Speech of
Daniel T. Kingsley
National Venture Capital Association

Before the Conference on Corporate Governance and Equity Offerings

"The State of the Venture Capital Industry & Its Impact on the U.S. Economy"

February 24, 1999

I appreciate the opportunity to speak with you today regarding the state of the venture capital industry and how private equity in general is becoming an increasingly important factor in the U.S. economy.

In the past twenty years I have been with the NVCA, I have seen a remarkable transformation of the professional venture capital industry from one that invested small dollars in a few companies to one which in 1998 invested over $16 billion in emerging growth companies across America, a growing portion of which is invested right here in Southern California.

Specifically, over the past 2 years, Southern California-based companies received a record amount of venture capital dollars. In fact, this region received 9.36% of all venture capital invested in the United States in 1997 and 1998. During this period 338 Southern California companies received over $2.8 billion. This surpasses the amounts invested in companies located in the entire Midwest ($2.6 billion), or the Mid-Atlantic ($2.2 billion)! Will this incredible growth continue on the national and regional level through 1999 and into 2000? Even in light of the recent gyrations in the stock market, most venture capitalists agree: these are very good times for the venture business and its investors. Returns remain healthy and the number of emerging growth companies which have the potential to receive venture financing has not measurably declined. Most research firms which track venture capital investing believe 1999 will likely be on par with the records set in 1998. We will not see dramatic growth, nor will we see a major contraction in venture investing.

Moreover, the long-term performance of venture capital funds remains good. Venture funds returned 16.8% for the ten-year investment horizon ending September 30, 1998. Buyout funds are experiencing similar good returns.

However, there are clouds on the horizon. First, we are currently in a tight IPO market. The IPO market for venture-backed companies virtually shut down in the last quarter of 1998. Only nine companies went public during that period.

Also, the volatility of the public markets has had an immediate effect on the short-term returns of venture funds, as the 3-month and 6-month investment horizon returns were a 3.6 percent loss and a 1.2 percent loss respectively. We expect that as the IPO market improves so will short-term returns, but of course there is no guarantee.

Finally, there are concerns about a ramp up in company valuations as well as an increasing number of "me-too" companies.

Despite these concerns, venture capital remains a darling of the financial world. How long this continues is the subject of intense speculation, but two things are clear:

1. venture capital has become an increasingly important asset class for investors and
   
2. venture capital is now an increasingly critical source of funding and expertise for many emerging growth companies.

In addition, there is another change now taking place which affects how entrepreneurial businesses are being funded. In the past few years we have seen a growing importance of the role of angel investors. The Small Business Administration believes angels invest 8 times as much money in growing companies as that which professional venture capitalists invest. Angels are becoming more established and are even taking part in some of the same deals alongside professional venture capitalists. I believe angels will continue to wield a growing influence over the funding of seed and smaller companies.

The traditional sources of professional venture capital investing have largely remained the same over the past several years. Pension funds, both public and private, continue to be the largest pool of venture capital partnership capital, with endowments & foundations, banks, families, and insurance companies also investing.

One area that has seen increased activity over the past two years has been in corporate venturing, either through independent venture capital firms or through direct investing. In 1997, 24% of all venture capital dollars was committed by corporations, which is a sizeable increase from previous years.

This point is reflected in the fact that NVCA is now seeing a marked increase in the number of new member applications from corporations which have recently created venture capital arms.

Simultaneously, where venture capital dollars are going also has remained relatively static. Money continues to flow into companies involved in the biotechnology, communications, medical device, and software areas. As you are well aware, companies involved in Internet activities are particularly hot right now, and it appears that this will continue as well.

With that brief industry overview, I want to turn to a discussion as to how venture capital is literally changing the American economy.

The success of the venture capital industry is truly astounding. It is hard to believe that the professional venture capital industry has only been in existence for 25-30 years. However, in that short time we have literally taken the lead in changing the U.S. economy from one dominated by a few, large corporations to one dominated by emerging growth companies. Many economists, pundits and politicians refer to this dramatic change as the creation of America's "New Economy."

A lot has been written about this "New Economy," but exactly what is it? Venture capitalists believe that the New Economy is the shift in America's economy---that they have helped create---from one which traditionally relied heavily on large corporations for economic stability and growth, toward an increasing dependence on emerging growth companies for job creation, innovation, technology development, and global competitiveness.

