In the past few weeks, we’ve seen extremely positive headlines about the surge in VC fundings like “Venture Capital Hits Highest Level Since Dot-Com Bubble.” It must be the best of times for the industry with $8.1B invested in startups during the second quarter of 2012 (the highest in a decade!) along “…with seed-round venture capital hit[ing] an all-time high” [According to CB Insights].
But during this same month, there was a sobering report from Thompson Reuters & NVCA suggesting that perhaps rather it’s still the worst of times, with only $5.9B raised from LPs brought into the asset class this past quarter and the number of funds raising new capital its lowest in years. Sure, that figure is up from immediately after the Great Recession hit, but annualized it’s not nearly a full recovery, and nowhere near the height of the late nineties boom.
In fact, as the two above citied figures show, venture capital firms are actually actively deploying capital at a faster pace than they are raising it. Obviously that imbalance cannot continue in perpetuity, and some have said that “this won’t end well.” But what’s really going on here? Are VCs drunken sailors soon to spend themselves off of a cliff?
Quite the opposite – this fundraising paradox has resulted given the dynamic changes occurring within the industry. Two years ago, I wrote a blog post analogizing the beer industry to the VC industry as it has matured to create two bifurcated poles. On one side are the large VC firms resembling Budweiser-type macrobrews, competing based on scale and brand with a standardized product across multiple geographies, sectors, and stages. And much like the emergence of microbreweries specializing in craft beer, new Micro VCs (like my own firm NextView Ventures) are thriving by specializing along at least one or more of these three dimensions (geo, sector, stage) with a unique offering for a specific subset of entrepreneurs.
Included in the July 9th NVCA report where the figures above originated, Mark Heesen, President of the organization wrote: “As the number of venture capital firms continues to contract, we are beginning to see a clear bar bell forming with several large funds weighing in heavily on one side of the spectrum and a multitude of smaller funds on the other side… As the venture industry bifurcates further, successful LPs and portfolio CEOs are going to have to search for quality firms on both sides of the barbell.”
Given the size and scale of the macrobrews of the VC business, it’s increasingly the largest venture capital firms driving all of the fundraising figures quoted in the media. In fact, according to the NVCA report, “the top five funds accounted for nearly 80 percent of total fundraising.” The two largest funds this past quarter (NEA and IVP) raised over a $1B in capital each.
The imbalance between venture capital deployed and raised isn’t a collective irrational action of the industry – rather, it’s a leading indicator about the fundamental bullishness of the largest funds’ ability to raise additional capital. As there has been a flight of LPs to concentration in fewer VC names, the largest firms have been empowered to raise even larger funds as they expand their footprints. The meaningful dollars currently being deployed are not an unhealthy reflection backward, but instead an optimistic point-of-view about the capabilities to raise additional capital in the future.
This conclusion seems counter-intuitive given the anecdotal stories about the challenges that many venture capital firms have experienced in fundraising since the 2008 collapse as the industry has contracted into two distinct winning strategies of either a macrobrew or microbrew1. But again, the aggregate numbers are being driven by just a few of the largest macrobrew firms. Take just the two largest funds raised from this past quarter: both firms raised this most recent fund more quickly after their last one than the time-period of the previous fund cycle. Surely that conveys optimism.
So while the fundraising environment is more challenging than it was during the middle of the past decade, the pain has been felt unevenly across the industry. And there are many of the largest firms in the venture industry which not at all negative, but rather just plain wildly bullish. The bifurcation has by definition hit the middle the hardest while stirring the pot on the smallest end to create unique situation, the subject of my next post in this two part series on the best and worst of times in venture capital.
1Of course there are exceptions of unique firms with heritage brands, unique positional advantage, and/or exceptional historical returns which don’t fall neatly into one of these categories but are able to presently succeed by leveraging their own past success – call them the “Samuel Adams of VCs,” perhaps the subject of another post.