Is There Too Much Venture Capital?

I subscribe to VentureWire, an e-mail newsletter that summarizes new venture capital investments in Internet companies. An average issue lists about 20 deals, usually adding up to between $100 million and $200 million. What’s striking is that VentureWire comes daily—and yet doesn’t catch everything. Driven largely by optimism about the Internet, investment in American technology start-ups will probably reach approximately $50 billion for this year—about 10 times more than in 1994.

This eagerness to invest in the latest start-up is, of course, another aspect of the same rush of capital that we are seeing when high-technology companies go public. On Thursday, the stock of VA Linux Systems had the biggest first-day gain for any initial public offering in history.

This company, which sells computers that run the Linux operating system, faces serious competitors like I.B.M. and Dell, is losing money and will not turn a profit for the foreseeable future. Yet it was valued at almost $10 billion by the end of the day—a gain of 733 percent.

But high-technology start-ups are not just stocks; They are also businesses, and they have to operate. The giddiness about stock prices is obscuring the real needs of companies.

It didn’t used to be this way—in fact, we used to have the opposite problem. Until very recently, the venture capital industry was a small club, verging on a cartel, and the technology sector was for geeks in California, period. Money was tight, particularly during the technology sector recession in the early 1990’s.

In 1994, I spent five brutal months raising $4 million for my first company, an early Internet software start-up. At the time, there were maybe a thousand Web sites in the world.

But since the onset of the commercial Internet revolution in 1995, money has flooded into the Internet, with the size of the venture capital industry roughly doubling every year. A very real revolution—the growth of the Internet—is being accompanied, and sometimes damaged, by an epidemic of speculation.

Fund-raising has become a buyer’s market. Venture capitalists now must compete for deals, despite their vastly increased funds and the large number of Internet companies being started.

In many ways, this is good. It is now much easier for entrepeneurs to raise money. I recently founded my second Internet start-up. This time, I raised over $3 million in the first month.

The Internet has also made business life a lot fairer. You don’t have to stay in a big, bureaucratic company anymore; you can join a start-up. You can bypass middlemen and sell directly to the global market. And without a doubt, the Internet wouldn’t have come so far so fast if venture funding still behaved as it did a decade ago.

But the fact that virtually any idea—no matter how dubious—can obtain money, and that so much money is available, is also causing problems. Competition among Internet companies is increasingly a financial arms race. They must raise huge war chests, give away their products, advertise on television, and pay insanely high salaries—simply because their competitors do.

The glut of money also has companies—and the industry as a whole—growing insanely fast, leading to labor shortages everywhere—of not only engineers and managers, but graphic designers, accountants, headhunters, telephone system installers.

Fortune seekers, many of them unqualified, flood to the Internet—both to start companies and to work in them. This leads to sloppy work and some fairly sleazy behavior.

In some respects, the rush and confusion are natural costs of moving forward as a major new technology becomes widely available.

Relative to the benefits that the Internet brings, these problems are comparatively minor. But the inherent dangers of a speculative environment will eventually hurt many naive investors—and perhaps, more importantly, they also make life more difficult for serious entrepeneurs.