At a recent event in Silicon Valley, I asked a venture capitalist, “Do you think the market volatility and lack of IPOs will hurt your business?” While it was clear he had too much to drink, his answer was clear: “We are focused on the long term. So we’ll win in the end.”
You have to love VCs’ optimism. It’s what has led to the emergence of great companies.
Yet my venture capitalist friend should be somewhat worried. You see, it really does not matter what he thinks about the future. What matters is what his own investors think. These include pensions, endowments and institutions that are looking for strong returns. For the most part, they make up most of the funding for VC funds. And unfortunately, they are getting careful with their wallets.
Just look at the latest VC report from Thomson Reuters and the National Venture Capital Association. In the third quarter, 52 operators raised $1.72 billion, which was down 53% from the same quarter a year ago.
Now it’s true that 2011 still has seen a strong gain of 26% in capital raised, for a total of $12.2 billion. But the Q3 figure — it was the worst quarterly performance since 2003 — could be a turning point. Keep in mind that since the middle of August, the IPO market has slammed shut. Even high-profile companies, like Zynga and Groupon, have had to pull back their offerings.
At the same time, this year’s deals have been mostly duds. Take a look at Pandora (NYSE:P), Demand Media (NYSE:DMD) and Skullcandy (NASDAQ:SKUL), which are all well below their IPO prices.
Some IPOs have hung around, including LinkedIn (NYSE:LNKD) and?HomeAway (NASDAQ:AWAY). But hanging around doesn’t equal success. Without more successes, if the market does not expand much, it could mean a prolonged contraction in VC funding.