Yes, limited partners have been duped. Just like anyone with money will get fooled when not paying attention to how that money is put to work correctly.
The subprime investment tactics by Venture Capitalists have a damaging impact on the returns provided to Limited Partners (those who provide the funds to the Venture Capital firms, such as pension funds, university endowments, insurance companies, etc.) and on the technology asset class as a whole.
We predict that as a result – and within two years when the gestation period of the post-911 VC funds has expired LPs will dramatically reduce the inflow of money in the technology asset class, disappointed by unfavorable returns. To no fault of great entrepreneurs in this great country.
Here is how subprime VC fools LPs:
1/ The LPs believe they are investing in a premium technology asset class, but in reality, they are investing in an artificially constricted commoditized asset class we call bootstrapped innovation.
2/ The LPs believe they are investing in a high-risk high-yield asset class, yet the VCs operate using low-risk (almost investment banking style) tactics with inherently low yields.
3/ The LPs believe they are spreading the risk by investing in multiple VC firms, not realizing that the majority of them invest using the same rulebook and therefore identical risk patterns. The LPs unknowingly are investing deeper rather than broader.
So, like when my daughter misbehaves (rarely), and I need to take control of the situation, so must the LPs take control and tighten the leash with VC firms that are behaving “badly.” The behavior of my daughter (or dog if you consider that your child) is my responsibility; the practice of VCs is an LP responsibility.
Here is what every LP should do right now:
1/ Bring every invested VC firm in and re-assess whether the invested amounts, category, and valuations per portfolio company match the initially stated investment thesis and more importantly, your current risk profile across all assets.
2/ Ensure the spread between the investment in technologies versus the application of technology to markets aligns with renewed opportunities and your current risk profile. The impact of technology has dramatically changed (rather than reduced), and many VCs are still stuck in the past.
3/ Hire an operational partner that establishes continuous oversight into the VC investment allocations based on the risk and identity associated with each participating fund. That oversight should prevent the fund from investing outside pre-established criteria.
Now is the time to reassess the investment opportunities in our technology industry. We know opportunities for investment are aplenty, just not with the current investment tactics.
As Cesar Milan, a.k.a. The Dog Whisperer teaches us: it’s not too late to rescue any dog – as long as we can change the behavior of its caretaker. Similarly, it is never too late to improve entrepreneurialism if we change the behavior of its investors.