Kauffman Foundation’s research also tracked the performance of VC investments over time from the early 1990s to 2008 at the start of the global financial crisis. According to this analysis the VC industry in the United States was the architect of its own destruction. Investments in many traditional VC areas were becoming less capital intensive, while exit strategies via IPO or trade sales were more problematic. As such markets were less willing to take on immature and unprofitable companies. As shown in the following diagram, the level of committed capital rose dramatically in the late 1990s only to reach a point of saturation resulting in a rapid decline in VC performance.
Despite this maturing of the investment markets into which VC funding can be placed, the fund managers who control such investment pools have continued to invest in deals in order to maintain their business models. Some of this investment has been into clean technologies and biotech, but as shown in the diagram below, the investment returns have continued to be poor.
According to the Kauffman Foundation the best option for addressing this problem is to “right-size” the VC industry, reducing the size of the venture funding going into the US economy. Its size within the overall context of the US economy grew abnormally during the 1990s and early 2000s, but has now become a largely unattractive asset class.
For Australia the plunge into VC investment paralleled that of the USA albeit on a much smaller scale. In 2007, there were 186 VC funds managers and 280 investment funds operating in Australia with around $15.2 billion. A study by the Australian Bureau of Statistics (ABS) into the Australian VC industry in 2008-2009 just prior to the GFC identified around $17.6 billion in committed funds with 56% of this money coming from the superannuation funds. These were part of the Federal Government’s Innovation Investment Fund (IIF) and Innovation Investment Follow-on Fund (IIFF) rounds.
In 2012 the Australian Private Equity and Venture Capital Association Ltd reported that there is over $26 billion worth of VC and private equity (PE) investments in Australia. However, like their US counterparts, the Australian VC industry has suffered equally hard times in recent years. Since 2007 investment performance has been poor and fund raising has become more difficult.
The GFC has had a significant impact on the availability of money for VC investments, and the superannuation funds are increasingly reluctant to take risks with their money. In recent years, Australian VC funds managers were more likely to be reinvesting in their existing portfolio of businesses than looking for new ventures to invest into. For example, around 65% of the VC fund investments made in Australia in 2010 were follow-on funding.
Australia’s VC success stories were businesses such as Cochlear, SEEK, Resmed and Look Smart. However, in a similar pattern to the USA, the Australian VC industry has found it increasingly difficult to identify new frontiers for growth. Most VC funding continues to go into ICT and biotech, although clean technologies have started to attract attention.
If the Kauffman Foundation is correct the VC industry is likely to shrink over coming years and return to what it always was, namely a valuable but very niche form of investment. They recommend a cleaning up of the VC industry in the US, with the aim of essentially avoiding inefficient VC funds managers who have drawn too many excessive fees from their portfolios for little genuine return on these investments. As an investor Kauffman recommends moving away from VC funds towards the open stock market.
In Australia the key concern is how to find the money for VC funding. Superannuation funds and governments are increasingly unwilling to put up the capital. There is also competition for available funding from other sectors of the economy such as infrastructure. A shake out and downsizing of the Australian VC sector is highly likely in the current environment. Dragon’s Den may look exciting but it is far from the reality of entrepreneurship and VC investing.
Tim Mazzarol is a Winthrop Professor in Entrepreneurship, Innovation, Marketing and Strategy at the University of Western Australia and an affiliate Professor with the Burgundy School of Business, Groupe ESC Dijon, Bourgogne, France.This article first appeared on The Conversation.
Andrew Sadauskas is a former journalist at SmartCompany and a former editor of TechCompany.
