The Q3-07 issue of OVP Partners newsletter, “Charting the Course,” analyzes the NVCA Yearbook numbers to get a better sense of what is going on with the consolidation in the venture capital industry. By simply looking at a number of firms that made at least one new deal they conclude that the US venture industry has been cut in half from 2000 through 2006. (In 2000, there were 1156 different venture firms that made at least one new deal. In 2006, there were only 597.) OVP also observes that surviving firms are double the size of those in the bubble, signaling a flight to quality.
In Canada, this metric yields 129 actively investing funds in 2000 and 75 funds in 2006. This represents a 42% drop for the Canadian market. (MaRS Venture Group Associate Kevin Downing prepared the numbers with this disclaimer: (a) Numbers are based on published investments made within a given calendar year. (b) Undisclosed and ‘and others’ could contribute to a margin of error.)
It is fairly typical that as an industry matures it drifts towards a structure with several major brands at the top, an array of boutique firms on the low end and, unfortunately, a struggling middle tier. In the financial industry this has already happened in mutual funds, brokerage firms, commercial finance shops and is likely to happen in buyout funds as well.
Dominance of large venture funds is further re-enforced by institutional investors who strive to reduce guesswork from their fund allocations. It is somewhat logical to assume that a larger venture firm has a deeper array of resources and domain expertise to draw from. Because institutional investors often are restricted by the 10/10 rule (need to put out at least $10m and don’t want more than 10% of the fund), they are limited to $100+m funds. Thus, a sub-$100m fund is likely to be either a specialized sector-fund or a $30-50m high net worth fund.
Ironically, the larger funds have not performed as well as smaller venture funds. Historically, these firms, which typically do seed rounds and A rounds, have outperformed large funds. At 10- and 20-year horizons, early/seed stage VCs returned at 36.9% and 20.5% respectively, according to data from NVCA and Thomson Financial. By comparison, later stage VCs, typically bigger, returned at 9.5% at year 10 and 13.7% at year 20. (Source: National Venture Capital Association)
Is it an opportunity for a new generation of early stage funds? My current hypothesis is a resounding yes, especially for sector-specific funds.