Nearly everything exists in cycles; from the lynx population of Canada to the S&P 500.
The idea was pioneered by Edward Dewey, former Chief Economic Analyst of the State Department in examination of the Great Depression, and it can be applied to private financing.
“The venture business has a pattern of roughly eight years of growth followed by six years of retrenchment.”
This can be seen in the following graphics:
We’ll use number of funds as a measure of venture capital health because that means limited partners are more confident in venture capital. The cycle begins a peak at 1986, then descends to around 1992. This marks the first retrenchment that we’ll be following. Then, it begins expanding on an 8-year run to around 2000. This is the notorious dot-com bubble, when LPs, GPs, and entrepreneurs were in a frenzy to pour capital into private companies. The same trend continues in the subsequent years:
This time, we’ll be using gross venture capital investment as an indicator of venture capital health rather than number of funds. Both measures convey the same trend. From 2000 to 2006, we do see an overall negative trend from approximately $30 billion to $7 billion. Then, the positive, 8-year trend comes back to 2014. Right now, the venture capital investment, according to Patterson’s postulation is amidst its 6-year retrenchment cycle.
Why does this happen?
As expected, the answer is not clear. Patterson never offered an explanation; probably because of a lack of hard evidence for outside causes.
Dewey would postulate that this is constructive interference of multiple exterior factors. Since nearly everything exists in waves, the crest of multiple phenomena could cause a crest in even the venture capital sector. Conversely, troughs in exterior phenomena could create destructive interference in the venture capital sector. That could explain the periodicity of Patterson’s Cycle.
However, one Quora user (Venkatesh Rao) made a very interesting postulation. VC firms tend to follow the traditional 10-year horizon of expected returns. If one were to account for the 1 to 2 years of pre and post processing for a VC fund and spread in fund start dates, this would conveniently total to the 14-year Patterson Cycle. This is an interesting take, and one that definitely deserves more research.
As for what this should mean to entrepreneurs:
Yes, the obvious answer would be to start a company near a trough to enjoy the benefits of a bull market. This would lead greater valuation over revenue multiples. However, entrepreneurs would feel the same hit of a retrenching market in subsequent funding rounds. A successful company’s horizon should be greater than this 14-year cycle, so entrepreneurs should be careful in depending on the Patterson Cycle in their endeavors. It’s all about developing the right company regardless of macroeconomic noise.