Predicting Venture Capital (Blog Post)
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Abstract
Short and corny blog post on what to read into on venture capital.
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From Snapchat to DoorDash, and Uber to Lyft, 2016 has already been a bustling year for venture capital as we reach the start of Q3(1). With a total of $33.3 billion raised over 190 deals, 2016 looks to continue breaking records. According to statics from Pitchbook News and Analysis, Q2 2016 raised more in VC funding than any quarter over the past three years.
Laid to rest, now it seems, are the rumors from last quarter(3) that venture capital was entering a "pullback" in which a "continued slowdown for investment and deals into venture capital" was causing macroeconomic concern. The worry surrounding the lack of "unicorns," firms which are valued at over $1 billion, in Q1 2016 seems to have been abated as well. The "trend of well-known firms securing $1 billion-plus in new funds" rose in Q2 of 2016(2).
This dramatic, less than three month, reversal of trends and news demonstrates an excellent point: the incredible volatility of venture capital. This is a trend long-recognized by academics and professional researchers into the field, outlined as early as 1999 from the National Bureau of Economic Research(4). This volatility of raising funds for high-risk investments is further compounded by the volatility of the IPO and acquisition process.
What trends then, can one even attempt to discuss among such a speculative and ever changing industry? One aspect of venture capital which has always held true beyond its volatility is its value. While oft debated exactly how valuable any one investment fund may be, extensive research has shown that venture capital is threefold valuable(5). Value is extracted financially, for both the startup in the immediate, and the investors in the long run, and economically, with major economic growth being driven by the rise of successful VC-backed enterprises(6).
Value is also extracted in terms of human capital and guidance, with new businesses or businesses about to take steps in innovation receiving disproportionate benefits from VC(5). This is a component of venture capitalists lending their expertise and knowledge in addition to their funds to nascent businesses.
Individual investment values have been shown to be surprisingly positive, with research from the NBER(7) showing that only one in ten investments not returning any money. One in four investments on the other hand, were shown to have a rate of return above 50%. While these statistics may be positively biased, other estimates point to 2/10 investments making substantial amounts, and only a small amount of investments not at least breaking even.
The take away from this summary, starting in popular news and "instant analysis" and ending with academia and "professional analysis" is that venture capital, like many other aspects of our world, is difficult to predict in the moment. It is a powerful and volatile industry, with enormous economic potential and high risk. It is an industry that, like we saw in 2016, may seem to be on its death bed one quarter, and breaking records the next. For the policymaker and student of entrepreneurship, heed these words; about the only things you can predict with venture capital are that she's a strong and ever changing mistress, and she's here to stay.
References
(1)http://venturebeat.com/2016/04/13/vcs-raised-billions-in-q1-even-as-they-made-fewest-investments-in-3-years/ (2)http://pitchbook.com/news/articles/why-last-years-valuation-bubble-led-to-more-record-vc-fundraising-in-2q (3)https://home.kpmg.com/xx/en/home/media/press-releases/2016/04/venture-capital-pullback-deepens-in-q1-2016.html (4)http://www.nber.org/papers/w6906.pdf (5)http://www.sciencedirect.com/science/article/pii/S0883902696000523 (6)http://www.legis.state.tx.us/tlodocs/84R/handouts/C2702016041213001/be8b25df-8858-4430-b508-ec4109449d38.PDF outlined (7)http://papers.ssrn.com/sol3/papers.cfm?abstract_id=136388
