The Return of the VCs?

Various folks are discussing the same generally silly article in today’s NY Times about the recent upswing in venture capital financings. I beg to differ with the optimistically spun piece for a number of reasons, so let’s count ’em:

  1. It conflates an increased willingness on the part of venture capitalists to invest with an improved venture business. The two ain’t the same. Just because VCs are willing to spend doesn’t mean they will earn appropriate returns for their investors. By way of analogy, no-one would confuse car companies pouring cars onto the market with a healthy auto business — why do journalists pretend that venture capital is different?
  2. There is no mention of valuations in the piece, and valuations are worse than they were two years ago — and they weren’t great then. Given that the public market exit environment is likely be much less receptive over the next few years, those poor valuations are going to come back and bite over-eager VCs.
  3. The piece suggests soliciting venture capitalist advice about niches and market opportunities. There are many dopey ideas in “how to deal with VCs” tracts, but this is one of the dumbest. Venture capitalists are precisely the wrong people you should be asking that sort of question. They are over-aware of everyone doing everything in a market, to the point that they will steer you away from yawning opportunities that they wrongly deem to be be over-filled. Customers, yes; VCs no. Case in point: Recall how many venture folks said “no” to Google. What would those firms have suggested if Sergey and Larry had come calling while still noodling a search engine in 1998?

Sure, all of this means that more startups are being funded, but it has to be put in context. A venture business that can’t earn back its invested capital plus a reasonable return is an unhealthy venture business. And there are many people, myself included, that think that this merely means venture returns are regressing toward the public market mean, despite the inherent illiquidity premium that should be attached to the asset class (i.e., you can’t sell private stock, so you need a higher return for the higher risk).