Driving Force: The Venture Capital Crisis

18 September, 2010

What follows is a proposal for a research paper for The Future of the Infrastructure, Art Kleiner's scenario planning class I'm in this semester. The assignment is to report on a driving force that will affect the professional and personal opportunities of the students in the class between now and 2022. In the next few weeks, I'll be doing research, collecting data, and talking to people in the VC industry. If you have any input on this topic or any ideas for sources I should be sure to contact, let me know in the comments.

Venture capital firms have played a critical role in the development of technology since the 1960s, enabling the rapid development and dissemination of innovations from the personal computer to the internet. A radical change in the economics of these firms would have a dramatic effect on the direction, speed, and effectiveness of technological development and commercialization.

During the internet boom of the 1990s, the amount of money invested in venture capital firms increased by an order of magnitude (from around $3 billion to around $30 billion). With the crash of 2000, this period of expansion came to an end.

Simultaneously, the ever-decreasing price of hardware and the advent of "cloud computing" services caused the cost of starting a web-based business to drop dramatically, resulting in less demand for venture capital amongst web startups. To make matters worse, the Sarbanes-Oxley Act of 2002 created large obstacles to the issuing of Initial Public Offerings, the main vehicle for VC-backed startups to earn large returns for their investors.

Most venture capital funds have a lifespan of around 10 years after which they are expected to return their investors' money with a large increase in value. The 10 year deadline for the funds created at the peak of the internet bubble is rapidly approaching at a time when those funds have fewer and fewer high yield investment options available to them on the web and when other technologies (like biotech) have yet to reach commercial maturity.

The result of this history will be a dramatic change in the funds' behavior in the coming years in a manner that could affect technological development in a number of possible different ways: 1) injecting a large amount of capital rapidly into emerging technologies (i.e. biotech) could cause a flood of innovation to reach market readiness and impact our lives; (2) increasing panic could cause the venture capital firms to make ever worse and more irrational decisions causing most of their invested capital to be wasted; (3) the loss of venture capital as a viable option could reduce the ambition of american technology companies in comparison to their overseas competitors, speeding up the movement of high tech dominance away from the US.