Is Venture Capital affected by current crisis?

NOT MUCH FOR NOW, is my answer. First it is important to understand the difference between the venture capital and private equity. The private equity model is based on first finding investment opportunities and then raising capital to finance the deal. Therefore, the PE market has been hit by the economic crisis because cheap financing is not available even if a PE firm can spot good investment opportunities. Venture capital does the reverse.

A venture capital firm will first raise enough capital to finance a minimum of 5 deals and then look for investment opportunities. Therefore, even in the current market scenario, a VC has money in his pocket to invest in opportunities. Typically, a venture firm will raise capital every 3 years. Further, the venture firm is obliged to invest this fund over 3 years so that it can see returns on the investment in 7 years (i.e. the longer you take to invest, the longer you will have to wait for the returns). Therefore, it would be incorrect to say that a VC firm is making fewer investments every quarter to extend the life of its fund. 

I agree that new money is not flowing into venture capital because the limited partners are facing a cash crunch. However, there are plenty of funds raised in the bubble of 2006 and 2007 that are looking for investment opportunities. I know for a fact that 5 funds, each north of $400M, dedicated to energy investing were raised so far this year. Looking into the future, I believe that venture capital funding will be hurt if the markets don’t stabilize within a year. For now, I think, any VC using the economic crisis as an excuse is only trying to get better deal terms from an entrepreneur….

Comments

[Ken Kaufman]

I think venture capital is affected in one major way by this credit crisis. It seems like a lot of VCs like to make their investment and then get the business to leverage itself as much as possible to grow.

With lending tightened-up, some of their investments are not going to be able to grow as quickly as they planned.

[Varun Dhanuka]

I agree with your observation, that existing portfolio companies are hurting the VC's. However, I think early-stage investments should be affected much less by the crisis.