Robert Ackerman: Venture Capital At A Tipping Point

Venture capital is not dead. Despite the protests from the Kauffman Foundation and others about its demise, it is very much alive.

Having just returned from a trip abroad to talk to numerous investors, I sense a true tipping point in attitudes toward venture and in the appetite for investing. I’ve been traveling abroad for the last few years and meeting with investors to educate them about the U.S. venture market, and sentiments are changing regarding this asset class.

There are a number of important factors that suggest venture returns are poised for a skyward trajectory.

First and foremost is the incredible new era of entrepreneurial innovation and creativity – a Cambrian Explosion within the technology universe. The Cambrian Explosion refers to a period of evolutionary innovation about 500 million years ago when most forms of life ceased to exist and entirely new life forms began to develop. That’s exactly what’s happening in the innovation economy today.

Groundbreaking developments in cloud computing, social media and mobile technologies are giving rise to an entirely new technology ecosystem. What’s really interesting is that innovation is pushing out in all directions simultaneously. For young companies, the opportunity to disrupt the status quo and create value is unprecedented. And from an investor’s perspective in Silicon Valley, it does not get much better than that.

What’s more, there is a security overlay that must now sit on top of all of these breathtaking innovations. To a large degree, the high-tech universe was built on computing, communications, and storage—the three legs of the innovation stool. Security has become the fourth leg of this innovation stool because of the interconnected nature of the global economy and the untold risks associated with the sharing of information.

At Allegis Capital, security is king and our entrepreneurs are building companies like Symplified, which provides controls and authentication for accessing cloud-based services, and Coraid. Companies like these are remaking the infrastructure upon which the future of computing – in all its forms – will be based.

The second reason for optimism is the availability of capital to support these innovations. It is no secret that venture returns have suffered as a result of excess capital in the marketplace. But that excess capital, a hangover from the heady dot-com days when some $200 billion flooded into the market, has finally bled off. In fact, since 2008 the amount of money invested in young companies by venture capitalists has exceeded the amount of capital flowing into the industry from limited partners.

The Right-Sizing of Venture

The end of the supply overhang has some interesting dynamics. Essentially, the industry has right-sized. We have much smaller pools of capital that are targeting an unprecedented number of innovative startups. That is a very interesting environment from an investor’s point of view, and it points to much higher venture returns in the near future.

Another positive trend for the venture industry is the rising level of corporate M&A activity. In the globalized economy, corporations have made the strategic decision to cede research and development to innovative young companies, which they can then acquire at some period down the road.

Just look at the numbers. In 1981, large corporations with more than 25,000 employees represented 70.7% of industrial R&D in the United States, while organizations with less than 5,000 employees represented 10.5% of industrial R&D. Some 25 years later, innovation at small corporations is up 400%, while it is off almost 50% at large corporations. There has been a wholesale shift in terms of where innovation takes place. The result, of course, is that corporate M&A is now a much more significant exit path for startup companies.

Finally, there is the new JOBS Act, which among other things is designed to ease the path to initial public offerings for startups. Our portfolio companies see that the regulatory burdens have been significantly reduced. There is less financial information that has to be reported, there are fewer regulatory hoops they have to jump through, and there is a greater ability to confidentially draft IPO registration filings for the Securities and Exchange Commission, without those documents landing in the public domain. All of this is making young companies once again think positively about going public.

The combined effect of all these various factors is now being felt throughout Silicon Valley and beyond. In 2011, both M&A activity and IPO activity were up significantly compared to the last five years. Moreover, the first quarter of this year saw the strongest IPO activity since 2005. And judging from the registration backlog, 2012 is on track to see the highest level of IPO activity in more than seven years.

The rebound is clearly underway and venture returns are on their way up. We have entered a virtuous cycle where innovation is feeding exits and exits are feeding more innovation. Talk to anyone who’s been in Silicon Valley for a while and they’ll tell you the same thing: If you are a technology entrepreneur or an investor in tech startups, this is one of the most exciting periods in history. It’s nothing short of a Golden Age.

(Robert R Ackerman, Jr. is founder and managing director at Allegis Capital.)

 Images courtesy of Robert Ackerman.