The venture capital business needs Washington’s money like it needs a hole in the head (with apologies to Thomas Friedman).
Silicon Valley is just getting to the long-overdue end of one bubble. It really doesn’t need another one, courtesy of government bureaucrats. The contraction that is coming will be painful, but that’s no reason to put it off in the misguided name of stimulus (or the equally woolly “innovation”).
The fact is, the massive over-capitalisation of the VC industry during the dotcom boomhas never been fully unwound. I was puzzled, by about the middle of this decade, as to why that was, until Bruce Dunlevie of Benchmark Capital supplied the answer: venture capital, as he put it, is “a business with barriers to exit unlike any I know.”
The partners in VC firms can live off a fund for years. Equally, the limited partners who oversee big endowment funds can delay the day of reckoning on their VC returns for years. And low returns, when they finally materialise, can always be blamed on a historic anomaly – the dotcom boom and bust! – rather than any inherent and lasting over-capitalisation in the business.
The returns haven’t been so impressive recently. Also, note that the profits in VC are very heavily skewed towards the most profitable firms: if you’re not in a fund run by one of the top handful of firms, your returns would have been a lot worse than this.
So it’s highly ironic that, now the day of reckoning is finally at hand, it is happening for reasons that have nothing to do with decisions taken on Sand Hill Road, the clubby heart of the VC world.
As Bill Gurley, one of Dunleavy’s partners at Benchmark, put it to me the other day: “It’s very different from ’01. This sickness wasn’t caused by Silicon Valley.”
The sickness in question is spreading instead from the limited partners – in particular the big university endowment funds, which over-invested in all classes of private equity in the boom years. As other parts of their portfolios fall in value, they are being forced to cut back on private equity – including VC – to maintain asset allocation ratios. The money flow is being turned off. And the new and more conservative managers who are taking over (as at Harvard) are also likely to reconsider whether the diversificiation into private equity ever delivered all it was meant to.
So does that make it a good time for Washington to step in and try to cram $20bn into the VC industry? Hardly. The best firms, with superior returns, will do just fine on their own. There is still probably room for new ones – given his contacts and track record, for instance, Marc Andreessen is unlikely to have much difficulty raising the VC fund he first talked about last week. For many others the cyclical downturn will be severe – but that’s what happens when you put off a day of reckoning for so long.
