Venture Outlook 2011: Returning to the Way We Were

Charles River Ventures partner Bill Tai made an interesting analogy between surfing and venture investing for the San Diego audience that gathered last week at the San Diego Venture Group’s panel discussion on the venture outlook for the coming year. The annual event usually draws big crowds, and this year was no exception. Some 350 people attended.

Tai told the crowd that VC investors had an advantage during the glory days of venture capital—10 or 15 years ago—because they could anoint an entrepreneur by simply funding his or her startup. “Syndicates could form and we would essentially own all the surf boards at the beach, which meant that we could limit the number of riders on each wave of new technology.”

But Tai said the tables have been turned on VCs in certain categories, such as the consumer Web and iPhone apps. “Now there are 600,000 new apps a year, and we can’t keep up with those kind of numbers. So now there are 2,000 riders on each wave, and they all own their own surfboards.”

Tai says startups require much less funding in his areas of greatest interest, which are digital media, enabling technologies, and Web services. As a result, more startups in these sectors are self-funded, or they are getting funding from friends, family, or angel investors. Because venture firms are no longer anointing industry leaders, Web-based industries are more fragmented—with a multitude of startups fighting to gain a foothold.

“If there are two areas I’d encourage you guys to focus on,” Tai told the San Diego audience, “it would be around mobility and cloud computing. The cost of building a company is down by a third these days and the cost of building an app is down by 50 percent.”

The proliferation of digital media and Web startups has been fueled in part by the emergence of so-called “super angels,” who invest about $250,000 individually or in syndicates, according to Peter Solvik, a managing director at Sigma Partners, which has offices in Boston and Menlo Park, CA. Some super angels are investing in companies by the score, but as Solvik noted, “super angels can’t afford to keep 200 to 300 companies going. So if you’re not in the top 5 percent of your class, it’s really hard to get a second round of funding.”

Tai’s surfing metaphor was an example of how the venture industry has changed from its glory days. But the overarching theme that Kate Mitchell sounded in her presentation was how the industry has come full circle to a level of venture investing that is more like the mid-1980s.

Mitchell is a co-founder and managing director at Foster City, CA-based Scale Venture Partners and the current chairwoman of the National Venture Capital Association. She acknowledged the industry’s pessimism, saying there has been an exodus of capital from the industry, and venture capital’s 10-year return on invested capital has been terrible. Yet Mitchell also said “VCs are perennial optimists,” and she maintains that the industry has been slowly resetting itself. She sees venture capital moving to “new normal” in which fewer VC firms are raising less capital and investing in more deals.

One encouraging slide in Mitchell’s presentation is the increasing number of IPOs and buyouts of venture-backed companies.

She also says that the pre-funding valuation of venture-backed companies is slowing increasing, which seemed to hearten the San Diego audience.

Some other highlights:

—The U.S. venture capital industry is now raising about $12 billion a year for less than 200 venture funds. That’s a far cry from the peak in 2000, when the industry raised more than $100 billion for nearly 700 funds. Yet Mitchell noted that $12 billion is less than 0.1 percent of U.S. gross domestic product, while the revenue generated by venture-backed companies accounts for about 20 percent of total GDP in the U.S.

—Still, venture returns have been poor compared to other equity indexes, returning 6.4 percent over the past year (less than half the investment return of Nasdaq, S&P 500, and the Dow Jones Industrial) and losing 4.2 percent over the past decade. The venture sector shows the highest returns, though, over the past 20 years—24.3 percent.

—The U.S. venture capital industry has raised a total of about $56 billion over the past three years and invested about $67 billion over the same period of time. In other words, VCs invested $11 billion more than they raised.

Bruce V. Bigelow is the editor of Xconomy San Diego. You can e-mail him at or call (619) 669-8788 Follow @bvbigelow

Trending on Xconomy