What follows is not a forecast. It is only an observation. If anything, maybe it’s a note in anticipation, so that relevant parties can be watchful and prepare, take necessary precautions, craft out an action plan based on the scenario, just in case. There is a chance that competition for venture capital in the year ahead will surpass the norm, and will make individual transactions more challenging to complete. If the laws of supply and demand apply to this market like any other, then there will be a rebalancing up ahead. Both supply and demand have moved in the wrong directions recently, and, all else equal, assuming no immediate change in circumstance, experience may begin to reflect this dynamic soon.

On the supply-side – defining supply as the amount of venture capital available for investment – there was a continuing diminution of fundraising by venture capitalists in 2010. According to published reports, U.S. venture funds raised $11.6 billion last year, down 14 percent from 2009 and 70 percent from the $40 billion raised in 2007. On the demand side – defining demand as the universe of private enterprise likely to seek venture capital – there has been a concurrent increase. We’ve heard about growth in entrepreneurship everywhere in the past one or two years, but that’s not an easy matter to quantify. What’s easier to establish – although it may seem counterintuitive – is the amount of venture capital actually invested in 2010, and use the data as a relative indicator of future demand… because previously funded enterprise will typically require additional capital ahead.

According to the NVCA, venture capitalists invested $21.8 billion in 2010, an increase of 19 percent over the prior year. And now this next comment is key: “There were nearly 30 percent more new companies receiving venture capital for the first time in 2010 than in 2009.” Companies receiving first funding in 2010 will look for second funding in 2011, no? As venture funds took in $10 billion less in 2010 than they put to work, this will be a difficult flow to sustain and a tough environment for that follow-on round, unless venture capital fundraising steps up to reset the balance.

The best way to describe the issue, however, is less with statistics and more with example. Last week we saw the introduction of the Start Fund, a new seed fund that will invest $150,000 into every participant of San Francisco’s YCombinator program. This is the most recent manifestation of what some have referred to as a seed bubble, which has produced a number of new micro VC funds and “super-angel” initiatives in the past year. With all these new initiatives and the start-up frenzy that tends to build, the number of prospects that will be making their way to the doorstep of VCs for next rounds should increase. On the other side of the door, the venture funds have their own portfolio commitments to keep supporting, and may as always be entertaining syndicate opportunities to participate in select positions of other VCs. And again, as this occurs, and while the class of 2010 seedlings also knocks on the venture sponsor’s door with slide decks and product demos, the capital pool has been – according to data – shrinking.

For venture capitalists – at least the ones with adequate resources – the scenario is a good one to experience: With greater selection, greater opportunities to find good prospects; with greater demand, greater ability to drive good terms. For founders and entrepreneurs, the scenario becomes one in some ways directly contrary to their first-round experience. If the seed investing frenzy of 2010 led to relatively easy money for many, the second round is going to be much more selective and will be more delicate work. The competitive landscape will call for polish, preparation, thoughtful positioning, a solid execution plan, demonstrated traction – in short, evidence that graduating from the school of 2010 into the real world of 2011 is warranted. This will be a very different pitch from what may have been presented a mere year ago, when trying to gain admission to the program, in a manner of speaking.

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