The Overhang Shrinks, But Does It Matter? –

The venture capital overhang fell by 13% to $84 billion last year, thanks largely to a wave of fund reductions and very little new fund-raising, according to a new study by market researcher Thomson Venture Economics (Publisher of VCJ). Venture capitalists expect the overhang to shrink even more this year, as they increase their deal-making to take advantage of falling valuations.

The overhang has been blamed for a number of industry problems-from over-allocated limited partners to rising valuations. We’ll drill down into each of those problems to determine what’s actually true.

Before we do that, it should be made clear that there may be no other issue that has been more debated in the past year than the overhang. Even the very term makes some venture capitalists cringe.

“What overhang?” says Jeffrey Harris, a senior managing director with Warburg Pincus and chairman of the National Venture Capital Association. “I wouldn’t describe it as an overhang. I would say that there’s more capital committed to the business than there is being invested. People could debate whether there’s more than a normal abundance of that. Overhang’ has negative connotations.”

Overhang. Dry powder. Uninvested capital. Whatever you choose to call it, it is the amount of committed capital yet to be invested that remains in the hands of limited partners.

Figure 1 illustrates the dry powder estimate for venture funds from 1980 to 2002. Even after adjustments to account for givebacks, the overhang in 2001 stood at $97 billion. The total fell to $84 billion at the end of 2002 after accounting for givebacks, liquidated funds, new committed capital and new takedowns.

Since venture funds typically earmark anywhere from 25% to 35% of a fund for follow-on rounds, there is actually $50 billion to $60 billion available for new investments.

Separately, the overhang for buyout funds totaled $107 billion at the end of last year, down from a revised estimate of $137 billion in 2001.