01/19/2011 12:00 am ET | Updated May 25, 2011

Venture Capital Fundraising Keeps Shrinking In 2010

Startups raised less money in 2010 than in previous years, due to the continued downward trend in venture capital fundraising.

Thirty-five funds raised close to $3 billion, according to Thomson Reuters and the National Venture Capital Association (NVCA), representing a six percent decrease from the third quarter. For all of 2010, 157 funds raised $12.3 billion, the fourth consecutive year of decreases for the sector, and the slowest year for fundraising since 2003. But despite unfavorable numbers, some believe the industry may simply be evolving to survive the general economic climate.

"It is very much a Darwinian environment--those VC firms that have had a good track record in the past are going to be able to go out and raise a new fund, while those firms that have yet to be able to have a successful company are going to have a harder time in this environment," said Mark Heesen, president of the NVCA. "We are in a period where we are seeing contraction and we believe that is going to continue but at the end of the day we'll have very strong, competent VC firms investing and investing in solid companies."

A recent study from the NVCA found that the poor market for IPOs, as well as unstable regulatory environment and unfavorable tax policies, were a major influence on venture capitalists' pessimistic evaluation of the industry's immediate future. This marks the first time tax and regulation have emerged as concerns for surveyed American firms--Congress's agenda this year includes raising taxes on the profit known as "carried interest," the share of capital earned on long-term investments by the general partner in that investment.

But venture capitalists remain positive about the future of their industry, holding to the belief that even with a smaller pool of investors making less investments, what remains will be a more agile, intelligent pool.

"There have always been venture capitalists and there will always be venture capitalists," said Bill Janeway, managing director and senior adviser at Warburg Pincus. "Tonio in The Merchant of Venice was a venture capitalist--he had five different ships sailing on five different routes. Unfortunately, he lost all five and had a really tough limited partner."

Many venture capitalists believe that investments will shift over into emerging countries like China, India and Brazil and away from the U.S. as investors seek friendlier regulatory environments and growing markets. Only 18 percent of American venture capitalists expect the industry to grow in the next five years. Seventy percent of Chinese respondents expect growth of over 30 percent in the same period.

"I think that when you're young and new to the market you're very excited," said Heesen. "The Chinese, the Indians, are going to be more optimistic than folks who've been through the trenches as well as the good times. You also have burgeoning economies and huge numbers of consumers that you just didn't even have five years ago."

One notable exception to American venture's overall shrinkage is tech-focused firm Andreessen Horowitz, which raised $650 million in the fourth quarter. Indeed, giddiness over tech startups, particularly in the social media arena, has only seemed to flourish. While daily deal site Groupon raised over $950 million in their latest round of fundraising, a number of other social startups like Klout, Square and Foodspotting also recently closed funding rounds successfully. Of course, tech startups require far less capital than biotech or clean energy.

"Companies in that space grow up very quickly," said Heesen. "They move very quickly and they're not that expensive."

But neither Groupon nor social media giant Facebook have yet seen fit to make an IPO, a common pattern in the sector that has led some to believe that social media is headed for a bubble. Still, despite anxieties over the diminishing venture capital fundraising, most expect that the industry will continue to soldier on.

"If you're a venture capitalist and you're not an optimist, you're in deep trouble," said Heesen. "US based VCs are realistic about the current economy while being optimistic about the future economy."