Many Limited Partners are contemplating getting out of the venture sector altogether and end their commitments to Venture Capitalists (VCs), no surprise given the sector’s miserable performance of less than 10% IRR the last ten years and no more than 3% of moneys invested producing real public value.
Flight is a natural but inappropriate response.
The technology sector has a long way to go in supplying 5/6th of the world with meaningful technology applications. And with more (global) entrepreneurs at the ready to tap into that wide-open greenfield, the pain in the venture business is not with supply and demand, but with the arbiter in the venture business – the venture capitalist.
I use a simple analogy to make this clear: just because the performance of eHarmony (a leading dating site) is down, does not mean we necessarily have fewer potential marriages. It just means the marketplace (see our innovation primer) where those connections are being made is inefficient. Smart participants will seek to explore new marketplaces where the arbitrage fits their requirements, and so should Limited Partners.
Go for absolute, not relative Venture performance
Many VCs who smell the impending cannibalization of their cushy, no downside position throw anything at Limited Partners to make them recommit for another ten years at the expense of public money.
VCs continue to use any tactic in the book to persuade Limited Partners that none of the malaise in venture was their fault. They are aided by the conglomerate resources of their lobbying organization, the NVCA (the National Venture Capital Association) they drum up every statistic and external market factor known to man to hold on to their position in this ailing sector.
The mere existence of a lobbying organization (with international branches and replicas) alludes to the deployment of artificial market forces. It should be a wakeup call to those depending on it.
But great performance in the venture business should not be measured relative to other VC funds (using meaningless, self-serving top quartile accolades), or worse be measured against public market indices, but should be weighed against the opportunity to monetize the penetration of technology in its global greenfield.
To use another analogy:
The best athlete is not one who wins a race, but one who becomes the fastest man on earth.
The best of the worst
Now, I know the job of Limited Partners is to deploy assets (surplus cash) and get the best possible yield for a given period on that commitment and lockup, without a loss and better, a significant return. To the Limited Partner, it is a game of responsible diversification to a spread of asset classes in which not the individual performance matters, but the yield of all assets under management.
Venture, as one of the avenues with an average allocation of between 10 and 15% of total assets under management, has been for many Limited Partners just the “icing on the cake”, a nice to have but not a necessity. Until the other asset classes started imploding. Hence the reason why many Limited Partners first were reluctant to criticize VC and now suddenly debate to leave the sector altogether.
Some VCs have gone out on a limb and publicly cheered that on, forgetting that – using our previous analogy – a select few may have won the last ten year’s race but that their absolute performance still does not make for a great spectator sport. Especially not since their reason for winning is comparable to a winning streak in Vegas, sheer luck and unsustainable.
Technology Venture should outpace any other asset class
In any economy, Technology Venture should outpace any other sector or asset class for Limited Partners with a ten-year horizon, simply because of the following reasons:
- Technology is a low-cost production business (not a derivative) that capitalizes on the unwavering intellectual brainpower of global entrepreneurs to tap into existing macroeconomic needs.
- Technology taps into a massive greenfield consisting of 5/6th of the world population and is only at the beginning of its exploration.
- The internet provides a zero cost distribution channel that feeds relevant new technology directly and instantly to a massive market pull.
- The fluidity of technology implementations allows disruptive technology to respond and become resistant to economic aberrations quickly.
- Technology relies on nothing but itself to create and maintain instantaneous value, the only volatility in venture is venture itself.
A new way in
What is broken in venture is the VC as the arbiter, who claims to have the ability to spot disruptive innovation but has not delivered, some say for the last twenty years. The commitments from Limited Partners are still flowing, and so are the unwavering ideas from entrepreneurs. All that is needed is a different arbitrage that has proven to spawn highly monetizable innovation against the (absolute) spectrum of a massive technology greenfield.
The existing crop of VCs may not get there, as cannibalization of a complacent position will be painful. But I am sure that if we replace every VC today with an experienced former startup entrepreneur (with successful company growth under his belt), we will quickly produce results far better than the last ten years. The past is the past, so let’s not dwell – but get rid of it.
I can’t think of any asset class with a better risk profile that within a ten-year vintage has the propensity to deliver stellar results. But only with a few new rules of the game and referees that have the wherewithal and experience to make it happen. The instruments of change in its tremendous rewards are in the hands of Limited Partners who remain committed to technology venture.
So, we should treat Venture for what it is: the fastest athlete in the world. And recruit trainers who can get it there.