When a capitalist says that he is pleased to see profits increase as his competitors disappear and the remainder hold the line on price is that a cartel? How is it different from the CEO of, say, Honda, gloating about the elimination of other auto companies, and then asking the remaining companies to hold car prices?
All these questions came to mind in reading some of the more entertainingly outraged comments to venture capitalist Fred Wilson’s post today about the venture capital diet. Echoing my paper from last summer that called for the venture industry to shrink by half, Fred points to the latest industry data and says that we’re pretty much there, with annual outlays touching $17-billion. He goes on to worry, however, that Q4 of 2009 saw outlays tick back up to an annualized $20-billion, and suggests people need to pull back.
So, is Fred calling for a cartel to contract VC spending? I don’t think so. Fred is one of the good guys, and my position here is public: We need to shrink to have a healthy venture capital business. We have an industry that hasn’t delivered a multiple above 1.0 on invested capital since 1997. We have an industry that, as of end of year 2009, sunk to a negative ten-year IRR, with the bubble exits finally falling off the sheet. This is a sick business, and that is understandably leading to fewer investors wanting a part of it, which means outlays are shrinking. Eventually the industry will shrink back to a point where it delivers competitive returns — and it may even be there now.
Now, two points. First, some may say that venture can fix performance by making better investments. It doesn’t need to shrink: We have can have our capital, and our startups too. Fine, but history doesn’t bear that out. The modern venture industry has never delivered competitive returns with this much money under management, and you can’t point to deals that, had they been invested in, would have fixed that. Yes, absence of evidence isn’t evidence of absence, but the heavy-lifting must be on the side of those who would argue the venture biz can deliver compelling returns at higher levels of capital outlay.
Second, others may argue that it really doesn’t matter. Venture capital provides a valuable societal function — job creation, innovation, economic growth, etc. — and we can’t hold venture back when we need all three of those so badly. I understand the inclination, but a venture capital industry no longer tied solely to delivering competitive returns to its investors is newly a quasi-governmental entity, an expanded regional economic development agency, albeit one with your pension money at risk.
Finally, is it possible that venture is just so badly broken that we have no idea what the right amount of capital is? Yes, it is possible that we could see 10x as many startups and find that it is a distribution with many local maxima, some of which are much more attractive than the current level of investing. To be honest, I would love it if that were true, because it would be wonderful for the economy, and this assuredly isn’t physics — annual outlays is not fixed like Avogadro’s constant. Good luck making that case, however, to burned limited partners who have just watched an expanded venture industry deliver the worst returns in its history.