November 21, 2006
The future of VC
Venture capitalists spend a lot of time with their portfolio companies hashing out business plans. Now it may be time for the industry to indulge in a little self-help.
There are two big problems facing VCs. First, firms that raised massive funds during the bubble have to put all that money to work chasing a finite number of good ideas. Second, even when a firm stumbles onto a good idea, it’s not as easy to cash out as it used to be. Although the market for acquisitions remains healthy, the IPO market has slowed to a trickle, thanks to Sarbanes-Oxley. And public offerings are what the industry has traditionally relied upon to make most of its returns. This secular shift in the IPO market is compounding the pressure faced by the industry as it enters its fourth down cycle in 40 years.
The mounting pressure has led to calls for an overhaul of the VC business model. As Clint Harris, founder of Grove Street Advisors and a limited partner in several venture funds told me, "there are some trends emerging that aren’t favouring those who are sticking to their knitting."
One of the most pressing trends facing the industry is a shift in the locus of innovation away from Silicon Valley. While the Valley remains home to many of the world’s most successful technology startups, the technology behind the great new businesses of the future is increasingly likely to come out of Bangalore or Shanghai, rather than Palo Alto.
Tsinghua University, China’s top engineering school, graduates more engineers each year than are employed in all of Silicon Valley, according to Joe Schoendorf of Accel Partners, a veteran Valley VC. "Over the next five years you are going to start to see major global innovations come out of China. We want to be in a position to help build these companies," he says.
Steve Jurvetson, a partner at Draper Fisher Jurvetson, agrees. He says international expansion has been key to his firm’s success. Since DFJ opened its first office abroad in 1999, two of its best performing investments have been Baidu, the Chinese internet portal, and Skype, the European VoIP company that sold to Ebay last year for $2.5bn.
Does the emergence of China and India as engineering centres spell the end of Silicon Valley as a hub for innovation? Almost certainly not. For years, visitors have tried and failed to uncover the recipe for Silicon Valley’s entrepreneurial pixie dust.
While the Valley may cede its place at the cutting edge of innovation when it comes to new technologies, it is likely to remain the headquarters of the VC firms, law offices and other infrastructure that supports great technologies and ideas. Long-term demographic and economic trends mean the Valley may need to transform itself from an innovator to a service provider. It is in the provision of entrepreneurial services that the Valley is often imitated, and never replicated.
"There are a lot of places in the world that can produce good technologies," says Joe Schoendorf. "Turning these into a product and a company and an industry is still the core skill of this valley." In other words, great ideas will still be out there, but in the Silicon Valley of the future, venture capitalists may need to go farther afield to find them.
Over the next week or two, I’m planning to expand on these articles (1, 2) in Monday’s FT with a series of posts about how VCs are responding to changes in their business environment. Up next: A closer look at the firms that are taking the leap abroad. Look for it sometime after Turkey Day.
