The financial crisis and venture capital

A couple of days ago, I was chatting with an ex-entrepreneur who now acts as a consultant to technology start-ups.

We were talking about the current financial crisis and its implications on venture capital. His opinion was that VCs now need to recalibrate their return assumptions. Whereas VCs would typically have sought returns of many times their investment in the past, now they should look at relatively measly cash multiples of 2-3x.

That could be one possibility.

My perspective is that the ultimate providers of capital, LPs such as pension funds and endowments, would not be willing to accept lower returns from venture capital for the same (or higher) risk. Instead, they would apply correspondingly smaller proportions of their investment capital to this asset class, i.e., it is purely an asset allocation story. This will mean that fewer VCs will raise funds, the supply of funding will dry up and --in theory-- the multi-bagger exits will still occur.

Interestingly, that same evening, I read this on FT Techblog:

The massive over-capitalisation of the VC industry during the dotcom boomhas never been fully unwound... The sickness in question is spreading instead from the limited partners - in particular the big university endowment funds, which over-invested in all classes of private equity in the boom years. As other parts of their portfolios fall in value, they are being forced to cut back on private equity - including VC - to maintain asset allocation ratios. The money flow is being turned off.

Now the trick is to be among those few who continue to manage multi-baggers...