Let's just look at job creation for a minute. Over the past five years, venture-backed companies have aggressively grown jobs on average over 40% per year while the number of workers at Fortune 500 companies continues to shrink at an average rate of 2.5% each year.

Just as important, the jobs venture-backed emerging companies initially create are highly skilled jobs. They typically begin with a core technical team. Once these companies begin to grow, their operations expand and they add important manufacturing, sales, marketing, and other staffs. Thus, jobs ranging across the spectrum are created by these forward-thinking entrepreneurs and venture capitalists.

The New Economy, however, is not simply about the shift in job creation. NVCA member John Doerr of the California-based venture capital firm Kliener Perkins Caufield & Byers has put together an impressive presentation which he uses throughout the United States to discuss the New Economy. Here is a small portion of it:

In The  Old Economy	In The  New Economy
you had a skill	you have lifelong learning
security	risk taking
wages	stock options
status quo	speed and change
job preservation	job creation
labor v. management	teams
plants & equipment	patents & copyrights
people sue	people invest

Finally, I want to address the importance of the role of the government in the New Economy.

The recent and growing role of the venture capitalist in shaping the U.S. economy is nothing less than a remarkable development in U.S. history.

And to be blunt, the current very positive economic climate that Washington policymakers are basking in the glow of right now simply would not exist without these new entrepreneurial companies and the professional and angel venture capitalists who fund them.

And yet, our policymakers frankly do not know much about these companies and how they are financed. And, I believe the impact today's entrepreneurs are having on the operation of the very government these politicians believe they lead is beyond the comprehension of many of them.

I believe that the answer to this problem is not to put our heads in the sand and hope that the government will simply go away. I do not believe that it will. I disagree with those venture capitalists and entrepreneurs who assert that it is unnecessary and even counterproductive for us to take an active role in the public policy arena.

My experience in Washington has led me to firmly believe that we must educate our policymakers if we wish to continue to run our businesses as free from government interference as possible. What I continue to find, and what I am concerned will become even more acute, is that ignorance about the entrepreneurial sector has led and will continue to lead to the law of unintended consequences: legislation and regulations enacted without first examining the potential negative impact on our community.

In addition, like it or not, the government does provide the basic building blocks which entrepreneurial businesses must have if they are to succeed. Basics such as infrastructure needs---for example, highways: both concrete ones and the Superhighway. Other basics such as fundamental research which often is very expensive, sometimes questionable and always very long term.

Moreover, only our government can work with foreign governments to maintain the most open trade markets possible. And, only governments can provide a legal system which protects intellectual property and investors.

And let's face it, with all its warts the U.S. government carries out these necessary functions for entrepreneurs better than any other government. That's a major reason, but certainly not the only reason, why the entrepreneurial culture flourishes in the United States while it still is finding its legs in other parts of the world.

My point here is clear. The more we get involved and educate our policymakers, the better our industry will be. This is where you in the entrepreneurial, academic and investment communities come into play.

Each one of you have a role to play in educating government officials about the new economic order that already exists here and is quickly spreading across America. I offer you a challenge today to get involved in making certain that the economic gains we currently realize are not wiped away by governmental ignorance.

In particular, I challenge those of you in the academic community to produce clear and concise studies on the impact entrepreneurs are having in shaping the U.S. economy. I challenge you to question governmental regulatory bodies which cling to rules and regulations which were produced in an Industrial Age, not in a High Technology Age. Bodies such as the Federal Communications Commission and the Securities and Exchange Commission must understand that their existing regulatory frameworks do not work in the New Economy. Academics can play a powerful, non-partisan role in this critical educational initiative.

Entrepreneurs have a powerful story to tell our elected officials. As job creators, taxpayers, innovators and business leaders your stories can and will have an impact on the views of our elected policymakers. I challenge you to get to know them and to support candidates who support our entrepreneurial culture.

Notwithstanding your political identification, the fact today in Washington is that the center, not the left or the right, governs and will shape our economic policy. The views we express on the New Economy are essentially tailored-made for the center of the political spectrum. This is why both parties continue to fight to secure the allegiance of the high tech community and it is why we must take an active role in our political process.

In conclusion, I believe that the best days for the venture capital community have yet to come, and the best of times for Southern California's involvement in venture capital is just beginning.

Thank you.