Come See the Incredible, Shrinking VC Industry!

The VC industry is starting to shrink with some rapidity, according to data released today by National Venture Capital Association (NVCA) and Thomson Reuters. The trend, which first started in 2008, has only accelerated. During the second quarter of 2010, new money committed to venture funds plunged 49 percent from the previous quarter and 57 percent from the same period a year ago. NVCA believes the soft economic environment is to blame for much of the recent decline in new funds.?

The latest quarter saw 38 funds raise $1.91 billion — the lowest level since the third quarter of 2003. There were 26 follow-on funds and 12 new funds raised in the second quarter of 2010, NVCA noted. These included new funds by Polaris Venture Partners and Venrock Associates.

venturefunds.gifIf you look at the accompanying graphic, you can see that the total amounts being raised by venture capital firms are decreasing, and 2010 isn’t looking particularly attractive. I think the data (and financing trends) has some near- and long-term implications for entrepreneurs.

I don’t think the early stage startups, especially those who are focusing on the consumer web and mobile applications, are going to be much impacted by the shrinking VC industry. The startups of today are much more capital efficient and need a lot less money to grow in the early phase of their life. The rise of the new angel investors is only helping the startups, who are taking small amounts of funding to prove their ideas before hitting up venture capitalists for more dollars.

While fewer VCs would mean fewer dollars, it would also mean less funding for multiple competitors, a problem that reared its ugly head during the 1990s and then in mid-2000s, coinciding with a big upswing in VC fundraising.

However, if there is any good news for the VC sector, it is on the exit side of the equation. According to NVCA, during Q2 2010, there were 17 venture-backed IPOs that were valued at $1.3 billion and included Gaithersberg, Maryland–based Broadsoft, Inc (s BSFT), a developer of voice-over information technology, which raised $67.5 million and Tesla Motors (s TSLA), which raised $226 million. During the quarter, 92 venture-backed M&A deals were reported. The information technology sector saw 78 deals with a disclosed total dollar value of $2.4 billion, including Google’s $750 million acquisition of Admob.

These exits can only help the industry, which has struggled to show any meaningful returns that would convince investors to come back and up their commitments to venture funds, especially those who are looking to raise funds in 2011. It is clear that the true test of the industry is going to come next year, and we can (and should) expect some kind of a shakeout.

Related GigaOM Pro Content (sub req’d): What the VC Industry Upheaval Means for Startups