The first wave of Venture Capital began in the early 1970’s driven largely by some brave souls such as General Doriot at AR&D, Charlie Waite at Greylock in Boston, Peter Crisp of Venrock in New York and Arthur Rock in California.  They set out to raise risk capital from family trusts, and put that money to work largely in the nascent computer industry.  The amount of money they raised and invested was small.  But the gains they made were substantial.  In addition, they were helped along by one very significant change.  That was the emergence of a public stock market that would support liquidity of new and largely un-proven companies.  The rise of NASDAQ was a critical factor in the success of the pioneer venture capitalists.  So, there were three drivers to the first wave people, technology and liquidity.  They sustained that wave for a decade.

The second wave of venture capital arrived in the early 1980’s, driven by a major change in the laws regarding how pension funds could invest their money.  The ERISA statute was revised to allow for previously ‘risky’ investments in private equity to be covered by the ‘prudent investor’ mantra.  Money into venture capital exploded!  Pension funds put their stunningly large asset bases in play, and the cash bonanza was on.

This cash was coupled with a technology push brought on by powerful microprocessors and a related new wave of software and networking technologies.  In addition, both the medical device and biotech industries began to attract startup investment.  However, this flood of money and technology was not matched with the third component people. With too much money chasing too few good deals, and without the time to develop seasoned professionals to put the money to work wisely, returns for venture funds plummeted.  The average return for all venture funds founded from 1981 through 1988 was in single digits! Investors would have been better served in T-bills!  As a result, the early 1980’s VC boom quickly gave way to the VC bust of the late 80’s and early 90’s.  As the evidence of meager returns mounted, cash inflows into VC firms dropped dramatically.  So, in turn, did the outflows to startups.

However, this was not simply a matter of weak financial performance.  The technology revolutions pushing new startups in the 1980’s did not have the longest legs in the world.  The microprocessor spawned many new companies, but by the end of the decade, most of the rich veins had been mined.  Software companies taking advantage of this new distributed computing power lasted longer as a startup phenomena, but by the early 1990’s a few software powerhouses emerged, stifling new entrants.  Biotech proved to have a much longer gestation period than information technology, and the public markets got tired of playing venture capitalist.

In any event, the second wave of venture capital had two out of the three components necessary for sustained growth liquidity and technology, but the lack of skilled people helped it crash on the beach, taking many investors out to sea in the undertow.  It was all over in about five years.

We are now riding a huge third wave of venture capital investment.  Unlike the second wave, the massive flows of money have led not to diminishing returns but rather accelerating returns even taking into account the dot com meltdown of early 2000.  Entrepreneurs are finding it easier and easier to raise funds, and at ever increasing valuations.  Are we still in a speculative bubble, or is it “different this time?”

At the risk of looking foolish in relatively short order, I will argue that it is different this time, and although capital flows will rise and fall, as will returns, this wave is far more sustainable than the last.  Here are three reasons for my optimism: We have the most powerful liquidity engine ever, thanks to the bull market and the demographics of the baby-boomer saving for retirement investment surge. We have the most powerful technology engine ever, thanks to the web, broadband and wireless communications, and the human genome project. The people side is under control thanks to the large number of seasoned executives entering the venture business.

Unlike the short second wave, the financial inflows have been so large, and have been sustained for so long, that they are not likely to dry up overnight.  Institutional investors who have enjoyed outstanding returns the last five years are not likely to cut and run at the first sign of trouble.  In addition, venture firms now have so many overlapping funds that they can survive and provide money for startups for some time without new injections of cash.

Unlike the second wave, the truly global inter-connectivity of the web, coupled with the pending move to high bandwidth to the home, opens up so many new business opportunities, and business models, that innovation should thrive for some time.  Wireless technology is still in its infancy. While many people talk about the rise of the personal computer and local area networks as the dawning of the Information Age, I believe it is the rise of connectivity that heralds the real growth spurt.  In addition, we will probably see a resurgence of biotech investing, as the long gestation period started in the 1980’s suddenly bears fruit at the start of the 21^st century.  Building on the human genome project’s exciting results the possibilities are endless.

Finally, venture capital now is attracting not just a few brave souls, nor just fresh-faced MBA’s, but a cross section of experienced business and technology minds.  That broad base of talent will provide the sustained human capital to take the risks, learn from the mistakes, and persevere.

No asset class goes straight up for any length of time.  Venture capital is no exception.  However if you look at the three key drivers for this industry: Money.  Technology. People.  It’s all there.  Ride the wave!