It's Silly to Judge Venture Capitalists Only By How Much They Spend

I was just about to go to bed when I saw Sarah Lacy on TechCrunch predicting that a 50% drop in venture capital investing last quarter signals the beginning of the end of the industry’s golden age. True to TechCrunch form, it was an eye-opener.

And we share some of her concerns. A few weeks ago, we wrote that “the money in the start-up economy today is like the water in a hose whose faucet was just turned off,” with investors in venture funds at one end of the hose, and startups at the other. Last September, we argued that what was really scary about the lack of public offerings or even accretive acquisitions was that nobody was scared.


But in some ways we are more hopeful now than Sarah. The 50% drop that Sarah takes as the starting point for her argument that venture capitalists are “falling off a cliff” is worrisome for startups looking for good valuations, but not necessarily worrisome for venture capitalists. The drop in dollars invested reflects a few trends that Sarah doesn’t account for:

  1. Most startups this winter suffered a major dip in revenues as businesses and consumers stopped spending, and ad rates plummeted through the floor. As an entrepreneur, the last thing you want to do while your P&L is getting trashed is raise money. Every CEO I know who was considering raising a round put it off unless there was no way to avoid it. The only companies that were raising capital were the ones who had no choice.
  2. Valuations were much lower, so dollars invested were lower too. But no venture capitalist objects to getting a good price. You don’t judge a trip to the grocery by what you spent, but by what you got. So a better measure of the VC industry would be the number of deals done, and the amount of equity purchased.

And this is where Sarah’s essay didn’t ring true, at least for me. The VCs I know are as interested as ever in deal flow, and eager for a big hit. They still have plenty of capital to deploy, and happily anticipate fire-sale valuations. (Update: Bernard Lunn at Read-Write-Web has the same observations based on first-hand interviews with VCs and entrepreneurs.)

The reason I write this is not to defend venture capitalists: there may well be too many venture firms, with bloated fund sizes driven by management fees rather than returns. But just as it was crazy for venture funds to measure themselves by the dollar volume of their funds rather than the amount of money they could really put to work, so now it’s crazy for Sarah to judge the venture industry by the dollar volume of its investments.

In fact, rather than seeing this decline as the problem in venture capital, I think it’s the solution. Less money more selectively invested into high-quality companies will lead to better returns.

So where are all the high-quality companies? That’s the real question behind Sarah’s essay. When she says there is “no obvious high-growth sector of the tech economy,” what she is really saying is not simply that there are too many venture capitalists but there’s nothing left for them to invest in.

Reading all the media coverage this week about Ashton Kutcher and Oprah Winfrey on Twitter, it would be easy to believe we’re at the end of our days. But last I checked, the global economy collapsed because we didn’t have the right information about what financial assets were worth. Doctors still have no way to know what treatments a patient received before showing up in their office, and the human genome has become too complicated for the current generation of computers to track. In our corner of the world, real estate is still pretty screwed up too. Business as usual won’t solve these problems. Startups armed with new technologies will.

The challenge will be focusing our time, energy and money on these important problems, which so far the Web 2.0 movement hasn’t always cared about as much as kicking the crap out of one moribund industry, newspapers, over and over again.

We talk about the dot-com era as our greatest folly in Silicon Valley. But at least back then, startups tried to do something big: criss-crossing the country with Internet fiber, putting a computer on every office desk and in every house, changing how consumer bought almost everything and how businesses manufactured almost everything, too.

If we get back to the big stuff, the world will be a lot better, and VCs will do just fine.

(Photo credit: Bikeracer on Flickr)


  • MDH

    Hey Glenn, spot-on.

    As I was reading your assessment, the company in the back of my mind was Amazon. Audacious, Big, and needed plenty of capital… and you know what? I changed retail forever. Same opportunity exists for dozens of industries which have been mostly left alone because of the scale needed to approach it. I’m sure you appreciate it all to well… as I consumer, I’m rooting for you.

    Mostly, the problem is one of confidence on the VC-side. Lot’s of Jr. partner with loads of capital on-hand? Yes. Confidence on what to do with it?… not so much. Lot’s of pucker factor going on.

    We need some of the old school VC legend types to jump-in with big bold bets (they’ll be the ones with the balls to do it)… that will happen, the moment they think we’ve hit a bottom. Until then, everything will remain on hold.

  • Glenn Kelman

    Well thanks for the kind words MDH. I’ve seen VCs young and old on the look-out for game-changing investments, and I still believe a few will come through!