Is Venture Capital in Trouble?

Is the venture capital model "broken"?

If so, heaven help us. Because if it is, the recession we're sliding into will prove to be even deeper and darker than we imagine.

Venture capital's troubles have become a popular subject of conversation in recent weeks, not least because of the recent announcement that so far in 2008 only six venture-backed companies had managed to "go public" with their first sale of stock. That compares with 86 a year ago, and 265 during 2000, the last dot-com bubble year.

The venture-capital industry has been in trouble for most of this new century, never achieving more than a fraction of its success of the '90s. But this new figure -- and it is unlikely to improve by even a single IPO between now and year's end -- is devastating. And has led to growing speculation that the venture-capital industry, once the pride of American entrepreneurialism, may have reached a tipping point on the way to oblivion.

The two most recent advocates of this pessimistic perspective are the Web site VentureBeat, run by the former venture capital industry beat reporter for the San Jose Mercury-News, Matt Marshall, and TheFunded, a site to rate venture capitalists, run by Adeo Ressi.

Ressi apparently stunned, and angered, an audience at Harvard Business School recently with a slide show, "The Canarie is Dead" (see it here), that (bad spelling aside) argued that something is fundamentally wrong … perhaps fatally wrong with the venture-capital industry.

The HBS audience was stunned because Ressi finally said publicly what many in the audience had probably been thinking, and was angered because he claimed one of the causes of the VC's predicament was the "Old Boy" network that the Harvard Business School specializes in.

Still, there was one devastating slide in Ressi's presentation that no one could refute. It showed that for the first time in the half-century history of high-tech venture capital, two curves had crossed … and now VCs were taking in more money from investors than they were returning to them. Venture Capital, the jewel of American finance, the dynamo behind the high-tech revolution, had now, shockingly, become a loss leader.

Pretty scary stuff.

Now it was VentureBeat's turn. Wednesday, Marshall published a story that put it in the simplest terms: "The VC Model is Broken," the headline read. And although he didn't agree with many of Ressi's premises (neither do I), he did agree with the conclusions, and was prepared to take them even further.

Marshall offered three reasons for Venture Capital's current woes:

1. Early VC successes -- Companies like Intel, Cisco and Genentech were so hugely successful that they drew huge sums of money from investors around the world anxious to get into the VC game . . . over-stressing what should have remained a niche industry.

2. Established companies have gotten smarter -- Firms like Google and Microsoft snatch up hot new startups before they can become serious competitors, taking them off the market before they go public.

3. "Greed. Pure and simple." -- Those are Marshall's words, and by them he means that VCs have continued to raise ever-larger funds, even in the face of low returns, because the administrative fees are a major source of revenues to their own firms.

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