Investment in startups by U.S. venture capital firms in the third quarter plunged 70% from the same period last year. Third-quarter investment by venture capital partnerships, according to the Financial Times, was just $6.48 billion, compared with $22 billion last year, and $26 billion in the first quarter of 2000.
Investment in seed rounds fell to just $18.5 million from $54 million in the same quarter last year, while first-round funding dropped to $963 million from $5 billion. Even second-stage financing dropped to $2 billion from $6.2 billion.
This dramatic decline in venture investing should spark questions by pension fund executives. The first question these executives should ask of venture capital executives is: Are you right this year? If so, why were you so wrong last year? That is, why are you investing so little? Why are you finding so few good deals, when you found so many last year?
Another way of asking this question is: Has innovation dried up this year, or are you being too cautious?
Surely now is the time to be making venture capital investments. Those firms willing to commit now must surely get access to the best new ideas, and get that access at the best possible prices.
Before the collapse of the tech bubble, a common complaint from pension executives was that they could not get into the best venture capital pools, or could not put as much money to work as they desired. That was because the leading venture capital partnerships were being flooded with money quicker than they could find ways to put it to work.
All of the hype about venture capital investing during the `90s sucked not only vast amounts of pension, endowment and foundation money into the field, but also new venture capital firms, some with marginal experience.
The oversupply of capital also led to money being poured into poor projects, such as many of the dot-com companies that had no real plan for generating revenue and making a profit.
Perhaps the pension funds and endowments asked too much of the venture capitalists, pushing too much money on to them too quickly. But the venture capitalists also could have taken only the assets for which they could find suitable investments.
Pension fund, endowment and foundation executives also should be reviewing their venture capital relationships. Which ones have produced? Which ones put the money to work in a timely fashion? Which ones have had the best records in the wake of the tech bubble? Which ones have had the worst records?
Now is the time to shake out the worst performers. Many experts said there was excess capacity in the venture cap arena during the tech bubble. Now that venture cap investing has plunged, there is certainly overcapacity, and the industry will be improved if the weaker players are shaken out.
At the same time, the remaining firms should be encouraged to get out and find the nation's next generation of entrepreneurs and make commitments to those with genuine promise. The funds' allocations to venture cap are not earning their keep when they are parked in short-term investments waiting to be drawn down and invested.