The Incredible Shrinking Venture Industry

How small could it get? Nobody knows, “but a large scale experiment is being run whether we like it or not,” NEA’s Scott Sandell said earlier this week at the VentureWire conference.

Sandell tallied the enormous sums of money raised by U.S. venture capitalists over the last 20 years: $28 billion from 1990 to 1996 and a whopping $294 billion in the six years after that. Not even the dotcom bust could dampen this frenzy. But the global financial crisis did.

From January to July, venture capitalists raised only $4.5 billion — and NEA’s investors are saying they think fundraising for the rest of the year will be less than that. Almost all the financings taking place now are from insiders, Sandell said. “Very few people are putting money into new companies.”

Sigma’s Wade Woodson, who sat next to Sandell, said the venture industry is heading into “the perfect storm” because of a generational change in both investors and sources of capital. “We tend to get self-absorbed and feel that fundraising is based on our performance, but so much is driven by the alternatives people have — in times of low interest rates, people are driven to pursue higher levels of return.”

There are upsides to the bad news — fewer and better venture capitalists (David Sze of Greylock thinks a third of VCs will go out of business), better companies and, according to Rob Hayes at First Round Capital, smaller investments from smaller funds.

First Round, which got an exit recently when Intuit bought Mint.com, invests anywhere from $200,000 to $1 million in consumer Internet companies that are “two guys and a dog,” Hayes said. Some of their companies are getting to market on $50,000.

But investments in clean tech and biotech have to be bigger than that, according to Sandell. “Both models work well. If you’re a small fund and start with a small check, you have to have reserves to follow, and if you’re a large fund, you have to make sure the subsequent rounds are right for your LPs.” NEA likes to invest in every round.

Despite the gloom, all these VCs think it’s a great time to invest in companies. “All that’s left is the wild-eyed crazies,” Hayes said. “That’s what every VC is looking for and that’s all they’re looking for. They don’t want to be in one of those funds that a year from now are trying to raise money.”