It appears that years of easy money and sky-high valuations have caught up with the American venture capital industry. This is one more indicator that the economy of the United States lacks innovation and growth prospects, and it is an issue that needs to be solved before the nearly decade-long productivity slump is reversed. Starting a business is now too difficult and too few young companies survive, say researchers at the Federal Reserve and the Joint Economic Committee of Congress and the National Bureau of Economic Research (NBER).
Between April 2015 and April 2016, there was a 30% year-over-year decline in deployed U.S. venture capital. Deal volume fell 22% over the same period. Investors may be nervous about uncertain economic prospects in the United States and abroad, opting to wait for stronger indicators before committing capital.
Slump Began in Q4 2015
Venture capital saw record investment levels and deals during 2014 and 2015. In fact, the $58.8 billion in U.S-based venture investments was the second highest over the past 20 years, only exceeded by the dot-com bubble in 2010. Yet the data shows that momentum was already slowing significantly by the final quarter of 2015.
Venture capitalists dedicated $11.3 billion toward 960 deals in Q4 2015, a 32% decline in value and 16% drop in volume compared with Q3 2015. During Q1 2016, venture capital funding for U.S. startups fell nearly 25% to $13.9 billion. It was the largest quarter-over-quarter decline since the Great Recession. Deal volume fell accordingly, hitting a then four-year low of 884.
Slowdown in Tech Funding
There was a peak in venture-capital-driven tech funding of $31 billion in North America during 2014. That number declined to $28.8 billion in 2015 and was poised to be even lower in 2016. There are signs that investors are both fatigued and wary of the unicorn phenomenon among technology startups. Just two subsectors appear to have bucked the trend: Software and biotech industries saw the majority of VC funding during Q2 2016.
The West Coast felt the slowdown hardest. California's Bay Area saw 20% declines in startup funding between Q1 2015 and Q1 2016, enough for a $420.9 million drop. The same was true of other tech-based startup hubs, such as New York, Denver, Austin and Washington, D.C. These regions saw an average drop in startup funding of $56.7 million over the same period.
Without high-tech startups driving innovation and economic efficiency, the United States should experience less labor productivity. Since productivity is the critical variable for determining wages, this means a lower standard of living as households face annual inflation.
Death of Startups
Venture capitalists only succeed to the extent that promising young enterprises succeed. When there is a lack of startup investment opportunities, venture capitalists end up sitting on the sidelines. That appears to be the reality in the modern American economy.
Approximately 9% of the U.S. workforce is employed at companies that have been around for less than five years, an all-time low and roughly half of peak years in the mid-to-late 1980s. A June 2016 report from the Economic Innovation Group shows that 60% of U.S. counties experienced a net decline in their number of businesses between 2010 and 2014. One possible explanation is that added regulations create a competitive disadvantage for smaller and younger companies, which often lack the infrastructure to handle compliance. These regulatory pitfalls usually lead to older, more established and politically connected companies surviving while everyone else flounders.
Where Venture Capital Goes From Here: Cockroaches
It makes sense that venture capital investors are more selective after the exuberant years of 2014 and 2015. More than 145 startups received more than $1 billion in funding, but many of those ventures stumbled out of the gates and now the VC industry appears to have soured on the unicorn concept. What investors now want is resiliency and the ability for young firms to survive coming economic turmoil. This attitude has given rise to a new nickname: cockroaches. Cockroach companies build slowly and steadily and emphasize revenue and profits.