Is the venture capital model dead?

There's been an increasing belief over the last few years about the impending death of the venture capital business.  I'm not going to elaborate on the various theories floating around out there.  If you want to learn more then a simple google search with the keywords "venture capital dead" will provide you with plenty of reading material.

The bottom line is the venture business is alive and well but is in the midst of a long period of transition.  Alan Patricof, one of the deans of the venture industry, did a fantastic job in a NY times article a couple of days ago of explaining how the business has shifted over the last 40 years.  His view is very consistent with ours at Greenhill SAVP and exactly the view we shared with our LPs back in 2005 while raising our current fund.

Prior to fundraising back then we did a lot of research and crunched a lot of data about the venture industry and came to several conclusions:

• historically the most successful VC-backed companies are consistently the most capital efficient
• the most successful early stage venture funds were smaller in size with virtually no evidence in our industry (outside of late 90's bubble funds) of early stage funds generating strong returns above $300 million
• valuations matter - A LOT.  Fair and reasonable valuations work better for venture funds AND entrepreneurs.  Inflated valuations combined with too much capital consistently lead to exit value expectations which statistically have not been reached with enough frequency.  Most exits are less than $100 million in value with bigger exits serving as the exception, not the rule.  Too many venture funds are currently structured so they can only succeed by producing several "exceptions" in each fund.  
• the venture industry will need to contract signifcantly over the next decade.  Between 1997 (the year I entered the venture business) and 2007 the number of venture funds and number of investment professionals increased about 60% and average fund size increased 120%.  We think we'll revert back to 1997 levels over the next 3-4 years. 
• venture capital and entrepreneurship is democratizing and becoming increasingly global as core technology becomes widespread and cheap.  Silicon Valley will continue to be important but less so than the previous 30 years.  Innovation will become more distributed and certain geographies with particular depth of domain expertise (e.g., financial services in NYC) would stand out as future centers of innovation. 

Four years later our view is unchanged and in fact we expect to see these changes to accelerate.  We constructed our venture fund and investment approach based on the above-mentioned assumptions because we felt it was the best formula to serve both entrepreneurs and our investors.

We feel now is a terrific time to invest in innovative, capital efficient start-ups and we plan to be active investors in 2009.   We're fortunate to be well-positioned today with plenty of capital to invest and believe that we'll look back on the companies we fund in today's environment as some of our best performing investments.  On a macro level, we're long-term bulls on the venture industry, long-term bulls on a continued strong rate of innovation and long-term bulls on the entrepreneurial spirit that has always been the foundation of America.