As a general premise, we adhere to the "endowment model" of investing and believe venture capital has a place within every diversified portfolio. We think it is difficult to "time" the market as well as access the best managers intermittently, and that it therefore makes sense to invest consistently in the asset class. It is also our belief that investors that have done so over long periods of time have been richly rewarded. While speaking from an admittedly biased perspective and perhaps offering more tactical guidance than normal, we hope this piece offers our perspectives on the current state of the market, given the profound impact that extraneous factors continue to have on the venture capital industry. It is based on experience, empirical research, and ongoing discussions with our managers.

First, the macroeconomic turmoil of the past 12 months - declared by many as the worst financial crisis since the Great Depression - hastened the consolidation in the number of venture capital firms, which we had viewed as an inevitable and positive process for the industry. At the height of the Internet bubble, the number of truly active¹ firms approached 1,200. Today, that number is closer to 400 and trending downward toward what we perceive as a far more "right-sized" industry with 300-400 U.S.-based firms.

Second, in addition to hastening the venture capital industry's rationalization, the general market environment is positively influencing competition, investment pace, valuations, and recruiting, while negatively impacting managers' legacy portfolios. Regarding competition, fewer active funds leads to less look-alike companies, with only the best of the best able to secure capital.

Second-order effects include slowed pace and lower valuations; remaining managers are able to commit more time to due diligence and thus make better investment decisions, as well as complete financings at reduced valuations, evidenced by a dramatic decline in early stage pre-money valuations through the fourth quarter of 2008. Further, slack in employment creates a "buyer's market" to recruit toptier talent to portfolio company management teams. And most established managers have large existing portfolios, comprised primarily of company stakes acquired pre-crash and therefore at higher relative valuations. They are focused on triaging these portfolios by cutting burn rates and shutting-down poor performing companies.

The net result of all of the above factors is an attractive environment for new dollars committed to venture capital. Issues certainly remain, including constraints on General Partners' time due to legacy board positions and a still lackluster exit window. However, an attractively structured industry comprised primarily of proven General Partners should lead to attractive absolute returns (and we would argue that 3-, 5-, and 10-year venture capital data suggests that strong returns relative to public market indices never fled) over the next cycle.