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There is no doubting the phenomenal impact that venture capital has had on the US — and global — economy over the past few decades. A tiny number of VC investors have helped create some of the most dynamic companies in history and generated astonishing returns. But past performance is no guide to future results, as they say, and the world is changing fast. Is the VC industry — like Elon Musk’s latest rocket launches — about to flame out in a “rapid unscheduled disassembly”?
Ilya Strebulaev, a finance professor at Stanford Graduate School of Business and co-author of the Unicorn Report, dismisses any such talk, suggesting the VC industry’s current slowdown is more cyclical than structural. “The reason why the US produced so many huge companies like Apple, Facebook, Google and Nvidia is not because the US is more innovative but because it has a VC industry. It is causal,” he tells me.
His recently updated 350-page Unicorn Report strongly supports his thesis. Of all the public companies founded in the US in the past 50 years, VC-backed enterprises account for half their number, three-quarters of their market value and 92 per cent of R&D spend.
Of the top 10 most valuable public companies in the US, the average year of founding was 1946. In the rest of the G7 it was 1892. The US VC industry remains a formidable innovation machine. Backing hungry entrepreneurs with early-stage funding to leverage the latest technologies to satisfy everyday consumer and business needs remains a promising bet.
That said, it is hard to see the VC industry returning soon to the glory days of 2021, when 478 unicorns were minted in the US — about 31 per cent of all VC-backed unicorns ever created. The combination of low interest rates, abundant capital, sugar-high valuations and the rush to digital platforms during the Covid lockdown was the industry’s happy hour.
The outlook today is more sober. Investors are now confronting higher interest rates, malfunctioning capital markets, geopolitical turmoil, increased protectionism and the mass adoption of artificial intelligence. “I don’t think the VC model is going to die, but it’s going to change,” says the investor David Galbraith. “And the bigger picture is that the American model might be under threat.”
In his view, AI is rewriting the rules of the technological and investment game. The traditional capital-light software distribution model (think social networks) that has worked so well for VCs is fast evolving into one of capital-heavy hardware production (AI chips and data infrastructure), far harsher investment terrain. The companies leading this transition are the dominant tech giants that are collectively investing hundreds of billions of dollars. They have also emerged as the prime backers of the biggest AI start-ups, including OpenAI and Anthropic, usurping the historic role of VCs.
Most of the other smaller, VC-backed AI start-ups that are applying the technology in different sectors will fail, Galbraith predicts, because fast-changing AI will itself erode their competitive moats.
The other big secular change is that technology has now become the focus of intense geopolitical rivalry, with every major power talking about the need to assert technological sovereignty. The latest is Saudi Arabia, which has just launched a $10bn VC fund, aiming to become a leading AI hub.
This geopolitical imperative demands much deeper collaboration between governments, national corporate champions and dynamic start-ups, as has become common in north-east Asia. In their book Start-up Capitalism, Robyn Klingler-Vidra and Ramon Pacheco Pardo argue that China, Japan, South Korea and Taiwan have learnt the lessons of Silicon Valley and updated them for the new age, helping create companies such as Taiwan’s TSMC, the world’s leading chip manufacturer. Many of these practices are now seeping back to the US in a form of “return diffusion”, as they call it.
Europe, which this week launched a renewed effort to invigorate its start-up industry, appears stuck on the old Silicon Valley playbook. Although such liberalising initiatives are welcome, they need to be implemented fast and form part of a more muscular geopolitical strategy. “Adapting towards the north-east Asian model is much more viable,” Klingler-Vidra tells me.
It is sometimes forgotten that Silicon Valley was itself the offspring of the US national security state during the cold war. Geopolitics has now returned with a vengeance and — like everyone else — the VC world must adapt fast to that new reality.
john.thornhill@ft.com