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It should be no surprise that the current economic environment has had a dampening effect across all industries, and venture capital is not immune. The capital gap — the difference between supply of and demand for capital, which most define as the availability of early-stage funding up to $3 million — has long been a characteristic of the venture capital market. Most early-stage VC funds manage hundreds of millions in capital and need to put more money to work. This gap has widened considerably over the last three quarters.
Venture capital investors have suppliers — institutions, companies and individuals that provide us capital to invest in high-growth businesses — and we have “customers” to whom we, in a sense, “sell” our capital and value-add in exchange for an ownership stake in their business. Institutional investors --pension funds, university endowments and insurance companies — manage large reserves of cash, most of which are committed to “safe” investments with a smaller, defined portion (typically 5%-20%) allocated to higher-risk, higher-reward “alternative” assets like venture capital, real estate and hedge funds. Since the fourth quarter of 2008, two things have happened to dampen this investor class’ appetite for new commitments:
Push and pull
Concurrent with the decreased supply of capital is an increased demand for capital from growth companies. Companies that have already raised capital from outside investors (or were about to) are finding their needs for capital have ratcheted up. Lower-than-projected sales, for many, translates to greater cash consumption, as most companies’ expense base assumes a given revenue growth. A lower top line translates to higher operating losses — early-stage, VC-backed companies expect and plan to lose money in early years.
Companies that were planning to raise capital are also in a fix. The coupling of demand from both existing venture-funded companies and as-yet-funded companies translates to greater overall demand for capital. Venture capital funds are focusing on their existing portfolio investments and reducing new investments. So, the capital gap gets worse.
Individual investors, also known as angels, have a similar dynamic to both institutional investors and VC funds. Like institutional investors, angels have lost net worth and so have less to invest. Like their VC brethren, individual investors find their now needier portfolio drawing more of their attention, resulting in less capital available for new investments.
So what’s an early-stage growth company in need of capital to do?
Have other ideas? Email them to me and I’ll post them on my blog, clearventurepartners.blogspot.com.
Michael Gurau, managing general partner of Clear Venture Partners in Portland, can be reached at mg@clearvcs.com.
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