An ongoing, once-in-a-generation shift in the venture capital industry is consolidating more money into fewer hands but creating new opportunities for some Silicon Valley startups.
As pension funds and university endowments, unhappy with a decade of relatively flat returns, make fewer bets on venture, the number of big firms continues to shrink: From more than 800 nationwide in the wake of the dot-com bubble to roughly half that today.
Yet recently, a small but growing handful of VC veterans have launched their own boutique firms. Some industry experts call it a hopeful sign for better days ahead.
"I absolutely think that a small, focused firm has the ability to make a difference for its entrepreneurs in a way that wasn't true 20 years ago," said Greg Sands. The longtime partner at venerable Sutter Hill Ventures on Wednesday will take the wraps off his new $100 million fund, Costanoa Ventures.
Sands -- an early Netscape employee who coined that company's iconic name -- said that while a growing number of wealthy "angel investors" have made it relatively easy for consumer Internet companies to raise a few million dollars, startups targeting business customers are considered less sexy.
On the other hand, he said, those early stage enterprise startups can't get much traction with big venture firms, who are eager to work with later-stage companies that may be close to going public. "If you need $2 million to $5 million to build an enterprise software or data analytics product, there just aren't that many places that are a good match."
Data compiled by the National Venture Capital Association shows that through the first nine months of 2012, even as the number of U.S. venture firms raising money dropped 13 percent compared with last year, the dollars raised grew 31 percent. In other words, the big firms are getting bigger.
That's made it tough for them to cut the small checks that early stage companies need, Sands and others say.
"Most of the traditional firms, their core business is not seed-stage investing," said Aileen Lee, who stepped away from Kleiner Perkins Caufield & Byers earlier this year to found Cowboy Ventures, which weighs in at $40 million.
As she was mulling a move after 13 years at Kleiner, Lee consulted friends like Steve Anderson, a former Kleiner Perkins colleague who launched seed fund Baseline Ventures in 2006.
"They were like, 'Yes, there are lots of people who can write checks at seed stage, but there's not that many people who can offer hands-on help after the investment,' " Lee recalled. (Kleiner is an investor in her new fund; likewise, Sutter Hill has put money into Costanoa.)
Sands, who joined Sutter Hill in 1998 after Netscape's landmark initial public offering, said he expects other venture capitalists to follow in his and Lee's footsteps. "The Internet is doing to the venture industry what it does to other industries: It allows the fragmentation of markets," he said.
Among the 10 startups in which Costanoa already has invested is Lex Machina, a spinoff from Stanford's law school that aims to help companies manage intellectual property. CEO Josh Becker -- himself a former venture capitalist who helped found Redpoint Ventures during the dot-com era -- said he liked Costanoa's approach because a smaller fund can let a VC give more attention to each startup without the pressure to return billions of dollars to investors. (Another Lex Machina investor is Joe Lonsdale, a former hedge fund manager and entrepreneur who recently launched early stage firm Formation 8 with venture veteran Gideon Yu.)
Mark Heesen, head of the venture capital association, cautioned that few investors have the cachet to start new firms with staying power.
He called Lee and Will Coleman, who recently left Mohr Davidow Ventures to form his own cleantech fund, "in the 'A' class." But others, who may be leaving venture firms involuntarily amid downsizing, are being forced out of the industry -- or going into corporate venture capital, which has seen a renaissance in recent years as big companies look to invest cash from their bulging balance sheets.
Some venture firms, which have put off fundraising in hopes the economy will improve, may go out of business altogether, Heesen said. "I think when it comes to the number of firms and professionals in the industry, we have not yet hit bottom," he said.
At the same time, Heesen believes the new funds are a sign of hope that, after several up-and-down years, demand for tech IPOs and mergers will tick up in the new year.
"I think some of these folks who are out now saying, 'I'm going to start a fund' are trying to ride a wave of new optimism," he said. "If we can get over this fiscal cliff, I think we have a very good year coming."
Contact Peter Delevett at 408-271-3638. Follow him at Twitter.com/mercwiretap.
While the number of venture capital firms in the U.S. has plunged in recent years, a handful of boutique firms have arisen in recent years to shake up the industry. They include:
Union Square Ventures (New York) -- 2003
SoftTech VC (Palo Alto) -- 2004
First Round Capital (Philadelphia) -- 2004
True Ventures (San Francisco) -- 2005
Felicis Ventures (Palo Alto) -- 2006
Foundry Group (Colorado) -- 2007
Andreessen Horowitz (Menlo Park) -- 2009