I have disclosed in “How to fix VC once and for all“a critical aspect of how to fundamentally change the financial system in Venture, and that is to transform it into a real marketplace. A free-market in which marketplace transparency to all participants will establish the real merit of all participants; Limited Partners (LPs), Venture Capitalists (VCs), and Entrepreneurs alike.
Without that marketplace transparency, Venture Capital will continue to slide down the sub-prime investment slope it has been on the last 10, if not 20 years, leaving a growing opportunity of disruptive innovation under-financed and starving. Unchanged, the deployment of LP dollars will continue to fragment and yield even lower public value and trust than it has produced over the last ten years.
Top-level Venture reform
The systemic failure of the financial system in Venture is why its output does not generate enough value (M&A, IPO, etc.). Venture Capital needs to become agiler, risk-taking, transparent, and accountable (turn prime) to consistently attract entrepreneurs with a value that can change the world.
Its financial system is what turned Venture Capital sub-prime, not the lack of entrepreneurs, developers, visas, too many regulations, SarbOx, FAS157, etc.. Once we change Venture into an efficient free-market marketplace I can assure you many of the current restrictions, born out of an artificially regulated market, will naturally dissipate or become irrelevant.
Today, Venture performance is severely hindered by its black-box, under-the-table, institutionalized, monolithic operations. Lack of marketplace transparency (amongst many other deficiencies):
- allows walking dead VC firms to crush the dreams of (unknowing) entrepreneurs
- prevents competition between VCs, leading to a demi-cartel and a commoditized investment thesis
- enables GPs to hide behind the (often outdated) brand of their aging VC institutions
- clouds the difference between money and merit
Take me serious, for you sake
Building a new financial system for the sake of re-empowering innovation through Venture is “my new startup,” and as is typical to innovation, many first ignored me, then they ridiculed me, then they fought me, and then I win (Gandhi quote).
I win because Venture reform is the right thing to do for our country (not because I have an ax to grind). I win because the sector has lost serious money. I win because the opportunities in Venture have never been better. I win because the systemic failure of VC proves they are wrong. I win because there are no more bubbles for VCs to ride. I win because VCs are running out of excuses and time. I win because VCs (by their selections) have abused the trust of public markets. I win because entrepreneurs are unhappy with whom they partner and how they are being treated. I win because both asset holders in Venture are unhappy with the derivative. I win because I have identified the systemic failure in Venture and have a solution to fix it all in one fell swoop.
We all win because that solution gets us all to a better place, including VCs with merit.
LPs own the problem
LPs are becoming aware of VC dysfunction and have started calling their Fund-of-funds and VCs based on my conversations with them and my blog, some VCs have confessed to me. LPs are at the top of the food chain and can no longer deploy money without verifying the merit of the underlying financial system, top-to-bottom. The behavior of the dog is the responsibility of its owner, and so is the performance of VC the discipline of the LP.
LPs now start to realize that excellent performance in Venture comes from establishing discipline. Not just to who, but how they deploy money matters, and what the impact is on the rest of their value chain and the sector. How it affects VCs and how it finds the outliers of innovation that can produce substantial value. Only that discipline can fundamentally and consistently lead to high performance.
Smart LPs in Venture understand how to rely on a real marketplace in which merit and real competition (not the artificial one Tim Draper defines as “I have respect for all my competitors. We co-invest together.”) thrives on finding the outliers of innovation.
It still baffles me how some LPs continue to recommit to Venture without a change to the underlying financial system and marketplace characteristics. But perhaps I shouldn’t be surprised: a sector that has previously managed to sell the delusion of cyclical performance, measured against irrelevant market indices, and attracted the improper influence of the macro-economy, is very capable of producing new promises to maintain its position.
LPs should not expect those promises to come true, not again. That would be the definition of insanity.
What is not a solution to Venture is cutting management fees. Changes in fees and carry structures are not going to change a sub-prime VC to prime. You cannot train or coax sub-prime VCs to become prime, in the same way, you cannot teach or cajole people to become entrepreneurs. You are, or you are not (by your DNA and life experiences). And just like VCs need to focus on the creation of upside, not the protection of downside – so do LPs need to focus on the upside with VC, established by merit, rather than protecting the downside.
Lift the veil off my plan
But marketplace transparency is just one aspect of my plan. The Venture reform described in the (for customers only version of the) acclaimed presentation “The State of Venture Capital” resolves all of the issues mentioned above in Venture, including:
- reduces ten levels of diversification by more than half
- eliminates bottom-heavy diversification
- employs far less fragmentation of risk
- establishes a meritocracy of GPs
- creates natural competition between GPs
- de-commoditizes the investment thesis
- allows for the discovery of the outliers of innovation
- provides better support for entrepreneurs
- deploys real venture capital
- builds more stable companies
- builds more disruptive value
First movers advantage
Before Apple entering the music arena, many VCs invested in music without producing any lasting public value. Now in Venture, I am about to deploy a winner-takes-all Venture platform that leaves the LP laggers with artificial Venture marketplaces behind. Venture, the way it works today can never function nor scale because the market model is just incompatible with the discovery of the outliers innovation.
I invite the LPs who see the wide-open greenfield opportunity in Venture, to hop on board and use a brand new mower that is indeed capable of harvesting the hay that is ready for the taking. Innovation is by no means dead, and neither is the fantastic new opportunity to monetize it.