Venture capitalists are professional optimists – they have to be. How else could they keep investing in new businesses where the obstacles to success would seem insurmountable to most people?
But sometimes reality just has to be faced, and the reality in front of the VC industry right now is not pretty.
Bill Gurley of Benchmark Capital sums it up here: half the industry could be swept away by the current downturn (though as an optimist, he clearly thinks he will end up in the fortunate half).
I confess to being one of those who has (wrongly) anticipated this moment for years – since the tech bust that began the decade, in fact. So why didn’t it happen before, and why will it come now?
The way Gurley, whose past investments include SecondLife, OpenTable and Shopping.com, describes it, the venture capital business is really little more than a cork bobbing about on the turbulent sea of private equity. Forget VC investment returns, which in aggregate have been pretty woeful for years: that didn’t stop the money from continuing to pour in, as institutions continued to “rebalance” their portfolios towards illiquid investments.
I had thought that the glaring over-capacity in VC in the wake of the tech bust would force a shake-out. But in a private market where valuations represent estimates and it can take many years for the final reckoning to arrive, I guess that belief now looks a little naive.
What matters now, as Gurley points out, is the wholesale flight from illiquid investments that has set in. The endowment world has been traumatised by its excessive fondness for private equity and presumably won’t make that mistake again (well, not for a while, anyway). The managers who committed the error have moved on and the next bunch will discover a new fondness for liquidity.
How much does this matter to the technology start-up world?
I continue to believe that a significant reduction in available capital needn’t prevent good businesses from getting backing, or hold back the overall level of innovation in the economy. Silicon Valley revels in the glorious waste that comes from having many entrepreneurs chasing the same business opportunities, on the grounds that this Darwinian mess will eventually yield a handful of successful companies.
But how many online video sites or thin-film solar start-ups does the world need, and why should the funding of marginal players do anything to increase the chances that the best companies will rise to the top? (They would rise to the top anyway, with or without the garbage.)
So, bring on the shake-out.
There’s just one thing, though. Given the nature of the business, Gurley reckons it could take five years or so. It’s probably better not to hold your breath waiting for this one.
