As part of our annual analysis of key venture capital industry trends, this report examines the venture market as a whole, including fundraising, investments, valuations, and exits.  In contrast to prior reports, this year we also consider net limited partner returns, which have improved significantly for recent vintage years.  Our 2012 study of the state of the venture capital industry comes on the heels of the Kauffman Foundation’s scathing venture capital piece, which assigns primary blame to limited partners for poor venture capital performance.  While it is true that many LPs have regrettably funded marginal managers, our belief is that while the early-2000s suffer from seemingly poor returns, history would show that these will improve over time as those vintages continue to mature.  At the same time, the strong net performance of vintage years 2007 and onward is very notable given their youth.  

In this piece, we demonstrate that US venture capital fundraising seems to have settled around $15-20 billion annually. Investment activity is picking up, but off a relatively low base, and we believe a sustainable amount of capital was invested in each of the past few years.  In select categories, namely seed and late stage, as well as the mobile and social sectors, investment activity became a bit feverish. Nevertheless, despite much talk of an overheated venture capital environment, valuations at all stages remain well below those during the Internet bubble.  Although higher prices are certainly being paid today than a few years ago, we still believe the pace of innovation, consumer adoption, and revenue growth among technology companies in many cases justifies higher valuations.  Finally, life has begun to return to exit markets.  As of Facebook’s IPO on May 18, markets were on pace for 58 US-based venture-backed IPOs in 2012.  The event delivered monumental returns, but its clumsy execution has seemingly stalled subsequent venture-backed offerings, as there have been just three since.  

We conclude with the belief that the venture capital industry continues to achieve a more sustainable capital base, as we have consistently discussed in the past, and that the “flight to quality” of capital in the industry will continue to characterize the venture market going forward. The reasonable funding levels for elite venture and growth managers, coupled with the concentration of premium deal flow to those managers, will generate the most attractive risk-adjusted returns.