We’ve all heard it… is the venture model dead?

I won’t beat this question to death since many prominent venture capitalists and investors have talked about this. I think it’s too early to tell, but if you force me to answer the question directly then my answer is, “No, it’s not dead.. just somewhat broken.”

From the investors’ perspective, an allocation to venture capital still makes sense, but only if they can gain access to high-quality managers. In an uncertain economy, there’s something to be said about investing with managers who have a proven track record. According to some estimates, about 10-20% of all VC managers are responsible for most of the industry returns and that even a smaller percentage of that group has generated sizable returns (2x or greater) more than several times. This is like saying there are only few real players and the rest are posers.

While there are numerous problems in the industry, such as excessive capital overhang (between $60-$70bn according to some), increasing fund sizes, and lack of liquidity (6 VC-backed IPOs in 2008 according to the NVCA), there are still plenty of talented entrepreneurs and innovative technologies and services that can have a huge impact on the market. I really believe in the American entrepreneurial spirit!

In a way, I think the recession could be a good thing for the venture community. Sure, some 1st or 2nd time funds may not be able to raise capital, but that would a) decrease the capital overhang and b) kill bad start-ups, resulting in a lower pre-money valuation. There are simply too many venture firms pumping in too much money into too few investment-worthy companies.

By the way, if you want to know why excessively large funds aren’t good for the investors, go here. This article does a great job of explaining why venture funds should remain small. It makes a lot of sense both for the VC manager and the investors.

Now let’s all pray for a better 2009… though I don’t see things improving until at least 2010. But I’m often wrong.

By: Jonathan Lee
Twitter: @hi5at5

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