June 28, 2011

Venture Capital 2011: How the Past Informs the Future…Today


Kate Mitchell, Class 11 Mentor

More than a decade ago, the Kauffman Fellows Program set out to shape the future investors of an asset class that few in the United States had heard of and even fewer understood: venture capital.

In 1994, the Program’s first year, venture capitalists invested a mere $3.7 billion, including a $5 million round into a little company called Netscape Communications.1 The U.S. venture community—which doubled as the world’s, for all practical purposes—remained centered squarely in Silicon Valley. There, most investors rarely traveled beyond their own zip codes to populate their portfolios with high-tech, highly promising companies.

Even in this early stage, the Program’s founders realized the importance of establishing best practices, developing infrastructure, and guiding new generations of leaders for the U.S. innovation economy. Their vision proved extremely prescient. Despite its relatively modest numbers and footprint, the venture community was about to help fuel an explosive period of U.S. economic growth.

At a glance, the venture environment those first Fellows set eyes upon may bear little resemblance to that of today. The venture capital industry has gone global, as countries like India and China have embraced entrepreneurship and innovation with the same fervor of the United States in the 1990s. Venture investment has generated entire new industries, with the internet economy, social media, personalized medicine, and clean technologies leading the list. Yet during this same period, the U.S. economy has endured two recessions, including one in 2008 whose painful after-effects have lingered into 2011.

However, emerging venture capitalists may gain as much insight from the similarities between the Kauffman Fellows Program founding year of 1995 and the current 2011 as from the differences—for example, 1994 and 2011 both feature the perpetual triumph of innovation and the relentless spirit of entrepreneurs. Using this lens of history, new venture investors will be able to guide the next generation of innovative companies to success and in turn give rise to the next generation of venture leaders. This article examines today’s challenges with a historical lens, as well as opportunities, with an eye toward the coming decade.

Shrinking Back to the Future

The U.S. venture capital industry is shrinking—probably the last piece of news current Kauffman Fellows want to hear, but the numbers do not lie. Venture capital firms have dwindled in the United States every year since the all time high of 1,023 firms in 2005 to 791 in 2010.2 Venture fundraising from limited partners hit a seven-year low in 2010, coming in at $12.3 billion.3 Fund sizes between $50 million and $150 million will soon be the norm again.

With smaller numbers of firms and smaller funds, today’s venture industry resembles that of the mid-1990s more than any other time period—the good news is that those were very good years for venture investing. Therefore, I expect this present-day contraction to yield some positive and meaningful results for the venture industry and the entrepreneurs it helps to fund.

First, the supply of capital is better oriented to the opportunities available in the marketplace. While phenomena like the technology bubble of the 2000s provide more of an exception than the rule in the venture capital industry, the reality is that venture does experience investment cycles. Certain sectors heat up and draw in more capital; as a result, more startups receive funding—to the point where too many companies begin competing for market opportunities and next-stage dollars. In a sense, this wave of capital and new companies crushes the opportunity for even the best players, as in a contracting venture community with smaller funds, the strongest investors will likely focus on funding only the most promising companies. However, the result is a smaller crop of stronger companies better positioned to succeed.

Second, smaller fund sizes may lead to a shift toward more capital-efficient deals, in which venture investors deploy a relatively small amount of funding initially to help companies develop tools to achieve proof of principle early in the lifecycle. Social media companies, for example, can develop their technologies with relatively little capital because they do not have to manufacture physical prototypes or pass regulatory muster in order to launch a pilot or enter the marketplace. This efficiency keeps investments small during the riskiest stage of development and reserves the bulk of capital deployment for scale. (Capital-intensive investments will continue to be the focus of those firms committed to the life sciences and clean technology industries, but those sectors will have very few “venture tourists” in an environment where funds are scarcer.)

Third, a venture community with smaller funds focused on fewer companies will benefit those entrepreneurs who receive funding. With a smaller stable of portfolio companies, venture capitalists will able to spend more time working personally with each entrepreneur during the earliest stages of company development. Investment numbers fail to capture this value-added aspect of venture capital: the mentoring, the industry insights, and the transfer of business experience from one generation of innovators to the next. This is the very process by which U.S. innovation leadership renews itself.

Of course, the flipside of a smaller venture community is that life will be harder for many individual firms, especially those that fail to raise follow-on funds and must face the unpleasant task of winding down. In this Darwinian environment, there will be a reckoning for firms unable to demonstrate returns for their limited partners. As the industry shrinks, it will also be more competitive for today’s Kauffman Fellows to find jobs with the firms that continue to thrive. These challenges, however, are outweighed by the benefits that right-sizing will bring to venture capital in the years to come.

