Article : Too Much Venture Capital Money?

The last few years have been wonderful for the venture capital industry. While there are not firm figures on aggregate investment returns, most industry analysts agree that 100% annual investment returns were common during these last few extraordinary years. Clearly, venture capital investments have been a major driver in the success of the U.S. economy during the 1990s. The question now is, can we have too much of a good thing?

The statistics are revealing, and are a cause for concern. During 1999, $34 Billion of VC funds were invested in the U.S., and industry analysts currently project (10-00) that $70 Billion will be invested during 2000. This rapid growth of venture funds available for investment is also reflected in the substantial rise in the number of $1Billion-plus domestic funds, from 8 in 1999 to 22 currently. It is also noted that much of these large funds were raised early in 2000, when the technology markets were very hot. Are new investors expecting the same magnitude of returns that were experienced over the past few years? Recently, about 95% of these funds have been invested in technology related companies, a huge concentration in one industry. The question is, how will the VC firms invest these enormous funds? Will there be enough attractive ventures to warrant the investment of these large sums? Most leading Venture Capitalists contend that they have continued to approach their business with the same discipline that they always have. Going forward, however, this approach will be very difficult, if not impossible to maintain, given the dramatic increase in the funds that must now be deployed into the economy. There may be too many dollars chasing too few (good) deals in the near term, which will lower expected returns.

The other factor that will hurt VC performance going forward is the weakened IPO market. Through the Spring of 2000, when the NASDAQ peaked, the white hot IPO market richly rewarded the venture capital markets. It must be recognized that there were numerous companies, which were able to successfully go public in 1999 and early 2000, that could not in "normal" markets. The bear market in the NASDAQ, if it continues, will have a significant negative impact on VC performance.

Venture Capital should continue to be a major driver of U.S. economic growth going forward. Investors, however, must be realistic in their expectations. The investment returns that we see in the rear-view mirror should not be used as the basis for realistic expectations going forward.


© Copyright David W. Kellogg 2000. All rights reserved.

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