Nov 24 2009

The VC Model is “broken” (again? yawn!)

In the latest lob into the morass that has become somewhat of a sport amongst journalists and those that follow the venture capital industry, Carl Schramm and Harold Bradley write in BusinessWeek about “How Venture Capital Lost Its Way”. The evidence? Venture capital funding is down – from an “astonishing” 1.1% of US GDP in 2000; and in the 3rd quarter of 2009 down 33% from the same period a year earlier. To add to Schramm and Bradley’s collective horror, “two areas crucial to American progress cry out for capital-intensive investment: clean energy technology and biotech. And the VC industry isn’t delivering it. (Info tech, which by now requires few capital investments, still accounts for the lion’s share of those shrinking VC investments)” 

While I strongly believe that the venture capital model is (and should be) changing, this kind of journalism, drawn on incorrect interpretations of the data serve only to sensationalize and add little to the real debate on venture capital. It poorly sets up the 2nd half of their article that talks about the VC funding model (more on that in a post later this week). Here’s my view:

Is there a problem with the current market for VC funding?

Comparing anything about Venture Capital to the markets of 1999 and 2000 is a fools errand. Without question, the venture markets (and the markets in general) were completely overblown in that time period. There were too many venture firms and too many companies getting funded. While this might have been good for some VCs that managed to cash in on the bubble (I, alas, was not one of them – my venture career started in the very dark days of late 2001) it was clearly bad for the industry as a whole (none of the participants benefit when an industry goes through a bubble and burst cycle such as the one that venture capital and technology did during that time period – and we’ve been struggling to “normalize” the industry ever since). I’d argue forcefully that we’re still searching for the optimum level of venture capital funding. Schramm and Bradley seem to be relying on a “less = bad” analysis of the funding markets and are completely ignoring the question of equilibrium (whether we’ve reached one, what the right level of funding should be, etc). Markets function optimally when there is balance and while this balance in private markets such as venture can be illusive, we’re much closer to that balance now than we have been at any other time that I’ve been a venture capitalist (and certainly much more so than in 2000).

Are VCs falling short in their funding of CleanTech and Life Science and favoring IT?

Schramm and Bradley site the PriceWaterhouseCoopers study on 3rd Quarter 2009 investing to back up their assertions. Yet the study contains data that completely contradict a number of their key points. In fact event the title of the PWC press release that announced the 3rd Quarter funding results contradicts the conclusions that Schramm and Bradley draw from it: “Venture capital investment increase in Q3 2009 driven by clean technology sector, according to the MoneyTree Report” (I’ve added the italics). The very first paragraph of the release states in part: “The increase in dollars invested was driven by several large rounds in the Clean Technology sector, one of which is the ninth largest deal since 1995.  The Life Sciences sector (biotechnology and medical device industries combined) also had a solid quarter relative to other industry sectors, leaving Software as the third highest investment sector, a notable decline in industry ranking.“ I won’t quote it here to limit the length of this post, but if you click over to the press release take a look at the 3rd paragraph which is entirely focused on the shift of capital from IT to CleanTech and Life Sciences.  Also missing from the Schramm and Bradley article was that the 3rd Quarter funding totals were actually up from the 2nd Quarter (their article implies that venture funding is falling off a cliff – clearly not the case).

Is there still a market for IT investing?

As an IT investor, of course my answer is going to be a resounding “yes"!” But don’t take my word for it – just look around you at the amazing pace of continued innovation in technology and the Internet. From new ways to communicate (Twitter, Facebook), to new ways to advertise your business (Google, AdMob, etc, etc) to new ways to play games with your friends (Zynga), there’s still plenty of innovation going on in information technology.

What’s sad is that there’s a real debate to be had on the future of venture capital and the changing VC model (see my partner Jason’s take on that subject here). If we drop the pretence that “VC is Dead” perhaps we’ll finally get to the interesting part of the conversation…