Has the venture capitalism model of investment had its day after a decade of decline?
In venture capitalism, meaningful changes don’t take place overnight. Performance is often measured in decades. Unfortunately the results of the last decade make grim reading, not just for VCs but also for those start-ups who depend on them.
Since the dot-com crash, nowhere has this become more apparent than in Silicon Valley. The epicentre of tech innovation has become a valley of the dinosaurs for VC firms as their long-term returns continue to ebb away. The result is new companies starved of VC financing and advice.
The depressing reality for venture firms today is that the huge windfalls they brought in through investments more than a decade ago are unlikely to return. A recent report released by the National Venture Capital Association (NVCA) reveals that the situation in the US is much the same as in the UK.
Worse still, it is part of a long-term trend which shows little sign of recovery and anything like a return to those heady days of the dot-com boom. Even the NVCA themselves admit that the VC industry is contracting and will “continue to do so for the foreseeable future”.
Why? Because they know that the venture capital model of investing just isn’t working as it once was. The environment has become hostile for large scale venture capital firms. This has prompted a steady contraction in the industry and firms raising ever smaller funds and a reduction in principal numbers at venture firms..
As the number of companies they invest in is reduced then so to does is the chance of a windfall from flotation. This will be catastrophic for venture capital firms whose financial model relies on receiving these windfalls and securing healthy returns for investors. The IPO market refuses to emerge from a decade of slumber and is unlikely to do so in the current climate so vital returns on investment are also likely to be reduced for some time until conditions change, but there are no guarantees.
With a further contractions in venture funding now inevitable, where does that leave the start-ups who rely on them? Well let’s look again at those web start-ups of Silicon Valley. Many are now finding other sources of funding including a proportion from angel investors who are smaller and leaner than their VC counterparts.
Also major success stories of the past decade like Facebook and Linkedin are so far reluctant to go down the route of flotation, instead preferring to keep their businesses out of public hands, which again has kept them off limits to VC investors who rely on flotation to make their money.
Also Internet businesses can now be set up much more cheaply than at the beginning of the decade and many of those that have emerged and become powerful businesses are buying up some of the smaller outfits.
Another threat comes from the smaller, more agile fund type investments supplied by business angels. Angel investors in comparison to large VC firms are more agile and better able to swallow smaller returns on investment offered by emerging internet ventures.
Angel investing may be the perfect fit for those emerging companies, however this may not be the case in other industry sectors which require the much larger investments venture firms offer. Herein lies a problem. Angel investors are able to fill the funding gap for companies with smaller ambitions, however investment creates jobs and with smaller investments comes fewer job opportunities.
What is needed is a more agile, leaner approach to funding which business angels are better able to offer, but one that is better organised and able to withstand smaller returns. The alternative is to allow those businesses to survive and evolve on their own and invest at a later stage when the risk involved lessens.