The State of VC: Lack of Ideas or Lack of Courage?

All is not well in venture capital land; at least, it’s been a lot better. In April, the National Venture Capital Association (NVCA), which works with PriceWaterhouseCoopers to develop industry data, reported its numbers for both fund-raising and investment, and it represents a world turned upside down. Rather than paraphrase, here’s the actual data from the press release of April 12:

“U.S. venture capital firms raised (US)$3.6 billion in the first quarter of 2010 from 32 funds, according to Thomson Reuters and the National Venture Capital Association. This level marks a 31 percent decline, by dollar commitments, compared to the first quarter of 2009 and 44 percent decline by number of funds. It also represents the slowest opening quarter since 1993.”

You might recall that 2009 was not a banner year for very much, so what does this news say about the year we are in? There’s more (unfortunately), and though it sounds like good news, it really isn’t. Total money invested in Q1 ’10 amounted to $4.73 billion compared to $5.18 billion in Q4 ’09 and $3.36 in Q1 ’09. The bad news? Last year was the first in more than a decade in which the industry invested more than it took in, so the combined data shows that trend continuing.

Numbers and Meaning

The significance is this: It takes years for an investment in a new company and a new idea to bear fruit, and most of the time the investment is not successful. The emerging company may go out of business or its assets might be acquired, in which case the investors may get some of their money back. But the investment game is not about breaking even; it’s about winning big, frankly. In an IPO, an early investor expects to see an order of magnitude return on the money invested. But for those paydays to happen, and for them to happen on a regular basis, we need to fill the top of a very large funnel consistently.

Keep in mind that the data covers investments in all kinds of industries, from biotechnology to semiconductors. There were 144 deals in the software industry in the first quarter, and that leads all categories. But while that number might seem impressive, compared to the same quarter in 2006, for instance (a random pick), when there were 230 deals, it is small.

So the question I have, which I don’t have an answer for, is this: Are investors skittish about putting money to work, or are there simply not enough good ideas for them to chase? Or is VC investing simply a lagging indicator of economic health?

I think there is genuine uncertainty in the investment world right now, but that is is only partly explained by the economy.

The Apple and MS Connection

There might be a partial answer from last week’s news that the market value of Apple eclipsed Microsoft for the first time. You might think there isn’t much connection between the two, but consider this: We categorize Microsoft as the technology supplier to the enterprise and Apple as the supplier to the rest of us. The fact that the market values the two companies roughly equally for the first time says to me that consumer technologies such as iPods and iPads are taking over the economic driver’s seat.

An economic inflection point like this, especially when watched more closely by VCs than by me, could explain a bit of the market’s reluctance to invest more than it is, especially now.

This suggests that investors may be looking for something new and different, even among all the new and different products vying for attention and capital. Last week I suggested that something might be oriented toward sustainability in business processes. Products that drive sustainability in travel, product innovation and treating customers as resources have always been popular, at least as sound bites, but maybe sustainability is one of those new ideas whose time has arrived.

Regardless, the health of the VC industry is a barometer of health for all of us, and right now the patient seems to be playing it cautiously. Nothing wrong with a little caution, but I wish the news was more bullish.