The venture capital sector is showing moderate signs of life. Funds invested in startups and high-growth companies grew 12 percent in the second quarter of 2013, compared to the first quarter, according to the MoneyTree Report from PricewaterhouseCoopers. The number of deals was up 2 percent over that period. More money was invested in early-stage companies and first-round companies as well.
But, look back to where this formerly high-flying money-game once was played, and we see a decade of mediocre returns.
Right now, startups with ‘Internet’ or ‘IT’ in their business description are getting funded pretty decently. That’s in part because the cost of bringing technology products — software and apps — to market continues to shrink as computing expands to the cloud. Capital-intensive industries such as biotechnology and clean energy are still lagging. R&D and field trials can last a long time and swallow up a lot of investor money.
Overall, funding for startups hasn’t rebounded strongly since the recession. And the IPO market remains depressed, depriving high-growth companies, and the VCs that have invested in them, of an exit on the public markets. Many no await acquisition by large tech companies such as Intel, Google or Facebook, and venture capitalists’ money remains tied up until that happens.
The number of IPO’s dropped off significantly during and immediately follwing the last financial crisis. Though IPO’s are on their way back up, activity still hasn’t caught up to the early 2000s. 2013 is roughly on track to match 2012.
VC activity is way below the level of the late 1990s, when VCs were funding the likes of Google, says John Taylor, research director for the National Venture Capital Association, which co-publishes the quarterly MoneyTree Report.
“You have an industry that during the height of the bubble was investing over $100 billion a year,” says Taylor. Now, annual total investment hovers around $25 billion. Taylor thinks that’s a healthy level of investment and deal-making, and he says most VCs agree.
But at that level, it’s harder for the economy to hit many home runs like Google. Management consultant Peter Cohan, who is also a venture capitalist, says this just isn’t a very good business anymore.
“Look back at 1999, which was the peak year,” says Cohan. “The average venture capitalist earned an 83.4 percent internal rate of return over ten years. Very attractive, very glamorous business. Now, the internal rate of return is about 6 percent.”
Cohan says the S&P 500 delivers a better return. And, it’s much less risky than a typical venture capital fund.
1999 was a peak year for venture capital deals and investing when money was funding the likes of Google and other tech companies. As the rate of return has fallen off, so has capital.
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