Venture Capital and the Internet Bubble: Facts, Fundamentals and Food for Thought Thomas Hellmann and Manju Puri

An Industry in Crisis?

Or an industry on a much need diet?

Rates of return Overall VC industry 1-year average: -18.2% 3-year average: 54.5% 10-year average: 28.4% Internet: 1-year average: -38.3% 3-year average: 69.7% Telecom: 1-year average: -27.7% 3-year average: 35.7%

What are the fundamentals of venture capital? Alternative Investment Class Real Estate versus Venture Capital? VC = Value-added investors? Stanford Project on Emerging Companies Interdisciplinary project 170 Silicon Valley high tech start-ups Data on whether and when companies get VC No dotcoms!

SPEC: The external product market effect of VC Obtaining VC associated with faster time to market hazard rate increase by factor of 1.79 Larger effect for innovator companies Innovators self-select into VC Time-to-market effects does not driven seem to be driven by selection alone

SPEC: The internal professionalization effect of VC Founder replacement Support or Control With VC: 61% of founders replaced Without VC: 36% of founders replaced VC gives shorter time-to-replacement Friendly or hostile? In 40% founder remains involved Effect same for VC and non-VC replacements VC effect part of a broader pattern of professionalization Executive team building HR policies

A brief history of the structure of VC industry Old days: Tight collusive networks Post 1979 evolution: Differentiated competitors Unique skills and proprietary deal-flow Returns justify “expensive” GP contracts

The Internet rocks the VC industry New opportunities: Big and visible Low barriers to entry Winners materialize faster than losers Steady state: see mix of new winners and older losers Wrong extrapolations create feeding frenzy

The VC industry responds New entrants with little relevant experience Wall Street types Effect on experienced VCs Danger of defying trend Temptation of increasing fund size Change in VC business model: Invest in more companies Place more money => less syndication More later stage Increase in diversity of VC structures Incubators, corporate VCs, bank VCs, angel networks

How can the VC industry recover now? Can VCs live by their own medicine? Defensible value-proposition Value-adding component Competitive differentiation Building a franchise Accountability Inconsistent reporting Governance Legal constraints Reasonable valuations Revisiting GP terms Implications for public policy! Focus on enabling public goods