See this post on VentureBeat, entitled The VC Model is Broken which asserts that the venture capital model no longer works and that the Bubble 1.0 get-out-jail-free card given to the industry around 2001 has now come due.
- VC is too much of a “hits business” (i.e., returns are lackluster excluding the 1-2 top hits per fund, and that some funds, presumably the B- and C-tier ones, don’t even have those hits)
- VC is too clubby with too many exits of newer companies going to earlier portfolio companies at lofty valuations. (“Can you please buy my other company, at a premium?”) One cannot help but think of YouTube’s $1.6B exit to Google in this context.
- VC is too herd oriented, resulting in too many me-too companies being funded and too few truly innovative companies being funded.
- 2H08 is the first time period in which VC exits are less than VC investments
He recommends the following changes:
- Less funds and better funds
- More deals and equal treatment
- Simplified terms and standard structures
- Improved fund governance
- Restructure fund incentives
Personally, while I agree with many of his asserted troubles, I generally disagree with his recommendations. To me, market forces should work over time to correct all ills.
- Presumably, if mainstream VCs are too herd oriented then newer/different VCs should be able to stake out the different positioning. And LPs who seek such differences should be able to find them.
- Similarly, if there is a problem with mainstream VC terms/structures, then presumably B-tier and/or new VCs can attempt to differentiate themselves by offering these different terms.
- Increasingly, private equity firms are entering and innovating in VC already. I suspect they are exploiting the opportunities created by the standard criticisms of VC.
- With the fall in the stock markets, most institutions are presumably now over-allocated to VC and/or private equity. That is, if you want a 10% VC allocation and the stock market falls 30%, then presumably you end up in a 15%+ position. So I suspect institutions and investors will be seeking to reduce VC exposure, not increase it.
Basically, I’m a believer in Darwin/Malthus. Yes, VC was “too easy” in the 1990s and presumably too much money flowed in and too many firms and funds were created. But the natural response to this, over time, should be a weeding out of the weaker funds and players. Since VC timeframes are elongated, with the typical fund lasting 10 ten years, it will take a long time for these cycles to play out — but play out they will.
Here are the slides from Adeo Ressi: