Information on legal and business topics from Canadian business lawyer Shane McLean

NYT Article on the State of Venture Capital

Posted by Shane McLean on July 26, 2009

Someone recently pointed me to an interesting article  from the New York Times (see it here) about the state of the Venture Capital industry in the US.  I bring it up here on the Canadian Business Law Blog because the Canadian and US VC industries are naturally linked and trends in the US market are often mirrored in Canada.

The general concept put forward by the article is that too many VC funds are too large (in terms of the funds they have to invest) and as a result they push too much money into startup companies which is ultimately bad for those startups.   The article states that this will lead to a retraction in the number of VC funds (that’s old news and has already been happening) and a reduction in both the overall size of the remaining funds and the size of the individual investments they make in each company (given that there is currently very little investment happening at all, the concept of this reduction in the size of investments is a bit scary).

I agree with much of the article, but this is the first time since the dot-com crash that I have heard the suggestion that the VCs were pushing too much money into the companies they fund (“force feeding” is a concept mentioned in the article).  Maybe it’s a phenomenon peculiar to the American VC industry because I certainly haven’t seen that in Canada anytime recently.  More often, startup management underestimates the funding they need and the VCs underfund against the flawed plan.  This, in turn, means that valuations based on the flawed business plan are often overinflated and leads to additional rounds of dilutive funding based on successively overinflated valuations that cram down the early funders, including the founders, and remove much or all of the equity based incentive for  founders and employees.  As an aside, some might question why  professional investors are not better able to spot flawed assumptions in a business plan put together by the techie founders who are usually not accountants or MBAs, but I digress.

Either way, the article is an interesting read.  Check it out.


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