I covered the systemic risk of Venture Capital (VC) many times.
I came to this country some 15 years ago to pursue my entrepreneurial endeavors, and despite my successes, I have seen the effects of a debilitating venture business restrict the dreams and bright future of others.
Even some of my work could have yielded better financial returns, were it not for the subprime nature of some VCs (and their entourage). In an in-transparent business (read “How to fix VC once and for all”), it is often impossible to establish their real merit (and character) ahead of time.
The Venture Dilemma
Limited Partners (Pension funds, Endowments, Family trusts, etc.) who supply their money to VC in capital-calls are faced with the harsh reality that venture (the venture capital sector) has produced less than 10% IRR for the last ten years and are now asked again to buy into the rhetoric from General Partners (GPs) at the VC firm that none of this was their fault, and renew 10-year multimillion and sometimes billion dollar commitments. The question for the Limited Partner (LP) arises; should I stay or should I go?
Many Prime VC Firms have Turned Subprime Too
Top quartile performance (a meritless definition in its own right) by one VC fund is unlikely to rescue the plethora of under-performers nor yield much higher than 10% IRR in total LP sector returns. And even the performance of classic top-tier VC funds leaves a lot to be desired.
Mayfield Fund appears to have no regret admitting “classic bubble” mistakes and “bringing in big company management”, non-market risk mistakes that do not belong to a seasoned investor. Sequoia Capital issued a dramatic cutback message at first dawn of the economic crisis to its portfolio companies, in essence, communicating that their companies are not disruptive enough to withstand economic aberrations. From public reporting by a public pension fund, Draper Fischer Jurvetson does not appear to be knocking it out of the ball-park either. Rumor has it that another top-tier firm, Benchmark Capital is the only firm in Silicon Valley to produce more than a 1x return on all of its funds. This is unacceptable performance and behavior of venture firms we collectively tend to think of as top quartile. Or are they?
Many of the top-tier funds that flourished in strong winds and made even turkeys fly, have diluted their teams with general partners who simply lack the relevant operational experience (read “Why VCs really need relevant operating experience, now”) needed to prevent them too from sliding into the overwhelmingly subprime venture ecosystem.
The Threat to Innovation
Clearly LPs have alternative options of deploying money into other asset classes (liquid or illiquid) and not buying into the feeble VC (and their lobbying organization) arguments will by default yield to a significant reduction of funding for innovation if not cause the industry to spiral further down to inappropriately applied risk and deal commoditization (we refer to as subprime VC).
At least ten years of subprime VC continues to attract subprime entrepreneurs who, in turn, create more subprime performance and turns venture capital into micro private equity (PE). The erosion of the venture sector is well on its way, and LP assets meant to be deployed to high-risk/high-yield innovation have instead slid down to high-risk/low-yield scale. LPs who meant to invest in venture, have instead invested in micro-PE.
Technology is Not the Risk
Fragmentation and further diversification at the VC level is not the answer to an ailing venture business. While it is exciting for the unknowing entrepreneur to see new angels attempt to fulfill the role VCs are not; such as Jason Calacanis, Adeo Ressi from The Funded, and other new angel groups, the early stage technology trials (as I prefer to call them) continue to deploy the wrong risk and continue to pull the venture business further into the swamp of subprime innovation. As I described in my reference to Vinod Khosla’s model of investing, technology development is not the investment risk of the venture business.
Smart LPs Look for a New Breed of GPs
Those LPs who do not want to flee the venture sector and realize that technology still has a bright future ahead better not make the same mistakes twice. The dating service of innovation (VC) may not be working correctly, but the real asset holders in the marketplace of innovation (see my article on the innovation marketplace) are eager and aplenty to monetize a new world of change.
New VC fund requirements need to be established to reintroduce risk-taking Venture Capital to the technology sector, which subsequently attracts entrepreneurs that have the capacity and drive to change the world.
LPs need to:
- Establish new GP qualification criteria. Money without merit is not likely to yield outlier results.
- Re-evaluate Private Placement Memorandums to focus on market risk rather than technology risk
- Drive defragmentation and accountability of the investment thesis
- Implement merit-based GP remuneration, including the downside
Financial marketplace imperfections aside, the miserable performance of the venture sector has nothing to do with the economy and has everything to do with the risk we as early-stage investors deploy to attract genuinely groundbreaking innovation.
I have been called taking cheap shots at VC when they are down – by one VC titan I reached out to. But for some reason, I do not feel bad demanding excellence from people driving their Maseratis and Porsches from the mostly public money that feeds them. It is not personal, but we owe it to our economy to return merit-to-money.
Limited Partners are in full control of their destiny in venture, by how they commit. And now is the time to invest in venture with more discretion and expertise by hitting the VC reset button.