One quick point of order: I am not a VC but I get the dynamics pretty well. And I have invested in a handful of early-stage companies over the past few years; some with VCs, some ahead of traditional venture capital.
If one considers the amount of total venture capital raised from 2006-2008, and then take a look at the last three quarters of 2008 in the context of the larger macro-economic environment, current liquidity issues in traditional limited partner institutions, and the generic venture business model, there are some interesting implications for the not too distant future. This is the first in a series of posts that takes a look at what’s going on in the supply chain of venture capital.
The NVCA reported that $35.5 billion was raised across 327 funds in 2007; $27.9 billion was raised across 253 funds in 2008. During the last three quarters of 2008, you can see a decline (red, dashed arrow) mid-year and then a very sharp drop as the economy started slide (to put it mildly) in Q4 of last year. During Q4 of 2008, the total amount raised was $3.3 billion compared to $11 billion in the same quarter the previous year.
With a bit of extrapolation, it’s not hard to imagine that 2009 could be a year in which $10 billion or less! is raised across the entire industry.
Here’s why I believe that number is about right:
First, I believe that traditional limited partners are experiencing a liquidity crisis. More on the data and what this means in a future post. But, in short, the businesses that fund the venture capitalists are short on cash for that purpose. Not only are the short on cash, but they’re over-subscribed in their commitments to venture capital funds.
Second, in many cases, these same institutions analyze their investment portfolio, per asset class, on 10-year rolling averages. Guess what year rolls off next year? 1999 is gone from the average and that was a pretty good year in many venture capital funds. In fact, with 1999 out of the 10-year analysis, it’s very possible that the over-all weighted returns go from positive to negative. Pretty obvious what happens if an asset class shifts from positive to negative when it comes to how investors choose to allocate any new funds they may have to put to work.
So what is the implication? I think that 2009 may look like a $10 billion year at most and 2010 will put up an even smaller number; perhaps only $3 – $5 billion in total. What this means for the industry is that there is a looming venture capital crisis the likes of which the industry has never seen. It’s going start becoming increasingly obvious and play out over the next 24 months. Many, many venture firms are going to go away. The cost of capital will go up.
UPDATE: April 18, 2009
There have been a number of recent articles on this topic from TechCrunch as well as VentureBeat. Even as far back as October, 2008, Business Week blog has reported on mounting tension from the VC world:
(Tom) Crotty hopes the atypical investment approach will insulate Battery (Ventures), but he nonetheless sees a reckoning coming—specifically toward the end of 2010. He points to 2000 as the “last really good year” for venture capital. Looking back, “the one-year, three-year, and five-year indexes are all going to be terrible,” Crotty says. “And once 1999 and 2000 fall off, the 10-year will be, too. It’s going to be painful.”
If the 10-year investment period hits at or below the S&P 500, portfolio managers are going to wonder why they’re investing in such a risky asset class. Crotty estimates that 20% to 30% of the money going into venture will go elsewhere, and that is going to be bad. A lot of firms will go under.
To re-state my concern from the original post: the VC-start-up supply chain will be disrupted for the asset class performance issues noted above AS WELL AS the general liquidity issues in limited partner land.