It’s been five years since Deloitte and the NVCA launched the first Global Venture Capital Survey to measure the forward-looking focus of venture capitalists around the globe. And there are stark differences between 2005 and today.
Yes, VCs are much more attuned to the global economy and we’re seeing the maturation of some sectors—specifically semiconductors and telecom—while newer ones—clean technologies and life sciences—are emerging as exciting investment opportunities. But the overriding new reality in the worldwide venture capital ecosystem is, of course, the global economic downturn. VCs are adapting to these new challenges with targeted strategic choices in investment focus and are quickly acclimatizing to changes in the global environment.
From February through March of this year, we surveyed the attitudes of the global population of VCs, with 725 venture capitalists in the Americas, Europe and the United Kingdom, Asia Pacific and Israel responding to our survey. We wanted to know how the recession was affecting their investment strategies, how their investment levels would change over the next few years based on sector and region, the size of their next funds, the number of limited partners they expected to have outside of their home country and who those investors might be. We wanted to know which countries they thought had the most to gain and lose overall economically. And, we wanted to know what they felt the role of government should be to foster innovation and improve conditions for venture capitalists.
The results were revealing. Certainly, VCs are feeling the impact of the global recession, but they are coping and making adjustments. We concluded that, as usual, instead of waiting around for good news to just happen, they are making change happen, not just in the United States, but also around the world. VCs across the globe are moving forward.
For VCs, the recession presents an opportunity to fund promising young companies at attractive valuations. But are they investing? We found a significant slowdown in investment activity across all firms, with the larger firms setting the pace. More than half of these large firms—$500 million and greater—are decreasing their level of investment both in terms of capital and the number of companies they intend to fund.
Most VCs are not, however, changing strategy in terms of the sectors they’re investing in. Four out of five surveyed remain focused on the same industries regardless of region. But, more than one-third are shifting to later stage deals, presumably to support existing portfolio companies that are unable to go public or get acquired due to the troubled exit markets.
Another area that proved revealing were the sectors in which investment levels are anticipated to change. The hot spot by far, and led by the largest firms and all regions, is clean technology. While five years ago, we saw cleantech as a top area for future investing, today almost two-thirds of respondents believe their investments in this sector will increase while another 32% plan on investment levels remaining the same.
Half of all respondents in our survey anticipate that their investment levels will increase in Asia (excluding India) and 43% anticipate an increase in investing in India.”
However, when we asked VCs how the current economic crisis will affect the various types of limited partners’ willingness to invest over the next three years, a disconnect appears. While VCs plan to increase the size of their funds and level of investing, they nevertheless see the interest from their investors—commercial banks, investment banks, corporate operating funds and insurance companies—to be declining. Eighty-eight percent of venture capitalists surveyed expect commercial banks to decrease their venture allocations, while 87% anticipate lower VC allocations from investment banks, 65% expect a reduction from insurance companies and 59% anticipate fewer dollars coming from endowments.
Intriguingly, 54% of VCs believe that governments will have an increased willingness to invest in venture capital. Less than 10% are looking at commercial and investment banks. Among U.S. respondents, 41% expect a greater involvement by governments and 22% by corporate venture capital, followed by funds of funds (21%).
Winners and Losers
Given the responses to earlier questions about where VCs plan to increase their investments, it came as no surprise that when VCs were asked directly which country has the most to gain from overall economic stature over the next three years, China was the first or second most cited country. Even U.S. respondents chose China (42%) over the United States (24%).
Among respondents in the Americas (excluding the U.S.), Brazil (35%) was the clear favorite, with China second (at 18%). Israeli respondents believe the United States is the country with the most to gain in economic stature (36%), but again China ranked second (at 29%). Fifty-five percent of Asia Pacific respondents selected China as having the most to gain, with India following at 20% and the United States at only 5 percent.
European respondents (excluding the United Kingdom) see China as havening the most to gain (27%), followed by India and the United States (both at 16%). China also was perceived as having the most to gain by U.K. respondents (35%), followed by India (24%) and the United States (9%).
On the opposite end of the spectrum, the U.S. consistently was viewed as having the most to lose in economic stature—even by more than half of U.S. respondents. Given that the U.S. has long had pre-eminent status in terms of a thriving venture capital industry, it stands to reason that the country has more to lose than others. There’s no question among any respondents that the United States’ elevated status cannot continue to be taken for granted, particularly given this new economic environment. Over time, we need to monitor whether the United States is losing ground or whether the rest of the world is catching up.
Role of Government
While VCs plan to increase the size of their funds and level of investing, they nevertheless see the interest from their investors–commercial banks, investment banks, corporate operating funds and insurance companies–to be declining.”
Government has always played an important role in venture capital. It’s been involved in research and development through universities and national laboratories, and has basically set the foundation for many of the innovations in which VCs invest today. But as U.S. venture capitalists move away from the IT sector, where there is less government regulation, and toward highly regulated clean technology and life sciences, VCs are finding themselves more dependent on government policy and regulation.
For instance, if there aren’t sufficient tax credits or stimulus measures to help struggling solar and wind alternative energy companies get traction to compete with large traditional energy companies, they won’t prosper. Government can enact policies in key areas such as patent protection, immigration and, of course, trade. Clearly, VCs believe government policy can be immensely important in furthering the development of nascent technologies.
We asked respondents to identify the top two government actions over the next 12 months that they feel would most foster innovation. Among all respondents, two-thirds see government implementation of favorable tax policies as the most important, while nearly half are in favor of increased government support for entrepreneurial activity—items like research grants, small business investment incentives and increased training programs for entrepreneurs.
Amongst all respondents (except Israel, where it ranks No. 2) implementation of favorable tax policies is the key action respondents believe government should take in the next year. Amongst U.S. respondents, three-fourths of whom feel favorable tax policies are paramount, almost half believe government should encourage active public markets.
We also asked, in light of the current recession, what government could do to improve conditions specifically for venture capitalists. The top response by all respondents (at 58%) is to develop policies, presumably through tax policy, to motivate institutional investors to invest. When broken down by region, with the exception of Israel, investors around the world agree that motivating institutional investors is the most important action government can take. Israelis were more interested by far (86%) in increased investment by government in research and development. Amongst U.S. respondents, almost half were most interested in encouraging institutional investors, while 41% were in favor of liberalizing tax policies.
When comparing U.S. attitudes to those held in other regions, it’s important to note that the rest of the world tends to look to government for a more engaged, proactive role. Even as venture capital markets outside the United States mature, that cultural stance may not change. As VCs become more transient in both directions, they must be aware of—and sensitive to—this distinction.
We concluded the questionnaire with a general attitudinal question as a way of getting the pulse of the VC community. Respondents were asked to complete the following statement: “It is currently a (fill in the blank) time to invest in promising entrepreneurial companies.”
Despite a global recession, retrenchment of the capital markets and shifting competitive dynamics, the most popular response was “terrific.” Only 6% believe that it is not a good time to make investments. It’s comforting that venture capitalists’ optimism is unabated.
Mark Jensen is U.S. managing partner of Deloitte LLP’s Venture Capital Services and can be reached at firstname.lastname@example.org. Mark Heesen is president of the National Venture Capital Association and can be reached at email@example.com.