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Too much capital, too few investments

Too much capital, too few investments
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First Published: Tue, Apr 10 2007. 12 56 AM IST
Updated: Tue, Apr 10 2007. 12 56 AM IST
Google may have a poor record at venture-capital style investments. But leaving it to the pros might not be a better answer. The VC industry is drowning in funds, and the problem is getting worse.
The evidence is circumstantial, but persuasive. Over the past six years, about twice as much has been invested every year by funds and small “angel” investors than has been taken out.
As a result, returns have suffered. True, it takes several years for early-stage investments to ripen. But the median return on invested venture capital funds has been negative since 1998, according to pension fund adviser Cambridge Associates. Even returns for the top performing funds have shrunk to around the yield on a bank certificate of deposit. There’s simply too much capital chasing too few investments.
The industry’s overcapitalization, like Anna Nicole Smith’s baby, has several possible fathers. Innovation in enterprise software, the milk and honey of VC funds, has slowed.
Hot consumer areas, such as Web 2.0, don’t need much capital. And venture-backed IPOs—the most lucrative exit for investments—remain below pre-dotcom levels.
Moreover, lagging funds have little incentive to shut. Managers earn 2% annually, which is sufficient to cover their costs. They also get 20% of the profits—and one only needs the prospect of a single monster hit to turn a mediocre fund into a stellar one. This populates the industry with optimistic fund managers who won’t give up easily.
The consequence is that it may take years for the industry to shrink to a size justified by its returns.
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First Published: Tue, Apr 10 2007. 12 56 AM IST
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