Back in Black The VC industry is fattening up again--but what does this mean for your business?

Wondering what happened to that looming shakeout in the VCindustry you were hearing about a few years ago? The VC industryhas weathered the storm and is now entering a new funding cyclewith increasing momentum.

There are currently two prevailing schools of thought on thephantom shakeout. The first and more optimistic view holds thatfears were greatly exaggerated and the state of the VC industry wasnever as bad as was rumored. "I never believed the doomsdayscenarios for the VC industry," says Mark Heesen, president ofthe National Venture Capital Association. "We heard the numberof firms was going to be cut in half. Where we have seen a declineis in the number of VC professionals. Because the fund sizes aresmaller today, VC firms don't need as many partners. As aresult, many partners have gone out and started smaller, regionalfirms, so the number of firms has remained relativelyconstant."

The second point of view holds that the bad investments from the1999-2002 period have yet to work their way through the pipeline.These supposed realists suggest that in another few years, when VCfunds that were started in 1999 or 2000 go out looking for newfunds from their limited partners, they won't find many takersbecause their returns were so low. "When this happens,it's going to squeeze firms out of the industry," contendsRick Frisbie, founder of Wellesley, Massachusetts-based VC firmBattery Ventures. "Today there is too much money relative tothe number of good investment opportunities for VCs."

As with most debates, the truth lies somewhere in the middle.What is clear is that the amount of capital in the VC industry isdown significantly from the bubble era. According to ThomsonVenture Economics and the NVCA, in 2000, the industry raised $106billion. In 2001, that number dropped to $38 billion, and in 2002,it plunged to $3.7 billion. But in 2003, the industry rebounded,raising $10.5 billion. And in 2004, the industry continued itsresurgence, raising $17.6 billion.

These wide swings have forced some fundamental changes in theway VC firms are structured and run. Venture capital has evolvedinto a more mature industry with more procedures to follow."If you're going to scale the venture capital firm,inevitably you have to have process," says Stewart Alsop,venture partner with New Enterprise Associates, a Menlo Park,California, VC firm. "It's not a bad thing because youhave to keep track of what you're doing. Venture capitalinvesting can't just be pure intuition. Process can get in theway of actually making returns, but it doesn't have to."So today, for better or for worse, many VC firms are becoming morebureaucratic.

So what does all this mean for the entrepreneur? Sincethere's a favorable climate right now for fund raising fromlimited partners, the supply of VC capital available toentrepreneurs will also increase. Says Heesen, "Over the pastsix months, we have seen a marked change in attitude from VCs. Alot of that is due to the fact that we have seen and will likelycontinue to see good exits through the acquisitions market or theIPO process. That, of course, is the end of the line for VCs."So in the short run, it means a period of rising expectations, andthat's good news for anybody looking to raise capital. (For alist of the top VCs for entrepreneurs, check out our 5th Annual VC100 in the upcoming July issue of Entrepreneur.)

But in the longer term, it may cause problems for the industryif VCs take in more money than is prudent. "We should havelearned the lesson of 2000, which was, If there is too much moneyin the industry, a lot of it will end up invested in 'metoo' companies instead of important new technologies,"says Heesen. "If we, as an industry, don't staydisciplined, we could find ourselves in a situation where onceagain there is too much capital."