Is Venture Capital in Trouble?

During the late '70s and early '80s, venture capital in Silicon Valley was also largely frozen. New companies weren't getting funded and few were able to go public.

Why? One answer was that the VC firms had grown so quickly in the years -- and had responded with rapid hiring -- that many of the partners and associates were now out of their depth and doing a lousy job of advising the companies in their portfolio. Another reason was that the then-current crop of new companies weren't that interesting (which would change a few years later with the rise of the Internet).

Related

Pop! Welcome to the 'Mentos Economy'

Google's Good Deed: Web Access in Africa

Is Google Turning Into Big Brother?

But the real reason, as I discovered at the time, was that the high capital-gains rate was keeping investors out of VC funds, which, in turn, made venture capitalists more conservative with their investments. When President Reagan cut the cap-gains rate, we had the greatest new business boom in history.

I believe we are seeing the same thing now. We are looking at the current crisis in Venture Capital and assuming that it is self-inflicted. But the more likely reason is that the industry has taken so many external shocks in the past seven years -- Sarbanes-Oxley (which has killed new IPOs because of its onerous costs to young companies), full disclosure laws (which have driven smart people away from serving on corporate boards), and options expensing (which has all but erased the prime motive for people to join new start-ups) -- that it can't help but be in bad shape, a once-robust industry reduced to a sick, shrunken shell. [And now, of course, there's talk of raising the capital-gains tax rate again, which will be the final nail in the coffin of venture capital.]

In their blind frenzy to punish perceived evil-doers of the dot.com bubble seven years ago, government regulators and boards have taken the most efficient new company and wealth-creation process ever devised and set up roadblocks all along its path.

And the biggest roadblock of all is that they have taken away the all-important liquidation event -- the IPO -- to which VCs, their investors and their companies aspired. With that gone, these players have no choice but to opt for the earlier, and lesser, liquidation event of acquisition.