Venture capitalists style themselves "stewards of entrepreneurship", offering cash and expertise to young Thomas Edisons (the founder of General Electric).
Stunning returns for early investments in companies like Google (reportedly each dollar invested returned $10,000) kept the dream alive for investors and entrepreneurs alike.
And yet, like a Greek tragedy, the halcyon days brought the seeds of destruction. One recent analysis by Harvard Business School’s Prof William Sahlman demonstrated median returns peaked in 1996 at 45%, and by 2008, those returns were -10%. Technology defnitely lost its lustre.
Last year, consultancy Cambridge Associates reported returns in the electronics industry had decreased from 157% on companies founded in 1998 to 5% on those founded in 1999. They have been negative subsequently.
The year 1998 was clearly a banner year – returns on hardware companies founded then reached 150% and have oscillated between -13% and +30% in subsequent years, while 1998-vintage information technology companies generated astonishing internal rates of return of 275% and have been consistently less than 30% for all vintage years since then. It was not a bubble – it was a nuclear explosion.
The lower returns stem from the high fatalities in the VC industry’s train wreck. Sahlman’s study showed that most of the capital is lost – 62% of 600 analysed investments were lost, while 3% accounted for 53% of the profit.
Harvard Business Review reported reduced exits (17 initial public offerings a week in 2000, compared with 15 in 2008 and 2009 combined) and longer waits were taking their toll.
In 2009, PricewaterhouseCoopers reported that in the preceding three years the capital pool had been reduced by half to levels last seen 10 years ago.
The purge is likely to continue.Where will new capital come from? It is likely traditional corporate venturing will grow in importance and university-funded commercialisation will emerge as a new player.
Recently the New York Times said educational institutions, including the University of Utah, the University of Virginia and Carnegie Mellon, were intensifying their technology transfer efforts and starting to inject money.Consider New York University announcing a new $20m venture fund to commercialise internal research.
While powerhouses like MIT, Stanford and Caltech have long provided infrastructure to nurture new companies, the next tier of institutions wants to get into the action.
Building and sustaining a portfolio of 10 companies suggests a fund needs to reach about $60m in size. At that point, a university can keep up with the follow-on invest-ments required to bring the successes to maturity.
Funds of $15m to $20m in size are nice to test the concept with faculty but will make it difficult to provide real returns. However, it will be easier to reach organisational goals, such as attracting and retaining faculty members, without the extraordinary returns of the large venture funds, and it should be possible to reach internal hurdle rates of return to satisfy boards of trustees and other stakeholders.
The key risk – and it is a significant disadvantage – is the lack of understanding of market research and dynamics as these groups try to push their technologies into an unwilling marketplace.
On the other hand, a university reaching internally instead of to a state pension plan for funds will tolerate a steep learning curve.
Imagine a finance market where university professors go to internal sources of funds instead of external VC. The professor is happy because he has institutional support and can minimise his time dedicated to dog-and-pony shows.
University administrators can retain good faculty members with the promise of funding future enterprises. Technology development risk can be addressed and partially retired in focused development prior to funding by larger VC funds and strategic investors.
Traditional VC has collapsed. Mid-tier funds founded in the heyday and lacking a payday will be forced to exit the arena as institutional investors regroup. Meanwhile, university administrators will take advantage of the vacuum to create a new avenue of financialsupport for their innovators.
Expect to see more universities participate directly in early-stage investing in technology.
First published by E-Commerce Times