Is the VC Model Broken? Far From it

Updated: Adeo Ressi, the serial entrepreneur behind the venture-capital rating site TheFunded, has been getting a lot of attention for a presentation he gave at Harvard Business School in which he argued that the VC industry is “broken.” His central point is that there are simply too many venture capital funds chasing too few opportunities, with unrealistic expectations. The result, as he notes in one eye-grabbing slide, is that VC returns over the past five years have fallen below the total amount of money invested over that same time period.
It’s certainly the kind of slide that makes you sit up and take notice. But is it evidence that the VC game is kaput? Hardly. Instead, it’s reminiscent of Warren Buffett’s quip about how if he had been at Kitty Hawk he would have shot Orville Wright’s plane out of the air, because the airline industry over the last 100 years has been a net destroyer of capital. While that may be true (I haven’t double-checked Buffett’s numbers), that’s not to say investors haven’t been able to make money throughout that troubled history. To quote another great economic mind, John Maynard Keynes, in the long run we are all dead. In the short run, however, some successes are possible.
adeo1Have there been too many funds created, too much money poured into finding the next Facebook, Twitter or YouTube? Undoubtedly. But the VC industry is subject to the same economic forces and laws of supply and demand as any other industry — in other words, if some funds are making money, others will emerge and try to duplicate that success, even if they know the odds are against them. The same dynamic can be seen in plenty of other businesses, including the mining industry: When gold is hot, everyone wants to be (or invest in) a gold miner, even though they all secretly know that too many miners means less gold for everyone.
An industry like that is inevitably going to grow and contract, and now sure feels like a time of contraction. But that doesn’t mean smart VCs can’t prosper by concentrating on what they know, or by staying small enough to get more “home runs,” as angel investor Austin Hill notes in a comment at TechCrunch (disclosure: I know Austin, and consider him a friend). The VC industry isn’t broken any more than any other boom-and-bust industry is broken. It’s likely to go through a restructuring as a result of the current downturn, and some VCs will undoubtedly go out of business, as they should. But there will always be VCs, just as there will always be gold companies — and airlines.
Update from Om: Looks like Darwin is doing his thing. Bloomberg reports that universities and pension fund investors are dumping their stakes in VC funds. “Investors have venture-capital stakes valued at more than $2 billion up for sale, double the $800 million this time last year,” the newswire writes. Everyone including large university endowments are having sleepless nights. 

TheFunded – Canarie

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Image courtesy of Adeo Ressi via his blog.