The future of venture capital has been a hot topic lately — whether you are on the entrepreneur side or the finance side, it doesn't work for a lot of people.  Entrepreneurs feel that VCs ask for too much equity for a lot of deals, and the bar has been raised now such that entrepreneurs have to show real customer traction before even walking into VC meetings.  VCs are feeling pinched because M&A activity is relatively low and there have been only a handful of meaningful IPOs over the last several years.  It's hard to argue that VC can deliver a significant premium over other investment options when there are simply no meaningful exits.  The situation doesn't necessarily seem to be improving either, at least in the short-term.

Perhaps that is one reason why VC fundraising is down in 2009.  Some VCs, like Fred Wilson, suggest that there are simply too many VCs.  It's a compelling argument — arguably the explosion of VC in the 2nd half of the 1990s was a result of the bubble.  The shakeout just hasn't occurred yet.

I think the structure of the venture capital business makes it very difficult for VCs to adjust to changes in the marketplace as fast as entrepreneurs.  VC fundraising takes time.  Then after securing dollars VCs execute on the promised investment thesis.  We're now at a point in time when exits are rare and the costs of starting a company are very, very low relative to the past.  Think about it — today, some of the best opportunities for generating real shareholder return is in smaller deals where just a few hundred thousand dollars (if that) are necessary to generate significant traction.  It's why mentor-heavy, cash-light investor groups such as Y Combinator, the Capital Factory, TechStarts seem to be popping up everywhere.  A lot of VCs are equipped to fund relatively early-stage companies a few million dollars at a time — those are the ones who are probably finding it very tough to find qualified deals.

I take a middle of the road perspective on venture capital — there is no doubt that the old model is broken.  Exits simply aren't there to justify large, early stage investments anymore.  Entrepreneurs and early stage investors have adapted, and that's where the action is right now.  Things will certainly change once the IPO & M&A markets heat up again.  But until then, you'll see a lot less money going after big opportunity.  Entrepreneurs will nonetheless succeed, and a lot of value will be created with high investor returns.

Small is the new "black", but a lot of people simply haven't quite figured that out yet.