It Ain’t Broke: The Past, Present, and Future of Venture Capital

By Sadaf Aliuddin. 2010

148 citations recorded by the source corpus.

he U.S. venture capital (VC) industry is currently subject to a great deal of uncertainty and controversy. Some observers and practitioners believe that the VC model is broken and that the U.S. VC industry needs to shrink.1 In this paper, we put the U.S. VC industry into its historical context, assess the current state of the VC market, and discuss the implications of that history and the current conditions for the future. We begin by describing the fundamental problem that entrepreneurs face and VCs need to solve in order to invest successfully. There is a great deal of evidence to support what is now a highly developed theory of how the U.S. VC model provides an efficient solution to this basic problem of entrepreneurial finance. And there is little doubt that the U.S. venture capital industry has been very successful. A large fraction of IPOs, including many that are now among the most successful public companies in the world, have been funded by VCs. And, where possible, the U.S. VC model has been copied around the world. Next we look at the historical patterns of commitments to U.S. VC funds and investments in companies by those funds. U.S. VC investments in companies have represented a remarkably constant 0.15% of the total value of the stock market over the past three decades—the period for which we have reliable data. Commitments to VC funds, while more variable, have been consistently in the 0.10% to 0.20% range. These percentages have not changed in recent years. Third, we consider the historical record on VC fund returns, paying particular attention to returns of post-2000 “vintages.” Contrary to the popular impression, we do not find that returns to VC funds this decade have been unusually low (or high) relative to the overall stock market. This is true despite the relatively low number of IPOs. Overall, VC investment and returns have been subject to boom-and-bust cycles over time. Based on our historical analyses, we make some observations about the current situation and consider what is likely to happen going forward. The level of commitments to and the investment pace of VC funds since 2002 have been consistent with the long-term historic averages. At the same time, the returns relative to the overall stock market appear to have been roughly average. This does not suggest to us that there is too much money in U.S. VC, or that the VC model is broken. Instead it appears to reflect the natural evolution of a relatively competitive market. In fact, given the unusual and unexplained paucity of IPOs between 2004 and 2007, we argue there is more upside than downside for the VC vintages of 2001 to 2007. The costs for public companies associated with Sarbanes-Oxley are now smaller and more manageable than they were in 2005 and 2006. There are more boutique investment banks with incentives to market IPOs. And according to anecdotal reports, there has recently been growth in the pipeline of IPO candidates. We also note that commitments to U.S. VC partnerships were historically low in 2009, a trend that is likely to continue into 2010 and, possibly beyond. Based on the historical relationship between commitments and performance, the low level of commitments suggests that returns to the 2009 and 2010 vintage years are likely to be strong. Finally, we consider some of the longer-term drivers of venture capital financing. Corporate funding of innovation has increasingly moved from large, centralized research facilities to various “open innovation” models, including acquisitions and strategic alliances with smaller firms. This increased willingness to reach outside the organization, which reflects the difficulties of managing early-stage innovation within a large corporation, appears likely to create more opportunities for venture investors in the years to come.

Subfields: Accounting

View Paper: https://www.semanticscholar.org/paper/5a39d6af3a27adda4b890886fc0b7a4894275577

How researchers see this paper

The researchers whose trusted networks rank it highest, strongest advocate first. Every researcher gets a different order.

In Accounting

Citations in the corpus

What Do Small Businesses Do? (2011, unknown): “See, for example, recent work by Kaplan and Lerner (2009), Puri and Zarutskie (2010), and Hall and Woodward (2010).”
Venture Capital and Other Private Equity: A Survey (2011, unknown): “3 For survey papers focusing on venture capital, see, for example, (Fenn and Liang 1998), (Gompers and Lerner 2001), and (Denis 2004), and more recently, (Kaplan and Lerner 2010) and (Krishnan and Masulis forthcoming); for survey papers focusing on buyouts, see, among others, (Cumming et al.”
How do venture capitalists make decisions? (2020, background): “Kaplan and Strömberg (2004) describe and analyze how VCs select investments.”
Giants at the Gate: Investment Returns and Diseconomies of Scale in Private Equity (2015, unknown): “Kaplan and Schoar (2005), Ljungqvist, Richardson, and Wolfenzon (2007), Robinson and Sensoy (2013), and Harris, Jenkinson, and Kaplan (2014) have found a mostly nonsignificant relationship between total fund size and returns. Robinson and Sensoy (2011) document a positive association between fund si”
Venture Capital Data: Opportunities and Challenges (2016, background): “Kaplan and Lerner (2009) find that roughly 50% of the “entrepreneurial” IPOs in recent years are venture-backed despite the fact that only 0.”