The biggest complaint I hear and agree with is that Venture Capitalists (VCs) just don’t get it and in the words of a VP at Apple, VCs simply don’t line up with the needs of entrepreneurs.
Real innovation has no precedent and leaves many VCs, with their platitudes and an army of analytics in the dark in coming up with a reliable reason to invest. I personally had a VC become teary-eyed about the prospect of having to convince the rest of his team about an investment I presented, and I subsequently got it funded elsewhere.
With monetary assets being equal, it takes a visionary or a black swan (whichever classification floats your boat) to separate the good investor from the bad. Great investors have a strong belief that finds solace in an internal compass that is fine-tuned by years of risk-taking. Risk-taking in entrepreneurship or personal life, whichever one shaped that core competency. We have many VCs with strong beliefs, but few of those beliefs are founded on relevant experience.
So, entrepreneurs (and LPs) take note of what is the most important ingredient to look for in the bios of General Partners (GPs). With few exceptions, a GP (General Partner) that has never been a CEO at a startup, responsible for developing and executing its unique ecosystem, is not a great candidate to become a VC. Neither is the GP who has never challenged him/herself personally.
Venture Capital is government
But not only are those investors hard to find, the physical makeup and workings of the current VC construct is diametrically contradicting the decision-making for groundbreaking innovation. As long as the meritocracy at the VC level of the investment pyramid that started Venture Capital is not restored, the artificial arbitration of the current aristocratic model will continue to erode high yield returns.
Here is how VC acts like government:
1/ You (still) need to be in Silicon Valley
Just like you need to be in DC to make an impact on politics, do you need to be within 20 minutes of Sand Hill Road in Menlo Park to be on the radar of investors.
2/ You need an intro to the VC
In DC you need lobbyists to get anywhere, in Silicon Valley you need to find similar lobbyists that can introduce you to the investor you want to talk to. Most GPs simply refuse to talk with entrepreneurs they have not met before. Entrepreneurs who contact VCs directly will find themselves debating the vision with an academic white swan, dramatically improving their chance to get rejected.
3/ Investment decisions require internal consensus
Politics is based on consensus. Likewise, if the entrepreneur is lucky to convince one GP of their proposition, the next monday morning meeting at the VC firm is spent on getting other GPs to agree (except if the first GP is of John Doerr stature). In essence it means a unique invention is shoved through a democratic (government) filter to be validated with chances of a majority vote rapidly approaching zero.
4/ Deal syndication requires external consensus
Many VCs don’t have the balls (excusé les mots) to make independent contributions to companies and look for syndication to mitigate the risk. Just like in DC where politicians look for peers to join their charter, before they stick their necks out.
5/ Lack of accountability
VCs can hide behind the size of the portfolio to select one or two successes to brag about. Just like politicians that hide behind a party and associate themselves with many initiatives and get credit for the few that worked. Quite opposite to the devotion of an entrepreneur.
6/ Lack of transparency
To understand politics you need a graduate degree in the subject matter, to understand VC you need to be (or have been) one. Just because the type of businesses VC invests in are private, that doesn’t mean VC needs to be.
7/ Far removed from its constituents
Not only physically but spiritually many politicians are far removed from their constituents when they enter into office. So are the VCs who prefer to congregate more with each other than with entrepreneurs to develop unique support for disruptive innovation. VCs are oblivious to the many “false negatives” (as described in my previous blog) they don’t even get to see, just as many politicians forget that many americans don’t vote at all.
8/ Fewer real innovations are born here
DC (at least before Barack) is not the place to get anything done, and Silicon Valley choking on a vast supply of sub-prime VC is not the place to get anything really disruptive done. The real world is the market, not the current VC interpretation of it.
9/ Long incubation periods
Just like in politics, once the GP secures a fund with the LP the performance of the fund is in limbo for 5-10 years. That is a more secure job than the presidency of the United States. Many GPs stack funds or jump ship before it is about to go under, picking up new management fees under a different fund and LP structure. Another 5-10 years of GP safety lies ahead.
10/ External circumstances
Just like in politics, VCs blame their underperformance on anything else but their own decision-making. The state of the economy is their welcome excuse, even though startup economics are quite resilient to macro economic aberrations.
So, the point of this blog is to emphasize that in order to get VC to create high yield returns we not only need to take a close look at the GPs that take the risk but change the mechanics of VC from a “government” based system to a meritocracy at the VC level of the investment pyramid. That is the message I will develop further (and more constructively, I’ve hammered on VC enough) in helping individual LPs develop new relationships with VC firms.