From the January 2001 issue of Entrepreneur

If you believe the warning knells of those bearish on the venture capital market, that loud sucking noise you've been hearing is the sound of a deep pool of large institutional investor cash being drained dry.

An exaggeration, perhaps, but not entirely off the mark. While second quarter 2000 saw continuing record levels of VC investment, third-quarter numbers showed signs of leveling off, with VCs complaining that institutional investors have grown stingier. A survey from the National Venture Capital Association (NVCA) reports some VCs saying they've been investing in early-stage companies less aggressively since last April's sell-off that ravaged the tech sector.

The result? "Returns on the VC side, previously stratospheric, may settle down to realistic," says Miles Spencer, president of Norwalk, Connecticut-based media company MoneyHunt Properties. It's a dose of realism giving institutional investors used to 100 percent-plus returns pause for thought. With dozens of vanity firms, incubators, accelerators and virtual angels angling for cash, investors can afford to be selective-which could lead to a considerable shakeout.

But Darwinian natural selection among VC firms doesn't necessarily mean fewer institutional dollars. NVCA president Mark Heesen says some institutions have invested so much, they've reached their legally permissible limits. "But as they get money back from the venture funds, I'd be surprised if they didn't return it to the venture process," says Heesen. Meanwhile, as pension funds max out, corporations and individuals are picking up the slack. Heesen cites figures that say professional capital firms raised $30 billion in the first half of 2000, compared with $51 billion for all of 1999 and $27 billion in 1998 as proof that appetite remains strong.

Still, as more established funds raise record levels of cash, smaller funds are getting pinched, says Heesen, which could mean more time on the road for entrepreneurs pitching to investors. "But while it will take longer," he says, "most funds will reach their goals."

For now, anyway. A marked decline in VC investing would cut back on financing options. "And, as we say, one bidder makes a short auction," says Spencer. Valuations will have to come down. "Things will be more competitive," he says. "A return to realism, one might say."


C.J. Prince is a New York City writer who specializes in business topics and the executive editor of Chief Executive magazine.


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