Better days ahead for venture capital.

• Author: Pearce, Bryan
• Position: Venture Capital - Statistical data

From the sovereign debt crisis in the eurozone, to the slowdown in China's gross domestic product (GDP) growth, the global economic uncertainty of 2012 took a toll on venture capital (VC) investment. The industry dropped to its lowest level since 2009, with global VC investments tumbling 20 percent to $41.5 billion while the number of investment rounds dropped 8 percent, to 4,970.

For the United States, the news was not as bad. The U.S. leads VC investment by a substantial margin, compared to the next largest VC hotbeds, namely China, Europe, India and Israel. Last year, the U.S. and Europe accounted for nearly 85 percent of global VC investment. Though it must be said that VC investment activity overall declined by 15 percent in the U.S., to $29.7 billion, and the number of investment rounds also fell, those numbers are not as pronounced. Juxtaposed with the global trend, the U.S. held relatively steady.

Despite the tumult, innovators still had funding options. Angel investors and crowdfunding platforms stepped in to fill the gap at the start-up stages, while VCs moved to later-stage, high-growth ventures. Incubators and accelerators continued to grow, and some VCs offered seed funding, often accompanied by office space and shared services.

Going forward there is reason to be optimistic in 2013. Equity markets have started the year strong, and institutional investors are buying again. Early signs suggest better exit prospects, a pre-condition for increased fund-raising.

Fewer Exits Choke the Flow of New Funds

General partners (GP) of VC firms are finding it harder to exit their portfolio company investments. That slows the flow of capital being returned to limited partners (LPs), who have become hesitant to invest in new funds. The poor performance of many VC funds relative to benchmark indices, such as the S&P 500, also hurts the case for reinvestment. LPs are demanding stricter terms and the funds are requiring portfolio companies to meet more aggressive milestones and tighter time frames.

There is a historically low overhang of uninvested capital in North America-focused funds, and that underscores the need for the return of a successful exit environment. In the past, VCs were able to raise capital for a new fund and use that capital to continue to support their companies and fund new investments. But that has changed, and as a result, VCs do not have vast stores of cash. In some instances, VCs have funneled more money toward older...