The economist Herbert Stein famously said, “trends that
can’t continue, won’t.”  That admonition
is often ignored, however, in the sunny and magical precincts of Silicon
Valley.  After all, it can be hard to
believe that trees do not grow to infinity when our redwoods fight a daily
skirmish against the clouds for dominance of the skies.

Yet the inexorable pull of gravity never fails to exert
itself and, perhaps, one such falling-to-earth moment seems to be at hand.  For several years now, fundraising by venture
capital firms has lagged the amount of capital that has been invested into
start-up companies.  Summarizing data
from the National Venture Capital Association’s fundraising surveys and Price
Waterhouse Coopers’ Money Tree Report, the chart below shows that for the last
several years, capital deployment has far outpaced funds raised by venture
capital firms.

To be sure, fundraising and deployment do not represent an
entirely closed system, as angels, corporate funds, strategic investors, governments,
investment banks, and other entities often augment the money invested in start-up
companies by pure venture capitalists. 
Yet, a longer view, visualized in the following chart, supports the
notion that VC fundraising and capital deployment typically exist in a rough
equilibrium.

In fact, since 1995, in fact, the amount of capital raised
by start-ups has exceeded the amount raised by venture firms by only 13.9%.  By contrast, since the beginning of 2009,
companies have raised fully 50% more dollars than the venture capital funds
that are their primary backers.  Of
course, some of this over-deployment can be accounted for by the whittling away
of a modest surplus built up during the 2005-2007 timeframe, but ultimately the
industry cannot live beyond its means for very long, as the appetite of outside
(non VC-fund) funding sources to fund innovation can be fickle.  And unlike the Federal Government, which can
print money to satisfy a proclivity for spending more than it earns, the VC
industry is limited in its investing by its fundraising.

Indeed, the Lehman-induced financial crash of 2008 was a
watershed event, as fundraising became considerably more difficult for venture
firms; new fund formation has slowed to a trickle and many established funds
are worried about whether they will be able to ever raise a new fund.  This slowness in VC fundraising is putting a
damper on the otherwise buoyant mood here in Silicon Valley.  The double-whammy of a challenging overall
fundraising market coupled with the concentration of capital in fewer hands has
conspired to make many firms particularly thrifty as their fundraising efforts
languish and they worry about their next investment being their last.  Some estimate that the number of “active”
firms is below 100 today, a small fraction of the typical number of firms
making investments.  Additionally, this
year is also an important one in that those funds that were last able to raise
during the relatively flush times of 2007 and 2008 will find themselves at the
end of the five year investment periods during which they might make new
investments.  We expect a dislocation
over the next 12 to 18 months as the investing window for funds closes and
their management fees start to step down. 
As one General Partner recently asserted, “it feels like the Zombie
Apocalypse has started and I’ve only got two bullets left in my gun . . .”

Of course, an optimist might take comfort from the old claim
that, “value-added investing works best when capital is expensive and time is
cheap while bubbles are marked by cheap capital and expensive time.”  And, indeed, faced with a robust opportunity
set and scarce (and thus dear) capital, VCs seem to be working as hard as we’ve
seen them in recent memory.  There’s a
palpable anxiety in the air, though, that contrasts with the casual insouciance
that people typically ascribe to Silicon Valley.  The perennial gales of creative destruction
continue to blow here, but in addition to the typical Eucalyptus and Jasmine aromas
carried on those breezes, one can also smell a hint of fear, a scent not as
frequently perceived here.