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Venture Capital Is In a Recovery, Not a Bubble Just because venture investment is up doesn't mean we are awash in froth.

By Scott Shane

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Venture capitalists increased their funding of startups to $9.5 billion in the first quarter of 2014, the MoneyTree report revealed recently. The press thinks we've got a bubble forming.

I don't get their interpretation. The numbers show that the tech startup funding scene looks nothing like it did in 2000.

When the MoneyTree report – a joint venture of PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters – revealed the most recent venture-capital investment numbers, the Boston Globe wrote, "The venture capital industry is pumping money into new companies at a rate not seen since the dot-com heyday at the turn of the century." The Los Angeles Times said that "venture capital funding" had reached "levels not seen since the days of the dot-com bubble." And the Chicago Tribune was left wondering "whether things in Silicon Valley are a bit too frothy."

Sure the first-quarter investment numbers are up from where they were a couple of years ago, but they are a far cry from what they looked like in 2000, when we had a true venture-capital bubble. Measured in inflation-adjusted terms, the $9.5 billion invested in the first quarter of this year was only 6.1 percent more than what was put into young companies in the first quarter of 2008. More importantly, it was less than one quarter of the $39 billion (in 2014 dollars) that VCs poured into startups in the first three months of 2000.

If we look at the number of deals rather than the amount of money invested, the story is similar. Venture capitalists did only 35 more deals in the first quarter of this year than they did in the first quarter of 2013. That's 10.4 percent fewer than what they did in the first quarter of 2008. Moreover, the number of deals done in the first three months this year was only 44 percent of what occurred in the first three months of 2000.

Average deal size did jump in the past year – to $10 million in the first quarter from $6.6 million in the first three months of last year. But the current deal size is nothing when compared with the $18 million (in 2014 dollars) average deal in 2000.

The supposed frothiness in the market results from the ease that venture capitalists have in taking companies public these days. PricewaterhouseCoopers, Thomson Reuters and the National Venture Capital Association collectively report that 36 venture-backed companies went public in the first three months of the year, raising $3.3 billion. That's not a lot compared with the first quarter of 2000, when 70 venture-backed companies had initial public offerings, raising $10.4 billion in today's dollars.

The tech-heavy Nasdaq, where venture-backed companies tend to go public, remains below where it was in 2000. On March 10, 2000, the Nasdaq Composite index closed at 5,048.62. On March 10, 2014, it closed at 4,334.45.

Venture capital funds are making nowhere near the returns they garnered in 1999. Cambridge Associates, which reports earnings for the venture-capital industry, indicates that the "end-to-end net returns" earned by "venture-fund limited partners" for the third quarter of 1999 was 29 percent. In the third quarter of 2013, the latest period currently available, the return was 6.5 percent.

There's a state between the doldrums and a bubble. It's called a recovery, and it's healthy. Before we worry that the venture capital market has gotten too hot again, let's be glad it's no longer stone cold.

Scott Shane

Professor at Case Western Reserve University

Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).

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