April 7, 2009 — Entrepreneurial innovation will eventually pull us out of our current economic malaise, and venture capitalists and universities will both play leading roles in the process, predicted Thomas C. Skalak, vice president for research at the University of Virginia and the organizer of last week's inaugural U.Va. Venture Summit.
The event, held Friday and Saturday, brought together venture capitalists, U.Va. researchers and entrepreneurs.
Venture capitalists provide cash along with managerial and technical expertise to entrepreneurs and early-stage businesses that lack the track record or assets needed to secure bank loans. Typically the venture capitalists take a share of the company as payment, betting on big returns in the future.
"We provide some of the newest ideas upon which the capital can have a strong effect," said Skalak, explaining the natural partnership between university researchers and venture capitalists.
Commercializing research ideas brings the benefits to society. "It can reduce the gap between rich and poor. It can give us clean water. It can give us renewable clean energy," he said.
For the venture capitalists, this involves choosing good ideas, entrepreneurs and fledgling businesses that will have all the ingredients for significant commercial success and overcome the obstacles that derail many startups. "Venture capitalists must be able to see around corners into the future," Skalak said.
So venture capitalists place lots of bets and depend on a few big winners. "It's an incredibly cyclical industry, hugely volatile, driven by mega-hits," Peter Barris, managing general partner of New Enterprise Associates, said during a panel discussion on Friday. "For the most part, returns come from a very small number of investments."
After the panel discussion, U.Va. researchers connected with the venture capitalists in specialized roundtable discussions. Among the topics were genomics and personalized medicine, grid computing, clean energy, nanotechnology and medical devices.
Backing the right companies can result in changing the world, said Chuck Newhall, a general partner and founder of New Enterprise Associates, who decided to go into venture capital while he was hunkered down in a bunker during the Vietnam War. Newhall and his unit were doing a reconnaissance of the famous Hamburger Hill, and had no protection against Viet Cong artillery fire, other than air support from U.S. fighters that circled for hours thanks to in-flight refueling. Thinking about how he and his comrades' lives depended on a business called Inflight Refueling that his father had funded as a venture capitalist, he decided he wanted to go into venture capital and help companies succeed in making other indispensable products.
When Newhall entered the industry around 1977, the country was facing the economic challenges and pessimism of "stagflation" – a period of stagnant growth and rapid inflation. But in the following years, he and other venture capitalists funded a number of new and existing companies that have gone on to reshape the world, including Intel, Apple and IBM.
"The importance of the industry is far greater than it's understood in this country," said Newhall, suggesting that a scholar, perhaps at U.Va., should write a history of what venture capital has done for this country, going all the way back to 19th-century investors like Andrew Mellon and John Rockefeller.
Newhall and Barris funded UUNET, a company that became the world's largest Internet service provider. "We changed the way the world works," Newhall said.
"In light of 1977, you'll look back on today and wish you were an entrepreneur or a venture capitalist."
Seventeen percent of the country's gross domestic product is created by venture-funded businesses, while venture capital consumes only 0.2 percent of GDP, Barris said. "It is the most efficient form of value creation we have ever had."
The U.S. has three key ingredients for venture capital: an entrepreneurial culture, the best universities in the world and plentiful capital, explained Christopher Brightman, the chief investment officer of the U.Va. Investment Management Co., or UVIMCO.
The share of national income going to capital investment reached a historic peak in recent years, with corporations seeing record profits, and the rich amassing more and more wealth that could be invested. The trend is "tightly linked to income inequality," and is due to "societal choices," Brightman said. "We're seeing right now a shift in the political environment, and policies designed intentionally to change that outcome – to reduce the share of income going to capital, reduce corporate profits and reduce income inequality."
On top of these looming policy changes, global economic output is down sharply and global stock values are down 50 percent over the past year, drying up the once-plentiful supply of investment capital, so raising capital will be difficult in the next few years, Brightman said.
In the 1990s venture capital provided spectacular returns that are almost certainly unsustainable, Brightman said. The industry depends on matching the right amount of investment with a very specific number of startup businesses that are well-positioned to have booming business success. "What happens in our industry," Barris said, "is money pours in and you have an oversupply; returns go down. Money comes out, returns go up, money comes back in, etc."
Too much money flowed into venture capital over the past decade, Brightman said, and returns were disappointing and disillusioning, prompting investors to rethink whether to invest in the industry.
More than half of the roughly 1,000 venture capital firms that existed in 2000 have since failed. And perhaps a third of the remaining 400 to 500 firms will fail in coming years, predicted several of the panelists.
"I think that's a good thing for returns," Barris said.
Those that remain will survive through innovation, Newhall said.