Economist on Venture Capital

The Economist writes that things are looking up for the VCs.

In the fourth quarter of last year start-ups in Silicon Valley received $1.6 billion of VC money, $300m more than in the third quarter, according to VentureOne, a research company. Perhaps more importantly, for the first time in a while venture capitalists say they are spending more time looking at new business plans than nursing their ailing start-ups.

Over the past 20 years, even including the recent downturn, VC investments have yielded an average 15.7% per year, according to Thomson Venture Economics. That is higher than the returns from most other investments…If only venture capital can avoid the excesses of the late 1990s, it could be one of the last few sources of above-average returns.

Venture capitalists have typically concentrated their investing in two broad areas: technology and health care. During the enthusiasm of the bubble years, the term technology was stretched to include any dotcom, even if it aimed to sell pet-food or to deliver groceries in a white van. Today VC firms have mostly returned to genuine technology ventures, and notably to companies developing software applications for corporate customers. That has coincided with a rebound in company spending on IT projects.

One computing area that has continued to attract VC investments is open-source softwarethat is, computer code that is not owned by, say, Microsoft or Apple, and hence can be modified by anyone. For instance, Accel Partners, a big Silicon Valley VC firm, is betting on Jboss, which creates computer applications for corporate clients using Linux, the main open-source software.

Start-ups focused on data storage have also won interest, thanks to companies’ ever-growing demands for file storage. That has been driven in part by worries about terrorism and other forms of business interruption.

Nearly all information-technology new-business plans include some element of offshoring, notes Peter Wagner, a partner at Accel Partners. Doing software-development work in India seems like a perfect fit when start-ups are receiving smaller amounts of money at wider intervals. It is especially sensible in Silicon Valley, where housing costs alone mean that even mediocre software engineers are several times more expensive than their equivalents in Bangalore. Some start-ups can exist in the more sober funding climate only thanks to cheap foreign programmers.

WSJ builds on the last point:

Silicon Valley’s venture capitalists, famous for funding technology’s leading edge, now are pushing the companies they fund to be on the leading edge of an employment trend: moving white-collar jobs offshore.

The Valley’s ideal start-up business these days is the “micro-multinational,” a company that from its inception is based in the U.S. but maintains a less-costly skilled work force abroad. Venture capitalists also are prodding young companies in which they already own stakes to turn themselves into micro-multinationals.

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Rajesh Jain

An Entrepreneur based in Mumbai, India.