The Slog Continues (cont’d)…

So one final thought…something I have been wrestling with for some time now is how many venture firms can reliably, predictably and on their terms raise a new fund in this environment? Tough question to answer but the data may shed some light.

According to the NVCA Yearbook 2012 there were 842 VC firms in the US at the end of 2011 which have raised capital in the past eight years; of that cohort, 526 firms were deemed “active” – which means they made investments totaling $5 million that year (frankly, a pretty low bar). Interestingly, at the end of 2011, there was approximately $197 billion under management in the US venture industry. Also of note there were 1,012 firms in 2006 so the industry lost 170 firms (or 17%) over the past five years; that same year there was $288 billion under management, which means from a capital managed perspective the industry shrunk by 32% over that same five-year period.

So this is what is so potentially daunting. This past quarter there were 10 firms which raised funds larger than $100 million, which I would deem as a threshold to be material to the overall industry. If this past quarter is representative of the new reality then, and firms raise new funds every four to five years, might one conclude that there is only room for only 160 – 200 firms? Are we looking at an industry that may contract by another 50% – 75% in terms of number of firms?

More numbers. The median fund size of those top 10 funds raised last quarter was approximately $350 million; across those same 160 – 200 firms that would be $56 – $70 billion raised over the next four to five years. Does that start to suggest where we are heading and how large the VC industry will be? The last time the VC industry was less than $100 billion was in 1998 ($91 billion managed).

Undoubtedly this is too dark a picture. We are investing in a time of unprecedented innovation which will drive superior investment performance. As returns and liquidity come back, LP’s will be drawn back to the VC asset class – but the analysis is thought provoking nonetheless.

What do you think? What percentage of firms today can raise a fund on their terms? 5%? 10% 25%?


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4 responses to “The Slog Continues (cont’d)…

  1. I believe both the data and macro trends have suggested that the VC industry is moving more and more towards a greater amount of VC firms managing much smaller amounts of money. As a result, the industry isn’t shrinking at the rate you have just pointed out. While the total capital under management may stay relatively stable, I believe the number of funds will be increasing as most will be looking to raise much less than $100M.

    There has been a lot of talk about a “seed bubble” over the last year. We can confidently say that the financial crisis greatly hampered the IPO market which has only recently begun to slowly pick up steam (even in 2012). Current funds have made a transition to source deals that can earn a return when acquired instead of scaling all the way to IPO in order to minimize risk. These companies may not be as big, broad, or sophisticated as an IPO candidate, and instead, as you pointed out in your previous post, are often products or features.

    This attitude can be explained by the 2008 credit crisis. Companies were forced to build up large holdings of cash on their balance sheets. In addition, cost cutting measures were put into place which oftentimes meant vastly reduced R&D budgets. This means that over the last few years companies have a great deal of cash, are looking to take risk as the economy has strengthened, but have a weak pipeline due to a lack of R&D. To fix this, they have been seeking acquisitions.

    VC firms have caught onto the trend and we are seeing many “lean ideas” (as Bussgang recently discussed) being funded that are never expected to make a dent in the business world. Instead, companies are being tailored to be acquired or even acqui-hired.

    Ultimately, the VC industry isn’t shrinking by vast amounts, but the majority of funds are transitioning the model by raising less money (less than the $100M threshold) and investing less money in each business yet ultimately seeding more companies. What is shrinking is the number of firms looking for giant homeruns that an IPO can bring.

    Frankly, as a college student looking to go into venture capital, this attitude and mindset has been pushing me away from the startup/vc community as of late. Instead of companies being built to create jobs, better the lives of employees, solve a unique problem, make the world a better place, etc. – they are being managed in a way that tailors them to best get acquired in the shortest period of time. What are your thoughts? Does the data, economy, or trend point otherwise?

    – Zach Ringer

    • Thanks Zach. Very thoughful response. Time will tell which one of us is right! I think the VC industry is shrinking quickly back to historic (pre Internet bubble) both in terms of capital and number of firms, but that does not mean new models can not co-exist with traditional VC investment firms. The industry is also consolidating – perhaps like many maturing industries do.

  2. Pingback: The Daily Start-Up: Tenaya Capital Closes Sixth Fund, First Since Lehman, Above Target |

  3. Pingback: The Daily Start-Up: Tenaya Capital Closes Sixth Fund, First Since Lehman, Above Target |

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