The $25 billion-per-year U.S. venture capital industry has grown fat and ineffective, and will have to shrink by as much as half to regain status as an economic force in America. That's the conclusion of a gut-punch study released today by the highly respected Kauffman Foundation, a premier non-profit that supports entrepreneurship. The stunning conclusions will likely send shock waves through venture capital-dom.
Kauffman came out with guns blazing, ripping the VC industry for having become far too comfy with itself, its structure and compensation. And it debunks the myth that American entrepreneurship lives on VC support. In fact, only about 16 percent of the 900 unique companies that appeared on the Inc. 500 list of fastest-growing private companies over the last 10 years had venture capital backing.
And the report also reveals that only a tiny percentage - less than 1 percent - of the estimated 600,000 new "employer" businesses (more than 1 person) created yearly in the U.S. get VC money...
Despite venture capital's reputation for backing icons such as Google, Genentech, Home Depot and Starbucks, today's reality is different. Less than one in five of the fastest-growing, most successful young companies in the U.S. had venture capital backing,the Kauffman study says: Despite a rapid expansion of venture capital assets under management, the venture industry has been stagnating, and producing declining returns.
Study results argue that VC bloat has caused the industry to no longer produce competitive returns. "It's inevitable," says Paul Kedrosky, senior fellow at Kauffman and author of the study. "Whether it realizes it or not, whether it wants to or not, the venture capital industry has to change." In order for VC to get back to producing competitive returns "it will have to fall by half to a $12 billion per year investing pace from its current $25 billion or higher rate," the Kauffman study says.
That's billions of dollars that would no longer be available to young companies seeking venture backing for growth and expansion. But that would presumably improve investment returns for successful companies, thus helping resuscitate the industry, notes Robert Litan, Kauffman's VP of research and policy. Long-term returns on venture capital investments overall stink. The venture industry lags the usual measure of small company performance the Russell 2000 index by 10 percent on a 10-year time frame.
So what's the big problem? The venture capital industry itself might be structurally flawed, says Kauffman. "The core markets that made it successful - information technol9ogy and telecommunications - are now mature and less capital intensive. In addition, exit markets (such as IPOs) are unwilling to take on young and unprofitable companies.
Given that, the real question for VC's future becomes one of size. As opportunities shrink, the venture business may have to shrink as well - perhaps by 50 percent or more.
For more details check out the complete study called Right-Sizing the U.S. Venture Capital Industry.