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Venture Capital Enters the Bubble — of Irrelevance

At a conference in New York earlier this month to discuss the future of digital media, John Doerr was asked whether we’re in the middle of a tech bubble. Doerr, a leading figure on Sand Hill Road, the strip in Menlo Park that forms Silicon Valley’s venture capital heartland, since joining legendary firm Kleiner Perkins Caufield & Byers in 1980, immediately swatted the suggestion aside. Of course we’re not in a bubble, he asserted. In support, he pointed to the data: in 2000, at the height of the dot-com bubble, total investments made by U.S. venture capital firms topped $100 billion. In the past decade they’ve remained markedly lower, and remarkably consistent, hovering around $20 billion to $30 billion per year. VC investments this year have already reached over $33 billion, according to Thomson Reuters; once fourth quarter figures are included, they could top $40 billion. In short, it’s been a very good year for venture capital, but 2014 fundraising is still nowhere near levels of 1999 and 2000.

Doerr’s answer is the standard VC line on a standard question in technology today. Soaring valuations for private companies, some of them in sectors previously thought bubble-prone — even media start-ups are being valued at over $1 billion these days — have made the bubble question one of this year’s most asked. 2014 has been the year of the monster funding round, led by taxi service Uber, which raised $1.2 billion in June; Cloudera, a big data start-up, and Flipkart, an e-commerce site, also closed rounds greater than $1 billion.

Look at who’s leading those rounds, however, and you’ll see why Doerr’s answer gives an incomplete picture of what’s going on in tech today. For the most part, large mutual funds and hedge funds, not traditional venture capital firms, are controlling fundraising for late-stage, growth-equity companies such as Uber. Today, pre-initial public offering mega-rounds of equity fundraising are more likely to be led by firms such as T. Rowe Price, Fidelity, Blackrock and Tiger Global Capital Management than the venerable houses on Sand Hill Road. VC firms still participate in these rounds, but with far smaller balance sheets at their disposal, they can’t possibly compete with the big beasts of the financial universe.

To answer the question of whether we’re in a tech bubble by pointing to data on VC investments is like summarizing the year in U.S.-Russia relations by pointing to Vladimir Putin’s pledge to cooperate on reducing nuclear stockpiles: It’s an accurate detail masking a different reality. Today’s equity funding universe in the U.S. is the richest it’s ever been; at all stages, entrepreneurs have access to a far greater range of funding choices than they enjoyed during the dot-com boom. Angel investors and angel syndicates, accelerators, incubators and a new wave of micro VC firms have expanded capital-raising options for early-stage companies, with crowdfunding platforms set to become an even more significant source of capital as the 2012 JOBS Act comes into full effect. Further down the funding chain, mutual funds, hedge funds, private equity firms and corporate-venture arms perform much the same function for maturing companies already in the first throes of success. Some of these types of firms were active during the dot-com bubble; private equity and mutual funds were significant players in late-stage funding rounds at the turn of the century, although some of them, including defunct firms such as Hicks Muse and Forstmann Little, did not find the experience a happy one. But many in this wave of new funders, especially at the angel level, have only emerged in recent years. In 1999 and 2000, venture capital controlled the equity funding universe; pointing to VC investments for those years to get a handle on the size of the bubble was fair because VC investments and overall tech fundraising were largely synonymous. Today that’s not the case.

All of which prompts us to ask anew: Are we in a tech bubble? Providing a data-driven answer is surprisingly difficult. Traditional VC investments are comprehensively monitored, but “our ability to track the entire space” of all equity funding from all the participants now active “is limited,” says Josh Lerner, a professor at Harvard University who’s a leading authority on venture capital. Venture commitments are tracked closely because of the regulatory reporting requirements to which investments under the general partner, limited partner structure are subject. But data on investments from other parts of the emerging funding ecosystem is harder to come by. If this is a bubble, it’s a bubble still in search of its main data points.

Two firms that have had a stab at trying to piece everything together are CrunchBase and CB Insights; both put overall equity funding levels for this year, including investments from traditional VC, dedicated seed funds, angel investors, corporate venture arms and private equity, in the region of $100 billion. Once mutual and hedge fund stakes are added, it seems fair to conclude that investments in private companies will end the year at or above the levels seen during the dot-com boom.

It doesn’t follow from that that we’re necessarily in a bubble; yes, valuations in both private and public markets are high, but on the flipside, the market for technology services has greatly expanded since 1999 as the pool of global Internet users and online connectivity speeds have grown. The bubble debate has raged undimmed into the end of the year; some prominent venture capitalists, such as Marc Andreessen of Andreessen Horowitz and Bill Gurley of Benchmark, made the argument recently that so-called “burn rates,” a negative cashflow measure showing the speed at which start-ups chew through venture capital, are excessively, dangerously high in many young companies today. But voices of caution are in the minority — and the discussion itself may be moot. What’s more interesting than the tired debate of whether we’re in a bubble or not is the fact that it’s traditional VC firms that are making the argument for the negative case most forcefully.. This says more about the state of venture capital than it does about the state of the technology sector.

A couple of weeks ago WeWork, a shared office-space operator for startups and other small businesses, closed a $355 million funding round at an eye-watering valuation of $5 billion. The round was led by T. Rowe Price, Goldman Sachs and Wellington Management. What’s most interesting about the growth of WeWork’s funding base — beyond its sheer scale — is that traditional VC firms have played a marginal role in driving it. WeWork raised a $7 million seed round in 2012, but since then there have been only two funding rounds: a $150 million bridging round earlier this year, in which JPMorgan Chase and Harvard Management led the charge, and this month’s mutual fund- and bulge-bracket bank-led capital raise. For the most part WeWork has bypassed traditional venture capital; its cash stash has been amassed without the help of Sand Hill Road.

The fact that venture capital commitments have remained constant over the last decade perhaps proves less that we’re not in a bubble, and more what the remarkable funding story of WeWork suggests: that venture capital, as a discrete investment vehicle, is becoming less important to private markets by the day. As entrepreneurs seek out new avenues of capital, venture capital may be entering its own type of bubble — a bubble of dwindling relevance, and irreversible decline.

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