Two Venture Capital Surveys Chart Globalization Trends

by Philip Morton, Investors Offshore.com

15 June 2009

Two reports surveying US venture capital, one from the National Venture Capital Association (NVCA) with Deloitte, Touche Tohmatsu and the other from the Kauffman Foundation, were released this week. Seemingly different, the conclusions drawn were, however, reconcilable. Both indicated that venture capital is facing another watershed similar to the one after the dot.com bubble burst. Both implied contraction in the US in spite of the likelihood of significant opportunities to back tomorrow's winners at a low price in present conditions.

According to 'Right-Sizing the US Venture Capital Industry', a new study by the Ewing Marion Kauffman Foundation, the industry will continue to be crucial to some high-growth companies, but it concludes that the sector’s size must be cut in half in coming years in order to lower valuations and improve overall exit multiples.

The study argues that a five-fold increase in the amount of money raised by venture capitalists from 1996 to 2001 led to "a collapse in performance from which the sector has never recovered". Too much cash chasing too many unproven start-ups has led to pricey valuations and lower profits when companies finally do go public or are sold off. The industry’s current returns were said to be unsatisfactory, both in a relative and absolute sense, when compared to various public market indices; the industry lags the small-cap Russell 2000 Index by 10% over a 10-year timeframe, despite the fact that those 10 years include the dot-com period, inflating venture industry performance. The core markets that made it successful, information technology and telecommunications, are now mature and less capital intensive. In addition, exit markets are unwilling to take on young and unprofitable companies. As opportunities shrink, venture capital should shrink too, possibly by as much as 50%.

Recent statistics from the National Venture Capital Association showed a contraction last year: There are now about 882 venture firms in the US, down from 1,019 at the end of 2007. Total capital under management shrank to USD197bn, from USD258bn the year before. Mark Heesen, NVCA president, told reporters on a conference call last week that the industry would contract, but that he believed total investments this year could match the levels seen in 2008.

In the NVCA/Deloitte, Touche Tohmatsu survey, half of 725 venture capitalists queried said they expect their investment in Asia (excluding India) to increase over the next three years - only 12% projected a decline; 43% said they planned to boost their investing in India. The survey, which included US, European, Asia Pacific, Israeli and non-US American investors, found that 52% of respondents already invest outside their home country. 38% said China has the most to gain from the crisis; only 18% chose the US, while 51% said the US had the most to lose from the downturn.

Perhaps as a result of the anticipated pullback among US institutional investors in the next 3 years, VC investors anticipate that their investor base will become more global. In the US, 52% expect the number of limited partner investors from foreign countries to increase. According to the survey, investments are rising in cleantech and declining in the semiconductor sector, which includes electronics. The survey shows 63% expect to increase their investments in renewable energy and other clean technologies over the next three years, while only 6% expect their cleantech deals to decline. Conversely, 50% expect to decrease their investments in semiconductors, while only 6% anticipate an increase.

Perhaps, therefore, the conclusion from the two reports is that the downsizing of the US venture capital market will be accompanied by increasing globalization of the business and the growth of opportunity in Asia in particular.

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