Venture Capital boom and bust

We've looked at limitations of the venture capital industry before. Here's another interesting take by a Harvard Business School Professor in the MIT Technology Review.

The industry, he says tends to chase the latest fashionable area, which is often concentrated very narrowly.

I believe several essential constraints limit venture capitalists’ ability to promote true innovation. The first is that venture investors have financed a progressively narrower range of technologies. Recently, a few hot areas—most notably Web and social media—have dominated an increasingly large share of the venture landscape.

The industry is now overexposed to troubled companies like Groupon and Facebook.

A second critical limitation is that the venture market is extraordinarily uneven, moving from feast to famine and back again. Consider the tremendous surge in funding for biofuels, peaking in 2006, and again in social-media companies during the last two years. During booms, unjustified exuberance rules.

 

In other words, the industry behaves more like "dumb money" retail investors, driven by investment inflows in booms - supply - rather than opportunities. And it has been more successful in areas where development cycles are short, a year or three, than funding longer-term opportunities.

So when do booms turn to busts? Venture capitalists depend critically on acquisitions and the public stock markets to help them exit their investments and return capital to their investors. But the public markets are fickle. During the past decade, soaring enthusiasm—for clean tech in 2006–07 and social media in 2010-12—each time abruptly subsided, leaving the portfolios of venture capitalists, and stock investors, in shambles.

Ironically, busts may promote innovation precisely because they frustrate venture capitalists’ efforts to exit their investments.

That is because public companies, or those seeking a near-term IPO, are much more likely to slash R&D to satisfy Wall Street's shorter -term priorities.

Society depends on innovation, but venture capital is much less successful at delivering it than we had hoped.