In The Gutter, the Stars Shine Bright
There were two companion pieces recently published by venture capitalists: why VC returns are going up (WSJ) and investing at the bottom of the VC cycle (NYT). Both of these pieces look at the amount of money committed to venture firms in 2010 and, somewhat akin to the view of the stars from the gutter, conclude that there is no other direction but up.
The first piece, by Rory O’Driscoll, looks at the inverse relationship between venture commitments as a percentage of GDP and the returns of the top quartile of venture firms. The $11.6M raised for venture funds in 2010 is 0.07% of GDP, and portends a pendulum swing back to venture returns of 3X or better. Also for 2010, the low-water marks of $18.3 billion in M&A value, and $7.0 billion for
IPOs (both for venture-backed companies) suggest that an increase in deal value will eventually flow through to the minimal funds still targeted to venture investments.
The second piece, by Mike Kwatinetz and Cameron Lester, follows a similar narrative. Most telling is a graph that shows the amount of money committed to venture funds from 1998 to 2010 – with a high of $85.6B in 2000, and lows of $10.4B in 2003 and $11.6B in 2010. The authors than note that ten large technology firms ended 2010 with a cumulative $237 billion in cash on their balance sheets – 7X the total amount of venture-backed M&A activity in 2010, and find a simple imbalance between this demand and the eventual supply for acquisitions that will eventually yearn for equilibrium.
Both are insightful essays, but they remind me a little of the military whose future battle plan is always for the last war. Both essays incorporate many of the fundamental industry changes: primarily lower capital requirements for entrepreneurial companies, but also increased competition for deals at the early stages with the emergence of smaller seed and angel funds, diminished capacity for sustainable differentiation, and an increasingly winner-take-all economy, where top performers become verbs (google, facebook, groupon).
However both essays take as their fundamental logic a historical view including an industry structure that is now passed. That venture returns will improve seems a simple regression to the mean – what it does not anticipate is how the industry will reshape itself chasing these returns, which will in large part also shape the returns themselves.