Exits: No Longer Clearly Marked

During the 1990s, startups and their venture investors focused their exit strategies on taking the company public through an IPO, while the strategic sale was reserved as Plan B. The numbers bear this out: 1991 to 2000, there were 1,973 IPOs and 1,412 acquisitions (M&As).4 Emerging companies and the U.S. economy benefited from the robust IPO market because the capital raised and the reputations built in the IPO process financed further job growth of 92 percent.5 Since 2001, however, a succession of recessions and regulatory responses to those recessions have turned these numbers on their heads—from 2001 to 2010, IPOs totaled 476 while acquisitions climbed to 3,468.6

It must be noted that the economic promise of an IPO has not changed, but the pathway to IPO has. Through the frameworks of Sarbanes Oxley,7 the Spitzer global settlement,8 and Reg FD9 compliance requirements among others, policymakers have erected a virtual obstacle course for small, emerging venture-backed companies looking to enter the public markets.

As a result, venture capitalists and their portfolio companies are having very different discussions about financing the latter’s growth than they were in the mid-1990s. Back then, one of the primary goals was to find an investment bank to shepherd the company to an IPO within five to seven years. Success in this pursuit was never a given, but a number of niche players had emerged on the institutional side to create a true marketplace for all players; for example, firms like Alex Brown, Hambrecht and Quist, Montgomery Securities and Robertson Stephens—dubbed the “Four Horsemen” within venture circles—specialized in taking small tech stocks public. None of these firms exist today.

Boutique firms have not flourished in today’s market, because the current regulatory environment has stranded venture-backed, small cap IPOs in a “no man’s land” with regard to the institutional marketplace. Whether fair or not, most boutique banks battle the misperception among companies and investors that they lack the balance sheet, resources, and cachet to lead the book running of an IPO. The large, “bulge-bracket” banks do have brand-name appeal but little economic incentive to commit to risky, small-cap deals that do not move their respective needles fast enough or far enough.

For these reasons, venture investors must reinvent their relationships with the investment banking community and learn to take advantage of the full spectrum of value it can provide for portfolio companies. Just as yesterday’s venture capitalists (VCs) worked with bankers to develop the infrastructure to facilitate the IPO model, emerging VCs will need to create similar networks of resources to meet today’s exit strategies. For example, VCs can leverage the services and contacts of small and large institutions to find better-quality syndication partners for the longer runway to IPO, as well as to tee up high-quality M&A opportunities for their startups. The first step will be for VCs to become better educated about the dynamics and economics of this market in order to become savvier consumers of investment banking services

A World of Opportunity

Not long ago, the United States held a global monopoly on venture investments and high-tech entrepreneurship; today, entrepreneurs can go to China, India, Eastern Europe, or Latin America to start fast growing information technology (IT), life sciences, or cleantech companies. When it comes to spinning innovation into economic growth, the race has been joined and while the United States may still hold the lead, the emerging markets have the momentum.

To a certain extent, the rise of innovation in these countries mirrors the overall growth they have achieved by opening up their economies, and probably should be expected. More importantly, however, they are positioning themselves to maximize this growth and perpetuate it by explicitly copying the U.S. venture model—the critical difference between U.S. rivals today and those of decades past.

In hindsight, the globalization of venture capital was inevitable, as for decades now, U.S. VCs have been exporting their expertise by working with foreign VCs in their home countries to invest and grow businesses there. Such countries in turn have put these lessons to use by building their own VC infrastructures and offering significant incentives for venture-backed businesses to remain on home soil. In many cases, they have actually drawn U.S. startups—or at least their manufacturing or IT components—to their shores. U.S. venture capitalists must understand the dynamics of this new global marketplace and draw on the globe’s best available resources (be they vendors, syndication partners, or sovereign governments) to help their portfolio companies grow.

In fact, VCs must evaluate deals through this global lens from the outset, a significant departure from the mid-1990s when only the largest companies operated internationally. Global expansion was a post-IPO concern in those days, and thus beyond the typical VC’s purview; today, a startup without a global strategy is a nonstarter for most venture firms. Fortunately, advances in technology and the general globalization of markets have made it possible for even the smallest companies to go global. Regardless of whether companies have a global sales and marketing strategy (and most do), they certainly have global competitors from the start. The world has indeed become flat and the best VCs and entrepreneurs will keep their eyes focused on horizons that span beyond their own backyard.

While global markets are growing, a number of U.S. policy trends (from historical inertia on legal immigration reform to burgeoning financial regulation) have made it more difficult for foreign entrepreneurs to come to the United States to start companies and more burdensome for U.S. entrepreneurs to grow their companies at home. U.S. policymakers must come together to remove these obstacles within the U.S. innovation economy or risk surrendering U.S. global economic leadership for decades to come. More importantly, understanding how policy affects a portfolio company’s prospects has never been a more critical part of a VC’s job. Where possible, VCs must use their voices to advocate on behalf of their companies’ interests.

New Innovations and Industries Await

Despite the challenges that lie before us, the promise of innovation has never been greater. Social and mobile computing, personalized medicine, and renewable energy technologies are developing at breakneck speed at a time when demand for these products is stronger than ever. In many ways, the exuberance surrounding technology resembles that of the 1990s before the internet bubble—except this time around, it is rational and sustainable. This level of innovation will likely generate more high-quality opportunities for Kauffman Fellows in the years to come, even as the venture community contracts in the short term in response to market conditions.

