Reinventing Venture Capital

Today, Paul Kedrosky released a report, “Right-Sizing the Venture Capital Industry,” as part of his work as Senior Fellow at the Kauffman Foundation.

Now, I couldn’t agree more that the venture capital industry needs to reinvent itself. That was the theme of my recent feature in BusinessWeek, Super Angels Shake up Venture Capital. But I was a little surprised by the way that Kedrosky goes out of his way to diss the venture capital industry’s role in nurturing innovation, even though I know the Kauffman Foundation has a bit of an anti-VC bent.

“The industry has become conflated with entrepreneurship in the popular imagination as well as in policy circles, with the result being a widespread and incorrect belief that venture capital is a necessary and sufficient condition in driving growth entrepreneurship,” writes Kedrosky.

Kedrosky’s big data point? Of the 900 companies on the Inc. 500 list between 1997 and 2007, he reports that only 16% received venture capital backing. It’s an interesting data point. But to then argue that “venture capital and entrepreneurship are separate phenomena,” as Kedrosky does, seems like an overstatement to me.

Obviously, most new companies do not require venture capital but the ones that do need it play a hugely important role in the economy because they tend to be the ones that grow the biggest and create the most value. Think Google, which got a $25 million injection of venture capital at a key moment in its evolution. Without that money Google might have never become Google. There are many examples like this.

The rest of the report tries to figure out why venture capital performance has been poor lately and suggests how the industry will reshape itself. The upshot? The industry must shrink, perhaps in half in the coming years.

I basically agree that the industry needs to shrink. That’s pretty much what I argued in my super angels feature. The industry has an inversion problem: Fund sizes have gotten bigger while the capital needs of companies have shrunk. $500,000 is the new $5 million, as Mike Maples said in my story.

Will it shrink in half? Maybe. Maybe not. All I know is that it will get smaller and that’s a good thing for industry and for the economy. An excess of capital ends up wasting money and the scarce time of entrepreneurs to create great companies.

The more important issue to me is that the industry needs to develop new models to finance and nurture innovation that fit today’s capital-constrained economy. Super angels will be part of the answer but it won’t solve the whole VC problem.

My colleague Mike Mandel blogged about this issue, making the point that science-oriented VC requires more money and a longer time frame to come to fruition. I think he’s right. And I’ve heard many VCs who invest in clean tech make this point.

Another big issue: Without an IPO market, there needs to be a new type of capital market that helps young companies finance their growth once they graduate beyond venture capital.

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3 Responses to “Reinventing Venture Capital”

  1. hsb Says:

    The response to recent NVCA hyper-exaggeration on job creation falls right into Kedrosky’s thinking. The NVCA takes credit for job creation from VC-backed companies going back 20 plus years. The last I checked, VC firms by and large head for the exits after 180 days to put up the IRR numbers necessary to raise the next fund. Common shareholders and secondary offerings can claim credit for the job creation. Trim some millions off those numbers unless that early stake was held throughout the life of the company. That’s the problem with VC money these days — the reliance on late 90s quick pops. I prefer to see some tax holiday for VCs that hold stocks 5 years after the IPO. Or we should adopt a European, non-dilutive model for entrepreneurs where they earn a percentage of revenues that can be distributed to LPs.

  2. Shea Says:

    Great article, Spencer! This is exactly what we do at True Ventures. Connie Loizos over at PE Hub just did a write-up on our model – http://www.pehub.com/43279/the-true-story-of-true-ventures/.

    You probably also know our Venture Partner Om Malik from the Business 2.0 days.

    Best,
    Shea

    • Spencer Ante Says:

      Thanks She. I know about True and of course I know Om. But I could not mention every single micro-cap firm.

      I was thinking of creating a sort of wiki list of the growing number of these firms.

      Let’s get together some time soon!

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