I am on an Under the Radar Panel tonight titled: Will VC Market Decline in 08?
This is also the time of year for "what will be hot or not" forecasts. In preparing for the panel, the following jumped out at me.
The VC market is already showing signs of decline. How so? In 2006, venture funds raised $24.7bn from limited partners. In the first half of 2007, the fund raising number is $6.4bn, or $12.8bn annualized. $12.8bn represents a -48% decrease in capital invested in the asset class. Moreover, q106 saw LPs invest $8.5bn, while in q107 the number was $3.1bn, or a -63% decline.
What is going on here? See my post on Venture Capital and Emerging Managers for a more detailed answer, however, I believe that LPs are now wise to the Pareto distribution in industry returns, ie less than 20% of the firms drive 80% of the returns. If you cannot get allocation to the top firms, then get out of the asset class.
A few other stats to share: California is consistently taking 40+% of total VC dollars in the US, with the Bay Area taking 30+%. New England, a story of faded glory, now represents only 11%. Other, ie non-TX, CA, New England, NY, is 27%.
To paraphrase, while the world may be flat, it seems that there are two network effects taking place in the industry - 1) the top firms are taking more and more of the returns and, in turn, LP dollars, and 2) the Bay Area is enjoying a virtuous circle of innovation, wealth creation, talent acquisition, large company exits, repeat cycle that is seeing the region take a disproportionate amount of venture and exit dollars. The Bay Area appears ascendant and there are real ecosystem and systematic variables that suggest it will continue to be so.
Moreover, while total dollars into the industry may be falling, as capital leaves the combination of less money chasing deals plus strong fundamentals will result in not a decline in average returns but a rise. Yes, LPs are cutting back allocation, ironically, the top firms in the industry may be on the cusp of great results.
Am I bullish for 2008?
1) utility computing is real - cost per computing cycle and cost per gigabyte are no longer stuff of IBM and Sun marketing bs. Start-ups can now leverage the infrastructure assets and operating scale of AMZN, CRM, MSFT, and Google to grow their businesses where costs are now variable and not fixed. The cost of innovation, in essence, is plummeting with respect to non-differentiated infrastructure and there is no longer a need for expensive, bespoke infra build outs that suck dollars without adding customer utility.
2) performance based marketing is real - an economic downturn will accelerate marketing spend on high ROI and performance based ad units. In a consumer spending slowdown, brand advertising, whose value if hard to quantify, will get hammered and the reallocation of dollars from off line to online will accelerate - ie I think CPX Internet advertising will prove counter-cyclical because it is measurable and the spend can be tied directly to leads, orders, and revenue.
3) personal link analysis is real - while google monetized page rank, new companies are emerging to monetize person rank. Social networking will drive derivative investments of value - social networking analysis will become a mainstream marketing practice - ie rather than look at consumers as independent members of a market segment, marketers will now be able to analyze who you know, who matters to you and if they influence you, how well you know them, what groups you belong to, and word of mouth marketing campaigns that target "influencers" in given communities will outperform traditional direct marketing. I just looked at a company with powerful tools in this area - they are able to deconstruct a 3m member community into 17m discrete connections between members and over 300,000 discrete groups - by identifying the key "influencers" and "connecters" in each group, marketers will be better able to launch new products, drive product diffusion, and capitalize on the myriad of connections that now exits between us all, of which we seem to add 5-10 per day.
The lower costs of funding innovation, the speed by which products are diffused in a connected world, the virality possible in mining social networking and exploiting them, and the continued allocation of marketing dollars to performance based ad units should make 2008 one to remember despite the message of the video below - however, amusing it might be.