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Summary:

Amid an IPO drought and the economic downturn, one investor believes that the venture industry should take the amount of money it puts into startups each year and slash it by nearly half, to between $15 billion and $20 billion. That’s compared to the recent annual […]

fred_wang_bw_2414_3Amid an IPO drought and the economic downturn, one investor believes that the venture industry should take the amount of money it puts into startups each year and slash it by nearly half, to between $15 billion and $20 billion. That’s compared to the recent annual average of $26.51 billion invested over the last five years, or last year’s total of $28.3 billion.

I wrote yesterday about the triage beginning in the venture industry, and today I chatted with Fred Wang, a general partner at Trinity Ventures, a $300 million fund that does some 8-10 deals a year. Wang was optimistic about his firm’s portfolio, noting just a handful of cutbacks and one company that’s seeking a recapitalization in which Trinity won’t participate. But he was less sanguine about the fate of the venture industry overall.

As far as he’s concerned, the venture biz needs to cut back on investments. Wang argues that there’s still too much money backing deals. He believes that during the last downturn, more venture firms should have failed, but because there was still so much capital invested in VCs, private equity firms and other funds, the dot-com bust wasn’t able to last long enough to bring the industry back to a sustainable size.

“There was so much low-cost capital available, that it was inevitable that the balloon would re-inflate before it deflated enough,” says Wang. “This downturn could help the business get rightsized. We’re just waiting for the other shoe to drop after the last downturn.”

If he’s right — and others have made similar arguments — then startups will find less capital overall. That’s not to say that VCs will stop investing in companies (they can’t), but that with fewer VCs and less money, it’ll be hard to get a deal done. The fourth quarter of last year averages out close to Wang’s ideal size for the industry, which means that the last few months may presage the capital-raising future ahead.

Image of Fred Wang courtesy of Trinity Ventures.

  1. Wang argues that there’s still too much money backing deals!!

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  2. It’s not just slashing the amount invested, but smarter and better investing.

    VC has typically been a ruthless game, from what I know, and this Web 2.0 bubble created alot of stupidity all around… VC’s are no exception.

    They need to stop investing in things that are dumb. Things that have no income potential. Things that can’t even stay stable for more than a week at a time.

    I don’t care how many people love you, if you don’t have a revenue stream and your “featureset” is easily replicated, you don’t deserve funding.

    Period.

    –Kyle

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  3. The Forbes magazine did an interesting article on this topic recently (http://www.forbes.com/forbes/2009/0112/066.html).

    The bottom line is that the returns on VC investments over the last few years have simply not matched up to the higher risks involved. Any asset class that under performs over a long period of time will see diminished investment. So whether venture industry slashes investment or not is immaterial; the investors will make the decision for it.

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  4. It’s not so much the amount invested, it’s the types of investments and the expected returns. VCs need to do an expectations reset and also re-evaluate their model. The model of swinging for the fences with every deal fully knowing the majority will fail but the home runs will more than make up for it doesn’t work so well when the home runs are few and far between due to the non-existent IPO market. Time to start collecting singles and doubles and hitting for average. There are lots of well-run businesses out there that could use additional capital and produce a return in excess of VCs’ cost of capital.

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  5. Seriously, maybe they just need to take some real risks instead of acting like sheep. Funding a bunch of copycats because everyone else is doing the same thing is not taking a risk. It’s just HERDING.

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  6. Frank is correct. Investing in a couple of people in a garage with no capital needs are dead right now. The end of cheap credit and the whole reset of what “leverage” means make big success from small investment far less likely.

    Investments in things like “Green” or “Energy” or “Clean Tech” or any of the other imaginary new technologies to replace software & silicon require huge capital investments, deals with existing energy and supply companies. The technologies are based on 150 year old science and physics that is very well understood and very mature. It is a capital game not a knowledge game there.

    The new world will be with pooled investments with 6-7% returns over years with a few IPOs and the like at the end, maybe. Each investor in the pool will get a piece. Also know as “banks.”

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  7. Frank Rizzo is spot on. it’s possible the industry could handle all the capital (or not), but only if investment outcome expectations are much smaller. Alan Patricof (who now runs $75m GreyCroft but used to run a $30b fund) also noted in the NYT earlier this week that venture returns are out of touch with reality and that most liquidity is M&A exits in the $25m-$100m range. if that’s correct then the total for VC funding going into most companies should likely be under $5-10m, and possibly even under $2-3m. this would argue for most funds being dramatically smaller, or alternatively that their # of deals is much higher / avg size is much smaller. currently very few funds look like this.

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  8. when economy hit the ground of many INVESTOR expectations,the bright side of it should be in the hand of many INVENTORS.they think harder,they put the energy to perform better presentations and they turn to more originality to take the hole of gap differentiations that will make benefit to the end user,I think It is oke when investment is slowing down,this what make more energy for the new idea to reveal,new technology to develop and new service to be given

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  9. I find it laughable every time a VC says that his competitors should raise less, invest less, or disappear, but their fund is (a) doing fine and (b) doesn’t need to reduce its capital base or return capital to LPs.

    I would find Fred’s thesis a lot more credible if he put his money where his mouth is.

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  10. @Rizzo and McClure

    Well said!

    How many VC’s have lost their jobs? Not many at all. That’s because unlike the portfolio companies which are told to slim down their workforce these VC funds can live off their 2% management fees like fat cats in up markets and down markets. Its a joke!
    There is so much lip service from this industry it gets old.

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