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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

July 22, 2010 at 9:45 AM

Venture capital’s rebound doesn’t mean easy times for investors or building companies

Venture capital is hitting middle age, according to a forum at the Wharton School. The trauma of the dot-com bust is ancient history, but so too are the high-flying days of the 1990s. As a result, finding hits is harder and getting stellar returns more rare.

“Go back to 1990s and venture capital was about starting a company, making it large enough to have an impact on its own and taking it public so it would be Wal-Mart or Procter & Gamble in 20 years,” said David Wessels, a professor at Wharton. “Lately, it’s becoming a surrogate for internal R&D. Start-ups set out to build a product from scratch, prove it has legs with a small market and get swallowed by a larger company.”

This trend is of particular importance to tech and biosciences hotspots such as Seattle. Companies here won $550.8 million in VC in the second quarter, the best quarterly showing since late 2007. But the new dynamic makes it more difficult to build the next Microsoft.

VC funds are much bigger now, operating in turbulent capital markets and often facing such high company valuations that it’s difficult to show a strong return to investors. There’s plenty of money, but it’s often chasing the same limited number of the most promising firms. That competition drives up valuations.

Wessels sees the most promising areas for VC in life sciences and clean technology. Even so, providing the multiples that investors expect from these risky investments is getting more difficult. For example, according to Dow Jones VentureSource, VC-backed firms that went public in the second quarter required a median of 9.4 years to achieve liquidity. Meanwhile, excluding Tesla’s IPO, the 14 initial public offerings of venture-supported companies in the same period actually trailed the value of M&A deals. As the Wharton report stated, it is “hardly the grand slams the sector needs to get its numbers up.”

Today’s Econ Haiku:

Ben’s up on the Hill

Can the stock rally avoid

That Jack and Jill thing

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