More Venture Capital, Less Wall Street

05/05/2010 11:06 am EST

Focus: MARKETS

Josh Wolfe

Editor, Forbes/Wolfe Emerging Tech Report

Josh Wolfe, editor of the Forbes/Wolfe Emerging Tech Report, interviews entrepreneur and venture capitalist Paul Kedrosky on the uture of VC and entrepreneurship.

What are your thoughts around the venture capital asset class today?

The success of a number of high-profile endowments and pension funds investing in the space, combined with some notoriety, created this perception that it was an asset class.

Treating venture like an asset class swamped the industry with all this capital that the industry simply could not allocate fast enough at a high enough level of return to justify the large sums that had been raised.

The whole structure and appeal of the venture industry is very much driven around bubbles, but more specifically around a lottery effect, which [means] that within any given portfolio, one or two investments will deliver all of the returns.

It’s like the penny stock phenomenon but at the level of venture funds. People are willing to allocate far more money than is rational for any kind of expected value, because they’re buying what they think of as cheap lottery tickets. As a result, more and more people begin buying more and more lottery tickets, essentially making the odds longer and blowing up the original investment rationale. So, I’d be wary about the idea that the asset class is entirely driven by bubbles.

I believe the industry needs to shrink roughly by half. And so far, the industry is actually shrinking faster than I thought it would. At the same time, the industry has to restructure from being an asset-gathering game back to something more like the craft origins of the business, where general partners (GPs) raise the equivalent of a $50-million or $100- million fund as the norm again.

Has the participation rate in entrepreneurship in the US changed over the last 15 years?

Most people think it must have gone up in the late 1990s. What’s bizarre is that it’s actually stayed fairly stable. If anything, it’s probably declined a little bit in recent years.

Over the last ten years, there’s been a huge misallocation of entrepreneurial talent in the US. What’s happened is that an increasing percentage of the best and brightest in science and engineering have realized they can earn a far higher return for their working time by going into the financial community rather than starting companies.

[So,] Wall Street firms became the largest block recruiter in 2005-2006. All of the people who could have been out there using their knowledge of science and engineering to create companies found out they could earn higher returns with little or no risk in financial careers, as opposed to low returns with huge risks being an entrepreneur.

Now, it’s coming unwound as graduating classes are finding they can’t go to those places as easily and people who had been yanked out into these industries are finding there aren’t nearly as many positions available. My hope is that those people go off and use their talents in ways that could be hugely beneficial to society.

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