This is a common slide floating around the web which is held up as evidence that the end is near for the venture capital industry. As a venture capitalist I should be torked. For many reasons I should be blogging that it is a bunch of c***, for reasons not least of which it came from the garbage site "The Funded" - talk about adverse selection, but don't get me started, it's not the purpose of this message. Additionally, I would say that one data point does not a trend make, however (a big however), there is some truth in the above graph.
What is not said in this chart as well is that the number of VC firms have doubled in the last 20 years; the average fund size is $170 million versus $70million 10 years ago with (and here is the kicker) roughly the same number of deals completed (2,200 in 1997 versus 2,500 in 2007). That means roughly the same number of deals are getting 2x the amount of money. Is it that much more expensive to build a start-up these days? I think not, in fact, good layout a pretty good argument that it is cheaper.
Very simply, the venture capital business is in the business of building businesses. There has been a slow fade in the industry away from this notion. It is hard for a VC to be active if they are compelled to allocate so much cash, so quickly, which is often bad. I have observed this in practice. Too much capital to a start-up so soon can be detrimental as they are forced to scale up an unproven or broken model.
Why would they do this? Often times, the incentives and motivations are not aligned between the super large VC and entrepreneur. Venture capitalists are measured on IRR which is a function of time and return. They would rather plow a bunch of cash in early to see what happens than wait until the model is ready to scale.
I'm not sure what the ideal size venture fund is, but what I can say is I believe that most of the time, smaller funds are better aligned with the incentives of the entrepreneur. For example, the vast, vast majority of software exits are less than $75 million. Smaller funds and entrepreneurs can make money on a $75 million exit and call it a success. This is not the case for many larger funds. Somethings- gotta-give and it shouldn't be returns to LPs.