Bigger isn’t better Part 2: The right size for the Venture Capital Industry

October 12, 2009 at 5:01 pm Leave a comment

In my last post, I discussed size considerations of individual venture capital firms.

If VC firms ought to be smaller, what does that say about the VC industry as a whole?

VCs have been investing more than $20 billion each year since 1998. In 1999/2000 investments shot up to over $20 billion per quarter, but went down sharply afterwards, then starting a slow upward trend to an annualized rate of about $30 billion at the end of 2008 when the current economic crisis kicked in.

A Kauffman Foundation report by business-blogger-at-large Paul Kedrosky (his blog: infectious greed) pegs the reasonable size of annual venture investments in the US at $12 billion (instead of the $30 billion rate we saw in 2008). He largely gets there from return-considerations, as well as using a fraction of overall GDP.

Further suggesting the vc industry is contracting Bill Gurley from Benchmark gives a very good summary of how venture capital will likely get caught in the asset allocation squeeze (or the “denominator effect”): a typical institutional investor may allocate 5% of all assets under management to venture capital. As the total assets shrink because the value of all other asset classes such as stocks and bonds shrink, so will the money available for venture capital. Exacerbating this trend – and making it a long-term effect – would be a lower relative allocation. Whereas institutional investors have increased their relative allocation to venture capital over time, now may be the time to reduce it, following dismal returns from the industry for much of the last decade. The 5% could very well be cut in half – along with the venture capital industry. Gurley’s outlook still trends towards a “stabilized market size of well over $15B a year”.

Eventually, funds disbursed by venture capital firms will follow what they’ve raised. And little did they raise indeed so far in 2009: A dismal $1.7 billion was raised by VC firms from limited partners in the second quarter of 2009. Hopefully, we’ll see some recovery from such low numbers: This would lead to a very small industry indeed.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).


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Entry filed under: Financial Advisory, Restructurings. Tags: .

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