Silicon Insider: Bubble Memory

For all the talk about a new Internet bubble, the facts don't agree.

The U.K.'s Financial Times newsletter recently had a very interesting chart, based on data provided by the National Venture Capital Association. To give you a quick explanation: the chart has quarter-by-quarter measures of the returns on venture capital investments over 5, 10, and 20 years.

Venture capital funds pay out over a long period of time as the companies in which they invested fade away, are acquired, or go public. Not surprisingly then, the 5-year return shows the most sinuosity -- reflecting the fact that these investments are still highly volatile, with the measure largely dominated by high fliers and the short-lived. By 10 years, most funds have pretty much matured and are moving towards the industry mean, which is pretty well reflected by the 20-year return rate.

Now, let's take a closer look at each of these curves in turn. First, some good news. A nice horizontal 20-year line underscores that venture capital funds are among the best investments around -- if you've got a minimum of a quarter-million burning a hole in your pocket -- holding at a nice steady 16.4 percent (and, if you are a real risk-taker, the number jumps to 20.6 percent for early and seed-round investments).

But just as important, this flat 20 year curve is a reminder, which we veterans tried to point out during the dot.com crash of 2000, that over the long term the boom-bust -- even the bubble-crash -- cycles of high tech tend to balance out.

Places like Silicon Valley, which are perpetually accused of either being out of control or in their last days, always eventually return to the norm of innovation, entrepreneurship and strong growth. I often think of all of those people who bailed out of the Valley in 2001-2002, believing that the good times were over forever -- supported in their hysteria by far too many of my fellow journalists. How many fortunes were lost by folks who would now be working for Google or Facebook or Photobucket?

Now, the five-year curve shows the most impact of the dotcom bust. There is a lag after the bust and 9/11 hit as older investments closed out. If the chart went back a couple of years more, you would likely have seen a precipitous fall over the previous couple years, then the final ugly drop into negative returns. This was the moment when many investors finally pulled the plug on their venture funds, taking the withdrawal penalty rather than ending up under water.

I would also argue that, besides the dot com crash and terrorist attack, one other factor drove short-term returns into the red: the collapse of the IPO market, thanks to Sarbanes-Oxley and other new regulations designed to "fix" the errors of the bubble. Instead they built a devastating handicap into the U.S. tech economy.

How much of a handicap? My guess is that the five-year curve on the chart ought to be symmetrical. In other words, by September 2006, the five-year return on venture investments should have been 15 percent -- instead of zero. How many hundreds of billions of dollars of lost income does that represent? And tell me, do any of you really believe it has made companies more honest? Perhaps public corporations, a little, but that's why hot new tech companies these days are wary of ever going public, choosing the acquisition route instead.

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