The clean technology sector will likely provide many of those opportunities. In less than a decade, cleantech has matured into a robust and diverse category with the potential to solve some of the globe’s most pressing problems. Companies are pioneering new technologies in the fields of alternative and renewable energies, recycling, electric cars, clean water, power-grid management, and battery technology. VCs invested $3.7 billion in cleantech companies in 2010, solidifying it as the industry’s third major investment sector.10 As with information technology and biotechnology before that, venture investors again seem to hold a critical piece of our future in their hands—and they are shaping it quickly.

The key to keeping the clean technology industry, or any venture sector, growing lies in keeping the innovation pipeline flowing. Here, government policy can play a vital role. Discoveries in federal labs and universities remain the germination points for the breakthrough ideas around which entrepreneurs and venture investors build new companies; these young startups drive job creation and economic growth. This unique public–private partnership has delivered countless innovations to the U.S. public and a decisive competitive advantage to the U.S. economy for half a century. For these reasons, the U.S. government must maintain its commitment to funding basic research and development—even when economic times suggest cutting back.

Another area of opportunity for rising venture professionals is within the corporate venture capital subsector. Whereas many corporations were inwardly focused during the recession, they are now lifting their eyes to the innovation available outside their own four walls—and they like what they see. We expect to see more corporations creating venture capital arms to keep themselves in the game and their pipeline filled with new technologies. In turn, private venture firms are well served by syndicating with corporate venture capital arms to utilize their vast resources and global reach. In 2010, 14.3 percent of all venture capital deals had corporate venture involvement,11 and we expect this percentage to continue to grow over the next decade.

Amidst these opportunities, today’s venture capitalists must remain focused on fundamentals. As mentioned earlier, venture investing experiences cycles just like any economic endeavor. In any given market, one or two metrics may depart from their norms and generate more exuberance than is warranted; in today’s social media subsector, for example, one could argue that pricing for deals may be misaligned with the overall opportunity in the space. In these instances, VCs must consider the entire picture and engage the patience and the penchant for bucking trends—as opposed to jumping on them—that has marked venture investing over the course of its history. By doing so, they can keep the entire industry on firm footing and help it power U.S. economic growth for the foreseeable future.


While some aspects of the venture capital community have become more institutionalized over the last decade, personal development and investor training continue to follow an apprenticeship model. Our industry is too dynamic to offer a standardized path for rising venture capitalists. In this sense, venture is more of an art than a science—making a program like the Kauffmann Fellowship particularly valuable.

Today’s Kauffman Fellows face a complex journey, one propelled by the endless promise of the 1990s but tempered by the realities of economic and industry conditions. There is increasing global opportunity as well as global competition. Given the knowledge, experience, access, and exposure gained through the 2-year Kauffman Fellowship, I know the Fellows will rise to challenge and guide a new generation of innovative entrepreneurs to success. I predict that the fruits of this partnership will be critical to the continued birth of new technology and the rebuilding of the U.S. economy.

Kate MitchellKate Mitchell

Kate is a co-founder of Scale Venture Partners, a venture capital fund with over $900 million under management located in Silicon Valley, California. She leads investments in enterprise software bringing more than 25 years of experience in technology, finance, and management to her portfolio, and has worked with portfolio companies such as Hubspan, Jaspersoft, mBlox, Wayport, and Tonic Software as they grow to become successful enterprises. Kate is a member of the SVB Financial Group Board of Directors (NASDAQ: SIVB) and was the 2010–2011 Chairman of the National Venture Capital Association (NVCA). Kate holds a BA from Stanford University and an MBA from the Executive Program at Golden Gate University in San Francisco. She also attended the Harvard Executive Program and is a Charter Member of Environmental Entrepreneurs.

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1 ThomsonOne Database, MoneyTree Venture Investment Report (Thomson Reuters, 16 May 2011).

2 Thomson Reuters, National Venture Capital Association Yearbook 2011, 17.

3 Ibid., 20.

4 ThomsonOne Database, Venture Capital Backed Exit Report (Thomson Reuters, 16 May 2011).

5 National Venture Capital Association, Access to Public Capital Markets for Small Companies (22 March 2011), 8.

6 ThomsonOne Database, Venture Capital Backed Exit Report.

7 The Sarbanes–Oxley Act of 2002 was a law that applied increased regulatory compliance and accounting standards to publicly traded companies in the United States.

8 The Global Settlement was an agreement reached between the SEC and the investment banking industry in which investment banking firms could not sell both research and investment banking services to clients.

9 Regulation Fair Disclosure, also called Reg FD, regulates the ways in which publicly traded companies can communicate with investors.

10 PricewaterhouseCoopers and the National Venture Capital Association, Total U.S. Investments by Year Q1 1995–Q1 2011 (16 May 2011), Cleantech tab.

11 National Venture Capital Association (NVCA), “Corporate Venture Capital Group Investment Analysis 1995–2010,” 1.

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