Will LPs Really Help The VC Industry Downsize?

Connie last night posted a Q&A with economist/pundit Paul Kedrosky, who has released a paper arguing that the VC industry must shrink in line with the decreasing capital requirements of the startups they fund. Much of the blame for the buildup, Paul says, goes to limited partners – who have agitated for access to top-tier firms (or at least ones that used to be top-tier), and who jumped at the opportunity to invest when the firms’ fund-sizes grew.

Paul is certainly correct in his historical assessment – just look at Kleiner’s rapid growth – but I’m not so sure that LPs are going to help the VC industry rightsize/downsize. After all, for every new LP dollar committed to VC funds over the past few years, there have been a dozen LP dollars committed to buyout funds.

The result, in many cases, has been over-allocation to buyouts, which could cause some LPs to actually increase their attempts to invest in venture capital (to better balance things out). There obviously are other portfolio allocation strategies – including increased commitments to burgeoning segments like secondaries and distressed – but venture still seems to hold irresistable homerun appeal for many investors (even if 9-year returns don’t justify the risk).