The Venture Capital Squeeze?

Paul Graham suggests in his essay on venture capital that the industry is in a dire state of affairs. There is little doubt that software has been the growth engine of the VC industry over the past 10 years and it has centered on Silicon Valley. However, most VCs have figured out that there’s a world of opportunity out there outside of the valley- and they’re off to find it (Skype immediately comes to mind). They have also discovered that other sectors are equally, if not more attractive, than software.

As a contrast, I’d like to review the problems listed in the article and see how that compares to the early-stage market in London:

1. “Too much money chasing too few deals.”

No, not a problem here. There is too little money available for early stage companies. Most Private Equity professionals have never worked in a start-up. They have real issues with the risk involved- so the goverment is providing the cash to kick-start things. The UK government is the largest venture capitalist in the UK- it has set aside hundreds of millions to encourage early stage investing because UK Private Equity houses want to focus on Buy-ins, Buy-outs, MBOs, BIMBOs, etc.

2. “Those few deals now want less and less money, because it’s getting so cheap to start a startup”

No, not really the case here either. Most of the companies I’m seeing are University spinouts heavily steeped in scientific innovation. They require significant funds to reach market – their IP protection alone is in the hundreds of thousands and will only increase. These are cash-hungry early stage companies.

3. “Because starting a startup is so cheap, venture capitalists now often want to give startups more money than the startups want to take.”

We still have a problem with over-funding startups here.

4. “Sarbanes-Oxley.”

Doesn’t apply to AIM, OFEX or the FTSE.

5. “The acquirers have begun to realize they can buy wholesale.”

We’re definitely seeing this accross a range of sectors. However, becuase their is a higher risk-aversion profile in the UK, early-stage VC money is still required to develop the companies enough to warrant interest from the acquirer.

Over and above these points, there are tax-incentives to angel investors and tax-free capital gains on options granted to management.

I’d be interested in knowing what’s happing in other parts of the world as well.

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