On the Fundamental Role of Venture Capital

Federal Reserve Bank of Atlanta E C O N O M I C R E V I E W Fourth Quarter 2002 I n 2001 the venture capital industry experienced its biggest decline ever. According to the National Venture Capital Association (NVCA), investments by venture capital firms in the fourth quarter of 2001 were at $7.1 billion. This amount was approximately a third of the level the year before, which was $20.9 billion. Similarly, the amount of money raised by venture capital firms in the fourth quarter of 2001 was $4.6 billion, an 80 percent drop from the previous year’s $23.4 billion. This decline has raised alarm bells with many people questioning whether this trend signals the eventual demise of venture capital. However, it is important to put these numbers in perspective. The level of venture capital investments in the last quarter of 2001 was slightly more than in the first quarter of 1999. The $36.5 billion invested in 2001 is more than six times larger than the annual amount of $5.9 billion invested in 1995. In terms of total dollars invested, 2001 ranks as the venture capital industry’s third-best year. The developments of 2001 are thus a mere kink in an otherwise exceptional growth curve of the venture capital industry. Whether the industry is in a boom or a bust depends only on one’s perspective. In the short term, the industry would appear to be in a bust, but in the long term it seems to be on a strong growth trajectory. A similar picture emerges from the data on the rates of return to venture capital investors. The average one-year return to limited partners of venture On the Fundamental Role of Venture Capital