Many are speculating that 2009 represents a fundamental turning point for the venture capital industry. Some are arguing that the industry is in dire straits after years of poor performance. Others have argued that the math simply does not work for the industry’s current size. What Is Really Happening to the Venture Capital Industry?

It is indeed quite likely that the venture industry is in the process of a very substantial reduction in size, perhaps the first in the history of the industry. However, the specific catalyst for this reduction is not directly related to the issues just mentioned. In order to fully understand what is happening, one must look upstream from the venture capitalists to the source of funds, for that is where the wheels of change are in motion.

The issue, explains Kevin Durant of abovethecrowd.com, is that a lack of liquidity and fairly ordinary returns from VC funds have driven institutional capital from the venture space. If so, it’s not that the IPO drought and absence of exit events for start-ups is what’s hammering Sand Hill Road, but rather a perfect storm of fiscal crisis and shrinking capital sources. That, coupled with the fact that VCs travel in packs and tend to jump on the bandwagon AFTER the innovation train has already left the station.