Why VC Will Get Uglier.

Much of the $200 billion that was raised between 1999 and 2001 has yet to be invested.

Waltham, Massachusetts The wreckage is still all around us: dotcom detritus, depressed stock prices, ruined companies, destroyed careers. There was a bubble. There was a bust. Now we're in the aftermath. But who can do the math?
Ted Dintersmith is a partner at Charles River Ventures. In a PowerPoint presentation that's been creating buzz in venture-capital and technology circles, Dintersmith traces the rise, the fall, and -- here's the disturbing part -- the even-deeper fall ahead in the world of VC.
The tale of the VC industry begins in the 1970s, says Dintersmith, with a tiny group of companies: four firms in California and one in Massachusetts, managing less than $20 million each, and funding a total of about 100 companies a year. The IPO market was minuscule: In both 1970 and 1976, just 19 companies went public. Nineteen seventy-two was a boom year, with 75.
On to the 1980s. The industry was still small: only about 100 firms, 1,000 professionals, and an average fund size of $35 million. And then, in the mid-1980s, the VC idea caught fire. By 1983, $4.2 billion had been invested in various funds, and the number of venture-backed companies had spiked from an average of 100 to 500 per year. The IPO market was booming, peaking in 1986 at 377. Then came the crash of 1987. "We learned some lessons that we thought we'd never forget," says Dintersmith. "Among them: You can't absorb huge amounts of money and invest it all wisely. It can result in overfunded sectors, and when that happens, everybody loses."
At the start of the 1990s, things were getting serious. The industry had grown to about 400 firms, employing about 4,000 people, funding about 300 companies a year. What happened next defines the heart of the mismatch between venture and capital. "People became convinced that this was the key to retirement," Dintersmith says. "How did Forrest Gump make his money? He bought Apple."
The tech companies of the 1980s, which were all about servers, routers, and processors, had been too obscure for most people to grasp. But pet food online! That was an idea that anybody could understand. "Everybody knew about eBay and Amazon.com and AOL," says Dintersmith. "People were saying, I don't really fathom Cisco or Oracle, but boy, I understand Yahoo! So pile it on! The Internet changes everything!"
Money rushed into the market. By 2000, flush with $105 billion, some 700 VC firms were funding, on average, 10 new companies a day -- not the customary 300 or 400 a year.
Then the bottom fell out -- and the story got ugly. Internet firms went belly-up, and the dotcom business model blew up. And here's Dintersmith's all-too-serious punch line: Much of the $200 billion that was raised between 1999 and 2001 has yet to be invested. "The capital overhang is huge," Dintersmith says. "We're only 20% through the number of early-stage companies that will fail. The exit climate is horrible. Returns will be dismal. A lot of people in my business say that most of the bad news is behind us. The math says it isn't."
Here's the math: At the start of 2002, there were about 10,500 active-stage companies. During the next six years, Dintersmith expects between 500 and 1,000 from that group to go public or be acquired. At that rate, he says, returns on venture funds are likely to be about 25 cents on the dollar.
What is Dintersmith's take-away? First, limited partners still don't understand that the VC business isn't scalable. Second, he says, "There are a lot of worldwide opportunities and still a lot of unsolved problems. The model between entrepreneurs and venture firms really does work, and we've gotten better and better at using it. But it's a cyclical business."