This is a simple case of competition eliminating economic profits. Right now, investors generally make extremely good returns. The reason the LP's go with them

This is a simple case of competition eliminating economic profits. Right now, investors generally make extremely good returns. The reason the LP's go with them instead of a mutual fund or some other safer bet is that the returns are better so much better, even factoring in the risk. But consistent returns that are better than the other options (better meaning enough higher that it's a better option despite the increased risk) incentivize other people to get in the game so they can get a share of those profits. But with more investors out there, there's more competition for deals, which increases valuations. In a perfect world, it'll find equilibrium at the point where the expected value of investing in a VC fund is the same as the expected value of investing in a mutual fund--the returns will be a little higher in good times, but the risk of a bad fund will be higher. This is how the free market is supposed to work. Unfortunately, the market tends to overcompensate for things. So instead of finding equilibrium at just the right amount of investment money, what's happening is that we're going from too little money to what is probably too much money. This means that valuations will get so out of control that investors will start getting returns that are low enough that other investment options have higher expected values. This is also a bubble, as it means that startups will be overvalued. The only bright side is that it looks like the bubble will mainly manifest itself by VCs making no money and entrepreneurs making lots of money, rather than tons of failed startups like last time. So far, this bubble is characterized by good companies being funded at very high valuations, rather than hopeless companies being funded at very high valuations. (Of course people were probably sure pets.com would make tons of money in 1998.)