Venture Capital's Touch of the Bubbly

According to VentureOne, commitments to U.S. venture capital funds totaled $6.1 billion in the second quarter of 2005 (the latest figure available). That's still way below the record $27 billion in the fourth quarter of 1999. But it's the highest level since 2001 and roughly double the average quarterly commitments for 2003.

And, VCs say, if the figure isn't higher, that's only because VC firms remain wary about raising funds they can't invest -- and not because their limited partners aren't interested in investing much, much more.

"Even though the VC industry is still contracting, there's tons of money wanting to come in," says a general partner at a Silicon Valley firm who says some institutional funds are hoping to triple their venture investments this year. "People are shifting more money into private equity, and it's creating this big back pressure. People are getting desperate to get in."

So, why isn't this translating into a mad rush of start-ups back into the IPO queue? First, the venture firms left standing after the lean years are taking little of it. But you can only have billions of potential VC investments going begging for so long: Pretty soon, second- and third-tier firms will be willing to absorb the new surge in funds. And they're less likely to be judicious in investing it.

Second, the onerous costs of Sarbanes-Oxley compliance make going public expensive -- some estimate that the new laws add $3 million on average to a start-up's costs. So instead of grooming themselves for an IPO, today's impatient start-ups are grooming themselves for an acquisition. To some VCs, that's a big red flag -- the kind of cavalier strategy that heralded the dot-com excess of the late '90s.

"There isn't a huge public market bubble, or a sense that every idea with 'Internet' in it will be a success," says David Hornik, a partner at August Capital in Menlo Park, Calif. "So, there's more rationality in the market now than in the late '90s. But I am concerned about the growth of self-funded, small start-ups where the only real opportunity for exit is to be acquired."

What's wrong with that?