I am talking to a lot of Limited Partners and Fund-of-funds managers these days and the reputation of venture as a viable asset class (sector) is really bad (even though the opportunity dictates it shouldn’t be).
Few people at the top of the investment food-chain seem to have a good sense of what it going on down below (with General Partners at VC firms), and even fewer believe a further commitment to venture makes sense. Our government adds to that mistrust by not even acknowledging venture as a viable instrument to resurrect innovation.
No True Alpha
But can we blame them? The returns (of the portfolio of investments, some money managers represent by a formula that yields “alpha”) in the venture business have been deplorable from many angles:
- From a Limited Partner (or Fund-of-funds) perspective; with less than 10% IRR over the last 10 years and less than 3% of $2 Trillion invested yielding public value.
- From an economic perspective; more than $1.9 Trillion of (mostly) public money has been wasted in the last 10 years on so-called innovations by venture that never generated any public value.
- From an entrepreneurial perspective; the definition of innovation has severely eroded by the subprime nature of the investment thesis that makes it unattractive for meaningful innovation and real entrepreneurs to be discovered.
- From a consumer perspective; we have created no more than a handful meaningful innovations with an army of 800 Venture Capital firms chomping at the bit. We have eroded the trust of the people we aim to serve and those we rely on to spawn a high-flying public offering.
No True North
No True Alpha is the result of a defective compass of the Venture Capitalists (VCs) – implementing arbitration of the money-flows – that is no longer pointing towards True North, but rather Magnetic North. In this context Magnetic North defined as a gamble with someone else’s money, a very lofty salary and no downside for the next 10 years. Should we really be surprised that without transparency and accountability Magnetic North is much easier to achieve than True North?
Other temptations of Magnetic North are misleading VCs even further:
- Target acquisitions: many startups are funded and built with improper expectations. While exciting in nature for many, the past bull-market flurry of acquisitions misleads VCs to believe that they can target one. Yet most acquisitions of early stage technology companies are completely erratic (I can tell you many buy-side tales), because they are primarily based on internal corporate struggles rather than somewhat predictable, external market indicators.
- Exit at underperformance: we are soiling the acquisition pool. Acquisitions, in the majority of cases do not work out for the acquirer and are very often overpriced, overhyped and under-deliver (I can talk about many experiences here too). Usually not by design, but simply because they lack macro-economic value to begin with. And while money is money, every acquisition that does not deliver deflates the valuation of the next innovation that deserves better and therefore negatively impacts portfolio returns.
- Stay away from IPOs, the window has closed. I always smile at that popular phrase by VCs and reply: if I want fresh air I will open a window. The public mistrust we have created by pushing subprime innovations through the IPO funnel for the last 20 years, has quickly developed an innate scrutiny to invest only in what the public understands and what matters to their life. Macro-economic impact of innovation is the only value that can pass these days and VCs have restricted their thesis to the extent that they just do not know how to find and fund those. Our focus should be on building real companies, not technology gimmickry.
- Inappropriate deployment of risk: their lack of relevant market experience forces VCs to focus on the only thing tangible to them, the technology implementation. And that while the creation of technology is the least of the risks in a technology venture. What matters, again, is the application of technology to a viable marketplace. And so the risk is in identifying and fully addressing the needs of the marketplace, with whatever modern technology does the trick.
There are many other magnetic distractions that keep VCs from reaching or ever pursuing True North, some of which I have covered in other places in my blogs, but that laundry list would go beyond the patience of my readers.
From isolate to insulate
The point I am making here is that no-one should be surprised that venture is not performing. The LPs were there to allocate the money, the entrepreneurs were there to dream up innovation, and the public is still yearning for technology innovation to substantially improve their lives.
The problem in Venture is the derivative, the Venture Capitalist who without economic viability has no political leg to stand on to stay in business. We have isolated the problem: the “referee” is in trouble, not the players nor the game. Now we just need to insulate the problem, and the controls are solely in the hands of discerning LPs and Fund-of-funds that need venture to perform.
A simple fix
The solution to a healthy Venture climate is simple (in the same way e=mc2 is simple, its discovery took me and Einstein a while); change the construct of venture investing so it mimics the meritocracy of innovation that can produce uniquely disruptive value.