In the words of Danish poet and author Hans Christian Andersen, Silicon Valley has become the emperor who wears no clothes. Many Venture Capitalists (VCs), like the emperor, will hold their head high and continue their procession for the sake of protecting their management fees.
And even though more than 77% of funds will finagle themselves into the top quartile performance bracket (according to a recent study) and persuade LPs to hang on, the simple fact remains that very little disruptive innovation is born. And without disruptive innovation (and the risks that such innovation incurs), it is just a matter of time before the Limited Partners (LPs) recognize that the emperor’s procession is coming to an end.
It continues to amaze me how certain people and organizations (specifically the NVCA, desperately hanging on to the past) continue to protect the failed “dating service” between the assets of the LPs and the assets of the entrepreneurs and continue to blame external circumstances on the miserable performance (less than 10% IRR) from the last ten years.
A recent conversation with a technology journalist confirms how many VCs still blame their underperformance on anything else but themselves (see how we debunk their excuses). Another reason why the crop of current VCs could never be or align with entrepreneurs, real entrepreneurs would never stop until they get it right. If VCs are so entrepreneurial, why don’t they innovate themselves out of this malaise?
How did we get here?
In the early days of VC, originating from Bill Draper’s first innovative financing, the sector produced more than 40% IRR. New LPs, attracted by those generous returns, flocked to the sector and deployed massive amounts of money to VC without properly validating the GP’s relevant entrepreneurial credentials. And with VCs improperly calculating risk, the wrong companies are funded – in large numbers. Almost none of them can fool private or public markets, regardless of the state of our economy. That’s where we are today.
Innovation is not the problem
But just because the current VC “dating service” is broken, that does not mean the LPs or the entrepreneurs should lose faith in the monetization of disruptive innovation. Both should merely seek to establish a more effective dating service that focuses on and supports upside rather than worrying about downside risk.
Entrepreneurs should refuse to work with investors that improperly assess business risk; money from the wrong investor is a dead-end street anyway. But most influential will be the immediate action from LPs who should close their underperforming commitments (instead of fleeing), reset their fund requirements, and require more relevant operating credentials from General Partners (Venture Capital needs more relevant early-stage credentials and vision than other Private Equity sectors).
New opportunities abound
With the foundation of technology established (chipsets and the internet), the next wave of innovation comes from platforms and applications (macroeconomic marketplaces), all of which can be developed anywhere. Combine that with the dysfunction of Silicon Valley VCs, and you have the perfect storm of starting new entrepreneurial endeavors in other geographies.
Innovation should not and will not just come from Silicon Valley, but it will only thrive in the hands of investors who understand that the cost of disruptive innovation is priceless. So, merely starting technology innovation elsewhere is useless if it is not matched with an investor with the experience and foresight to see what others don’t: a unique innovation he wants to put his all behind.
The procession continues
The sheer size of LP commitments outstanding to the VCs will keep the emperor’s procession going for a while, and the VC’s refusal to criticize themselves is a sign that it is incapable of recovery and self-regulation. We need new VCs with a new mindset and a different DNA to get there.
While there were more important reasons for me to move (with my family) to the East coast, I certainly do not regret not being there when the naked emperor continues his procession through Sand Hill Road. My focus will remain on helping LPs understand how to invest in Venture Capital and how to regenerate the impressive returns the sector is still capable of producing — or show it to them myself.
We are, after all, in the beginning, not at the end of technology innovation.