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THE STATE OF VENTURE CAPITAL 2002
March 11, 2002
The boom in venture capital was one of the most interesting and well-reported trends of the late 1990s’ economic boom in the United States. One of the more mind-boggling statistics from that period is the amount of venture capital (VC) invested in 2000 — $103 billion. That’s a big number — roughly equivalent to the GDP of Ireland. In today’s more sober investing environment, few observers expect to see such huge numbers. Venture capital investments are down — but how far down, and what does this mean for the industry’s future? This NCOE Update seeks to answer these questions by taking a look at the state of the U.S. venture capital industry in early 2002.
After the boom years of 1999 and 2000, VC investing had nowhere to go but down. In fact, VC investments have dropped steadily for 18 months. In 2001, a total of $36.5 billion was invested.* While that figure sounds small compared with the year 2000’s record breaking numbers, it represents the industry’s third best year in terms of dollars invested.
While this aggregate figure spells some good news, a deeper look at the numbers offers a mix of positives and negatives.
While total levels of investment look pretty good, current returns from VC investing continue downward. The most recent data, which only cover the first three quarters of 2001, show one-year annualized returns for the industry of –21.4 percent (as of September 30, 2001). That’s bad, but not as bad as the returns from the Nasdaq (-64.4 percent) or the S&P 500 (-31.4 percent) in roughly the same period. Nonetheless, these poor returns understandably worry partners in VC funds, and those who back them. While industry leaders are fairly confident about VC and the economy in general (click here to here to read more about this: www.ncoe.org/newsletter/enews), some expect an additional shake-out within the VC industry. Some funds have yet to write down the values of their poorly performing portfolio companies. Meanwhile, the opportunities for exiting from these previous investments (via initial public offerings or mergers and acquisitions) look unpromising. Thus, VC investors may have to bite the bullet on some of their investments from the late 1990s tech boom. Thus, over the short term, returns could get worse before they rise again.
An Industry Shake-Out?
These tough financial dynamics mean that the VC industry likely will face some consolidation over the next few years. New VC firms that bought into the dot-com mania are the likely first victims. For example, Idealab, the original Internet incubator, is now facing a rash of lawsuits from disgruntled investors. But Idealab is not alone. In a recent interview in UPSIDE magazine, Richard Frisby, a founder of Battery Ventures, one of the United States’ premier VC funds, predicted that as many as 200 to 300 firms could disappear. At present, roughly 800 firms are recognized by the National Venture Capital Association (www.nvca.org).
Industry consolidation is further complicated by another seemingly perverse problem — too much money. As VC funds boomed in the late 1990s, everyone wanted a piece of the action and investments flew into these funds. Now, fund partners face a real challenge. They sit on lots of idle capital, but opportunities for fast growing investments (as in the dot-com mania) are limited. Meanwhile, the VC funds’ backers are clamoring for results and creating intense pressure for many funds.
VC firms continue to place faith in the power of information technology. Last year, 60 percent of all funds were invested in information-technology (IT) companies with software continuing to be the hottest sector within IT (accounting for 22.5 percent of total investment in the last quarter of 2001). The biggest funding shift has come in the area of life sciences, which includes biotechnology, medical devices and equipment, and healthcare services. These combined industries account for 18.5 percent of total investment in 2001’s last quarter. This figure represents a big spike from previous years when life sciences received small portions of overall VC investments. For example, only 7.97 percent of VC investments supported life sciences firms in the last quarter of 2000.
Still the Envy of the World
While the U.S. venture capital industry faces some growing pains, the prospects for a return to health are quite promising. Taking a somewhat longer-term historical perspective, the recent history of venture capital is not really one of dot-com boom and bust. What has happened is that the VC industry has grown and matured and, most importantly, it has become a regular part of the American business landscape. At the start of the 1990s, VC firms invested in the range of $3 to 4 billion per year. Today, these firms (with the exception of the extraordinary year of 2000) are making annual investments in the range of $20 to 40 billion per year. Even in lean times, this is an incredible source of financial support for innovation in the American economy.
*All figures come from the PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree Survey. To learn more, visit www.nvca.org or www.pwcmoneytree.com.