Last week I was invited to attend (thank you, Brenda Chia, president AAAIM) the panel discussion “Market Changeup: Fund Management as a Business,” with Priya Mathur (Board director of CalPERS, California Public Employees’ Retirement System; one of the biggest investor in LPs and VC funds), David Fann (President & Chief Executive Officer, PCG Asset Management), Jan Le Chang (Vice President, Centinela Capital Partners), Phil Phleger (Morgan Lewis) and Bob Grady (Managing Director, Carlyle Ventures).
Compared to last year (written up here), the opinion of the people at the top of the innovation food chain was remarkably introspective:
Venture Capital is broken in some fundamental way
So much so that PCG predicts a revolution and a complete redesign of the Venture Capital model, with CalPERS nodding in agreement. CalPERS has gone from a yearly review of their asset allocation to quarterly and is currently debating new hybrid asset allocation models. That means less dependency on VC and more on other vehicles. At the same time, it is looking to reduce its relationships to only the top quartile VCs and get out of the mid and bottom-tier ones altogether. Annex funds, created to fill the void of fleeing late-stage investors, are not impressive as the majority of the funds currently in the pipeline will not produce positive returns anyway.
The sentiment from the fund managers was that they are literally “fed up with the rock star parties from VCs that don’t produce returns.” A conclusion not received by all funds as we hear (from a trusted source) that general partners at a downtown Palo Alto walking-dead VC firm are still fetching $1M yearly salaries each this year.
Everything is going to change.
VC is not dead, but everything is under review. Fund managers are now talking to each other for the first time to fundamentally change the outcome of the game, regardless of the state of the economy. They all admitted that none of the widely used mathematical risk models prevented the precarious situation that now forces even CalPERS to pay close attention to its balance sheet and carefully manage available investment cash.
Limited Partners are looking for full transparency of the VC funds, going as far as to see their balance sheets and who is holding their securities. Under the magnifying glass are VC management fees (no more than 25%), splits, as well as exorbitant fees gained through stacked funds. Co-investment with endowment funds is debated as they are too over-allocated in the equity vehicle to provide sustainability. We may see more monolithic investments in VC as a result.
All fund managers think clean-tech and health-tech are exciting asset classes but think the fleeing from technology is somewhat problematic; they have become weary to over-allocate anywhere. Globally, no economy has proven to show any disparate advantage. The Asian and China plays fell equally as hard as the US and elsewhere.
Moving forward, but not so fast
New VC funds will need to come up with a better story. The creators of the new VC funds will likely be experienced operators (just like at the start of technology evolution), removing the pure money managers who failed to add substantial value. They are expected to, as a team, have demonstrated an ability to warehouse deals before, deliver a unique value proposition to the investment climate and provide substantial value to the disruptive plan of their portfolio companies.
CalPERS is eagerly looking to invest in emerging money managers who can expect their renewed support in due time (2-3 years expectancy to close a new fund). So far, in the first quarter of 2009, three new funds have been invested in (compared to 47 all of the last year), and no significant uptick is expected until this summer.
Fund managers are licking their wounds in a holding pattern for some positive news on the economy and perhaps some much-needed regulation concerning transparency. Rest assured, no fund manager seems to debate the value of venture capital as an investment vehicle. It is here to stay.
Help is on the way
The excellent outcome for entrepreneurs is that fund managers (as we predicted) from now on will pay close attention to the type, behavior, and performance of VCs that allows entrepreneurs to build new companies more effectively.
Better times are coming.