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More Bad News for the Venture Capital Set and Those that Want Funding

A couple of weeks ago, I mentioned how private equity did relatively poorly raising money in 2009. There's a reason for that. Not only has the economy been bad and free cash tighter than usual, but returns have slipped off the edge of a cliff, according to Cambridge Associates and the National Venture Capital Association.
The 10-year return fell to 8.4 percent from 14.3 percent in the previous quarter â€" and from 40.2 percent one year earlier. The decline was not unexpected as the lucrative 1999 exits are no longer included in the 10-year calculation. The 5-year returns also declined to 4.9 percent from 5.7 percent in the previous quarter and from10.7 percent one year ago.
For those who want to point the finger to the recent economic perturbations, hold off, because the NVCA says that all of this is the continued fall-out from the dot com bubble pop in 2001.
"It has taken a full decade after the technology bubble burst for the venture industry to fully realize the impact of that era and its aftermath," said Mark Heesen, president of the NVCA. "The significant returns created by the robust exit markets of the late1990s have carried the industry for a long period of time. The new reality is much more somber for many venture firms. There are still healthy returns to be made in venture capital, but until the venture community sees a more vibrant exit market we do not expect marked improvement overall."
I think this translates roughly into the idea that the out-sized economic hysteria ultimately concentrated in the companies that did make it, fermenting to such an extent that the returns masked the continued underlying weakness of the sector. Those who rode on the likes of Google (GOOG) and Amazon (AMZN) now face a market in which IPOs are hard to come by and many companies are wallflowers for the Acquisition Tango. Here's an interesting chart from Cambridge Associates, showing the relationship to the money that limited partners put into venture funds and the value of the investments:

The heyday was really in the mid-1990s, which makes sense, because by the time a bubble pops, the ugly truth is showing its head. For tech entrepreneurs to escape the cycle, they will have to break themselves of a dysfunctional culture that can often act as though it's still the mid- to late-1990s. Companies that want funding will have to show real potential value to investors, and that means showing real value to customers, with a strong sense of how everyone is going to make money. I think the Twitters of the world will become anomalies, because investors are showing by the reduced money flow that they are no longer satisfied.

Image via stock.xchng user nkzs, site standard license.