If the flurry of TechCrunch announcements over 18 months is any indication, the volume of startup investment is high and frenetic. However, the fund raising figures and liquidity figures show that the venture industry faces difficulty raising new funds or recycling proceeds from either M&A or IPOs. Ultimately, VCs cannot invest more than they have raised. So when does the music stop – when has the venture industry invested all of its cash?
I’ve used some data from VentureSource to develop a better understanding of the market dynamics.
Historical Review of the Fund Raising Market
VC fund raising grew dramatically in the mid 90s and peaked in 2000 and 2007, correlating with the public bull markets. However, the chart below shows that the fund raising pace has fallen dramatically and in the past 3 year resembles that of the venture industry 15 years ago. 2010 is trending toward a similar year as 2009.
The number of investments spiked again in 2000 but since have remained relatively stable and independent of the financing market.
Therefore, the financing market has oscillated dramatically, but the number of deals remained constant. There are two possible explanations:
- The total amount invested in each deal has decreased during tough times
- VC funds have “saved” money from good financing years to spend during tougher financing years. When a firm raises a fund, they typically spend 4 years investing. As a result, some years they raise more than they invest and there is a large surplus in the bank account that is used to invest when the fundraising market slows.
Let’s take a look at each.
Average dollars invested
The average dollars invested has a nearly identical trendline to the number of deals and excluding the 2000 spike is relatively constant despite the number of new firms, huge volatility in dollars raised and shifts in stages that occur naturally with aging portfolios.
Cumulative Investment Surplus
So we are left with the cumulative investment surplus to explain the disparity between dollars raised and invested. Viewing the chart below, we see that VCs hav saved some of their capital in good times to invest in bad times. However, 2010 represents a new historical low (and in this chart shows a negative cumulative investment surplus owing likely to some margin of error in the data).
Combining this data point with a relatively quiet exit market, fund raising conditions are very likely to cool in the next several months.
NB: This data isn’t perfect and has the following observed biases and issues:
- Data is gathered through surveys
- VentureSource data differs from Thomson’s figures, so they should be correct to within 15-25%
- Don’t take into account recycling of proceeds
- Differences of definition between a PE fund and a VC fund (eg, Norwest’s $1.2B+ fund)
- Collection methods have changed over the past 15 years