Is There Too Much Venture Capital?
By CHARLES FERGUSON
I subscribe to VentureWire, an e-mail newsletter that summarizes
new venture capital investments in Internet companies. An average
issue lists about 20 deals, usually adding up to between $100
million and $200 million. What's striking is that VentureWire comes
daily -- and yet doesn't catch everything. Driven largely by
optimism about the Internet, investment in American technology
start-ups will probably reach approximately $50 billion for this
year -- about 10 times more than in 1994.
This eagerness to invest in the latest start-up is, of course,
another aspect of the same rush of capital that we are seeing when
high-technology companies go public. On Thursday, the stock of VA
Linux Systems had the biggest first-day gain for any initial public
offering in history.
This company, which sells computers that run the Linux operating
system, faces serious competitors like I.B.M. and Dell, is losing
money and will not turn a profit for the foreseeable future. Yet it
was valued at almost $10 billion by the end of the day -- a gain of
733 percent.
But high-technology start-ups are not just stocks; They are also
businesses, and they have to operate. The giddiness about stock
prices is obscuring the real needs of companies.
It didn't used to be this way -- in fact, we used to have the
opposite problem. Until very recently, the venture capital industry
was a small club, verging on a cartel, and the technology sector
was for geeks in California, period. Money was tight, particularly
during the technology sector recession in the early 1990's.
In 1994, I spent five brutal months raising $4 million for my first
company, an early Internet software start-up. At the time, there
were maybe a thousand Web sites in the world.
But since the onset of the commercial Internet revolution in 1995,
money has flooded into the Internet, with the size of the venture
capital industry roughly doubling every year. A very real
revolution -- the growth of the Internet -- is being accompanied,
and sometimes damaged, by an epidemic of speculation.
Fund-raising has become a buyer's market. Venture capitalists now
must compete for deals, despite their vastly increased funds and
the large number of Internet companies being started.
In many ways, this is good. It is now much easier for entrepeneurs
to raise money. I recently founded my second Internet start-up.
This time, I raised over $3 million in the first month.
The Internet has also made business life a lot fairer. You don't
have to stay in a big, bureaucratic company anymore; you can join a
start-up. You can bypass middlemen and sell directly to the global
market. And without a doubt, the Internet wouldn't have come so far
so fast if venture funding still behaved as it did a decade ago.
But the fact that virtually any idea -- no matter how dubious --
can obtain money, and that so much money is available, is also
causing problems. Competition among Internet companies is
increasingly a financial arms race. They must raise huge war
chests, give away their products, advertise on television, and pay
insanely high salaries -- simply because their competitors do.
The glut of money also has companies -- and the industry as a whole
-- growing insanely fast, leading to labor shortages everywhere --
of not only engineers and managers, but graphic designers,
accountants, headhunters, telephone system installers.
Fortune seekers, many of them unqualified, flood to the Internet --
both to start companies and to work in them. This leads to sloppy
work and some fairly sleazy behavior.
In some respects, the rush and confusion are natural costs of
moving forward as a major new technology becomes widely available.
Relative to the benefits that the Internet brings, these problems
are comparatively minor. But the inherent dangers of a speculative
environment will eventually hurt many naive investors -- and
perhaps, more importantly, they also make life more difficult for
serious entrepeneurs.
Charles Ferguson is the author of "High Stakes, No Prisoners: A
Winner's Tale of the Internet Wars."
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