aside. Base hits win games. Since new companies are always reinventing themselves, today’s uninteresting base hit can be tomorrow’s breakthrough, but only if they have a business to build on.

    V.C.’s bring the finance. Entrepreneurs bring the passion and ideas, but who in the equation is building the organization? Usually no one. Someone needs to read E-myth or work at McDonald’s.

    As we build our business we are also building a platform that provides all of these organizational tools and access to manufacturing space so we can scoop up these unfunded or bankrupt projects and extract the value just sitting there for the taking.

    The micro-angel phenomenon is just the beginning. I think your industry is going to undergo some dramatic change when it realizes that scaling atoms is much more difficult that scaling gigabytes. i.e. it’s not 1999, so stop investing like it’s 1999.

    The world needs clean energy products and America needs to rebuild it’s manufacturing capacity with a lighter footprint. Those needs create a tremendous opportunity if the investment community has the right strategy to tackle them.

    To address your last sentence… “Blame needs to be shared.” That is exactly the mentality of people who spend/invest other people’s money (V.C’s, funded start-ups & grant administrators). When it’s your own money on the line, failure isn’t an option. I have $350,000 into my business and I don’t spend a single moment looking for anything to blame.

  4. Michael,

    I am reminded of a panel I attended 10years ago in Boston when I was an Associate at a VC firm where Josh Lerner moderated a panel of esteemed founding fathers. I remember Peter A. Brooke speaking among others. One of the elders said something I will never forget especially as it was 2001-02 something like:

    “…you guys don’t understand we would invest in these companies and help build them for 7, 8 sometimes even 10 years and in the end sometimes well we would just get a 1.3x or even worse only recoup 30cents on the dollar – it was like kissing your sister…”

    And I remember how that affected me. It’s got to be about building companies not fund performance and personally I think this shrinkage is a great turn of events. Shedding all these funds, assets and investment professionals is a healthy cyclical correction. The VC industry got way off course and polluted with a focus that became far too transactional.

    Sure it’s about returns to LPs but in the end there is no shortcut for building companies of value — too many jumped into VC for the returns and the carried interest when the gentlemen who funded Intel and others got in to build companies.

    This is a return to better norms and I look forward to investing as a VC again after hopefully having many years of success as a repeat entrepreneur. By that time this cleansing process will have greatly improved the quality.

    VC firms provide a service to both investors and entrepreneurs. Too many VCs forgot their obligation to be customer oriented to both parties and started thinking they managed and the company management were the staff. In truth that “sit back and let them do the work” model is what is dying off. VCs need to role up their sleeves and contribute to the value creation every week as adding capital alone is not value creation and will not generate respectable returns.

    I agree the world needs a healthy venture capital industry but it has to be be driven by principled PPMs, efficient metrics and effective company building and not just “quick-exit” oriented thinking.

    IMHO having fewer of the laggard underperforming funds around will not reduce the number of quality firms getting funded. And it definitely won’t hurt aggregate returns for the asset class! ;-)


    PS I think it’s really important to note how things have changed for startups. Note only do many tech companies need much less to get going but they can build and get to proof of concept much faster… I may have missed it in your piece but I didn’t see that as part of your comments.

  5. Michael Greeley says:

    Ben, thank you for the comments. I would be delighted to learn more about your company – but let me respond to two of your comments if I may.

    First, I worry that many “micro-angels” will not have the financial capacity to take their portfolio companies from beginning to end; the dilution risks being quite severe over numerous financing rounds.

    Second, to correct a misperception perhaps, most VC’s have a significan portion of his/her net worth invested in their own funds. My partners and I represent a significant amount of the dollars we invest in any one of our portfolio company – so believe me when I say that I feel every one of our losses! We don’t simply “spend/invest other people’s money.”

  6. Michael Greeley says:

    Josh, excellent comments. I am sure I was also at that same event with the “old guard.”

    I could not agree more. VC’s are known by the great companies they are associated with – we all must aspire to help build great companies which change the world in some manner. And accordingly, even though ~3,000 venture-backed companies are funded every year, a very small percentage of them will be truly great compelling businesses.