Today’s VC Industry: Too Big to Fail?

Based on the industry’s latest bombshell, the news that the venture firm Andreessen Horowitz has raised yet another $200 million to invest in the firm’s other “growth stage” investments, one might wonder if venture fundraising is on its way back.

It isn’t. Though Andreessen Horowitz has managed to now raise $1.15 billion in its mere 22 months in business, just $6.6 billion was raised by venture firms in the first quarter of this year, nearly all of it by four firms: Bessemer Venture Partners, Sequoia Capital, J.P. Morgan, and Kleiner Perkins Caufield & Byers, which raised $1.6 billion, $1.3 billion, $1.2 billion, and $930 million, respectively.

“For anything to be raised in this market, you have to have the special sauce — the brand recognition — that gives you momentum,” says Kelly DePonte, a partner at the San Francisco-based placement agency Probitas Partners. “Otherwise, you’re moved to the back of the stove, and eventually fall off onto the floor.”

“I don’t see much hiring going on at traditional venture firms,” says Jon Holman, a San Francisco-based recruiter who has hired more than three dozen general partners and roughly 140 CEOs in his roughly 30-year career. “But when you raise a billion dollar fund and you’re investing $20 million at a time, you don’t need a lot of partners.”

The question is whether the notoriously clubby venture industry is becoming too exclusive.

It may seem comical to worry about inequalities in the American venture capital system. Besides, all industries mature. “There’s a reason we don’t have 50 car companies anymore,” says Holman. “We didn’t need 600 venture firms, either. It just takes the world a while to sort it all out.”

But the gap between VC “haves” and “have-nots” is growing. Consider that in 2008, the average salary for a managing general partner was $956,000, up from $700,000 in 2007. Holman attributes the difference to the smaller number of VCs at firms – and the denominator has shrunk further still. “We’re still not out of the end of the long tail [of the industry’s downsizing],” says Holman. “I don’t know what the stats are, but there are many fewer GPs than five years ago, and still fewer early-stage GPs.”

Already, with far fewer venture firms in charge, things have grown strange. Who would have imagined Kleiner Perkins would be hunting down deals on the secondary market, or that a mobile photography app would garner $41 million before attracting its first user, or that investors’ obsession with daily group buying sites would grow quite so intense? (If you didn’t pay much attention to the news of LivingSocial’s fresh, $400 million investment this week, it may be because it marked the eighth $100-million-plus deal so far this year.)

Who would have imagined that Accel Partners would pour $40 million into a Hollywood production company, putting its LPs in the business of funding Batman sequels?

It’s easy to conclude that Accel has too much money to invest, along with Kleiner, and Greylock, and the 10 to 15 other firms that have risen to the top of the pyramid and are spending like it. The more serious issue is: What happens if all this concentration produces a raft of failed investments? Whether it could derail an already embattled venture industry for many more years remains to be seen, but it’s certainly worth asking: are these new funds now too big to fail?