As I explained in “The State of Venture Capital,” our innovation primer, and “How to fix VC once and for all,” Venture Capitalists are the derivative between the assets of the Limited Partner (money) and the assets of the entrepreneurs (ideas).
Venture Capitalists, because they are equipped with the keys to the kingdom by Limited Partners (LPs) therefore claim they must know what is best for the marketplace to function correctly and deploy their best practices (read regulations) to identify investable innovation. And money-hungry entrepreneurs bow down to learn from VCs how to build companies, approach investors, time the market, build scale, etc.
In absolute terms, Venture under-performs
The only problem is very little of that has paid off. With fully loaded commitments from LPs, more highly skilled entrepreneurs than ever, and an 80% technology green field with 7% growth in even the worst of economic developments, Venture Capitalists managed to perform below the technology sector it rides on. None of the financial theories (such as IRRs, financial sector comparisons, etc.) can debunk that Venture should have outperformed the organic growth in technology, and they should have tapped deeper into its virtually unlimited green field.
LPs are getting more frustrated by an exploding technology sector with imploding Venture returns, and one recently communicated on PEHub what I have heard many times now in private:
The correlation between “well-regarded firm” and actually profitable (for its investors) firm is close to zero. I’ve spent the last five years meeting with “well-regarded” firms and it’s the rare exception that has actually delivered returns.
Venture Capital arbitrage, deployed as a demi-cartel in Silicon Valley and feverishly and foolishly copied around the globe, can no longer be trusted. It is time to renew the marketplace and reset the compass of innovation.
The public buys stock
As depicted in the included chart, the role of the public is crucial in establishing a healthy Venture ecosystem. If for nothing else, the most explosive Venture returns are realized in turning a private company public (IPO = Initial Public Offering), and the threat of that investor independence can boost the company’s merger and acquisition value. So, a solid understanding of the importance of an early-stage venture by the public (which we describe as socioeconomic value) is crucial in establishing authentic public stock value.
The public buys product
The best way to have the public understand the value of innovation is to have them use it. Without many people recognizing the intricacies of social networking, it does not take a lot of imagination that Facebook would be a valuable public investment solely based on its user growth. Facebook tapped into an existing macroeconomic need to reconnect with people who were too busy or too remote to stay in touch with otherwise and now reaps the reward of deploying new monetization schemes to a large installed base with no lead generation cost.
Crucial for entrepreneurs is to realize that in building a product (product in the economic sense, so could be a service) for the public, “capital efficiency” is not only a blatant lie, it is the opposite of what creates public trust.
The public needs technology that offers significant attachment to sizeable macroeconomic value, a complete offering (spanning multiple technology silos), and a robust product experience. All the ingredients that are not dished up by the strategies deployed by so many of the subprime VCs who proudly plaster the blogosphere and technology “flea-markets” (you know which technology trade-shows I am talking about) with their spoon-fed investment tactics and meaningless advice.
The public buys into Venture
Not only does the public purchase stock from companies that turn public, but it also feeds the funds of Limited Partners, who deploy a portion of those funds to Venture.
Pension funds, endowment, insurance companies, etc., put their reserves from public cash to work to deal with fluctuations in their businesses. So, a Venture business that does not perform well will not only put pressure on the output of Venture but will have a devastating impact on its input. As the guardians of that money, LPs are increasingly instructed (by their often public boards) to lay off on venture capital.
The highly inefficient financial instrument of Venture severely erodes the potential and trust in the future of innovation.
Treat the public well
The Venture business does not and will not perform significantly better if it, or our government, does not change the market model it deploys (we have an answer for that). As an LP, investing in Venture unchanged is the definition of insanity. Marketplace transparency (to all marketplace participants) that opens up private companies for public review (not investment) is paramount to establish public trust before the company is put on the public auction block by investment bankers.
Entrepreneurs should partner only with Venture investors who understand that Venture Capital is designed to protect the upside, not the downside. That corners cannot be cut in addressing the needs of those who are expected to buy your public (or indirectly private) stock later on.
Treat the public how you want to be treated. After all, we are the public.