Interesting article: Pension Funds back in the early 2000's allocated a percentage of their funds to VC and Quant funds. Both areas of investing seem to have too many dollars chasing outsize returns that are not there any more, creating bubbles.
O'Brien: Grim numbers point to the end of the venture capital era
By Chris O'Brien
Mercury News Columnist
Posted: 08/25/2010 04:09:06 PM PDT
Updated: 08/26/2010 12:10:56 AM PDT
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Silicon Valley has passed an important milestone that may mark the end of one era and the beginning of another.
This dividing line in history was revealed this summer in the latest report from the National Venture Capital Association, which showed that 10-year returns on venture capital investments had turned negative at the end of 2009, and nose-dived during the first quarter of 2010. Let me translate what might sound like some insider mumbo jumbo: Venture capital investing, the lifeblood of the valley's innovation economy, has become a sucker's bet.
In the game of venture capital, the 10-year return on investments is one of the most closely watched benchmarks of performance. Everyone can have a bad year here or there. And in the short run, there's always going to be sluggishness from an economic downturn or two. But none of those excuses can explain away a whole decade of failure.
No, there's something bigger going on. The venture industry is in free fall. And that has big implications for the Silicon Valley economy, especially when it comes to job creation.
"It's harder to get venture money," said Mark Heesen, president of the NVCA. "That leads to fewer innovative companies being formed."
Until now, venture capitalists have occupied sacred ground in Silicon Valley. They grow startups by providing advice and precious financing. But that influence is waning.
According to the most recent NVCA numbers, venture capital funds returned 25.8 percent over 10 years for the quarter ending March 2009. For the quarter ending March 2010, that return had fallen to minus 3.9 percent. That spectacular dip is due to the outsize gains of the dot-com boom finally washing out of the official 10-year benchmark.
But the larger problems plaguing the venture industry are really about how the world has changed since the dot-com bust. The venture industry's financial model was built on having a significant number of their portfolio companies hold initial public offerings of stock. Venture firms depend on windfalls from these IPOs to overcome failed investments and to deliver healthy returns to investors. But except for a couple of years, the IPO market has been comatose this past decade.
Venture capitalists were hoping against hope that this year might finally be the year that the IPO made a comeback. But once again, that hasn't happened. According to Renaissance Capital, the Bay Area has had nine venture-backed companies go public this year, up from two last year. The most notable of those was Tesla Motors, the electric carmaker that represents the highest of high-risk bets.
What little momentum these IPOs generated has been offset by companies like Solyndra, a cleantech success story that filed and then withdrew its IPO plans. And worse for venture capital firms, companies that might provide a true home-run IPO, such as Facebook, LinkedIn and Zynga, have been doing everything in their power to avoid an IPO. These companies say they don't need the money enough to give up the control that comes with being a public company.
How gloomy is this picture for venture capital firms? According to an NVCA survey, 90 percent of venture capitalists who responded expect their industry to contract through 2015.
That trend is well under way. While firms have not started collapsing en masse, they have been quietly shrinking. The number of principals at U.S. venture firms fell from 8,892 in 2007 to 6,828 in 2008. As firms raise smaller funds, they need fewer people to invest.
Some will argue that at least in the area of Web startups, companies can be launched on the cheap, and growing numbers of angel investors -- those wealthy individuals who invest at the earliest stages -- are stepping in to give these companies a boost. True, but that kind of funding doesn't work as well for biotechnology, medical devices or cleantech. And these angel-backed companies are small and lean, and don't create large numbers of jobs.
It's not just fewer startups, though. When companies don't go public, they don't generate the same number of jobs in their later stages. Heesen said the cash raised from an IPO usually triggers an explosion in hiring.
"The real job creation starts far down the road, after they go public," Heesen said.
Instead of going public, the companies that do show potential now get gobbled up by the Googles and Facebooks of the world. At the same time, valley giants like Hewlett-Packard, Oracle, Intel and Cisco Systems continue their acquisitions of larger tech companies, a consolidation trend that more often than not is accompanied by big job cuts.
So we're seeing fewer startups and sweeping consolidation. Tie those trends together, and you've got a drag on job creation that could weigh down the valley for years to come.
With venture capital in retreat, we must look elsewhere for a new model for startup funding to kick-start the valley's next era of innovation and the kind of job creation we desperately need.