Some people do not understand why I do what I do and why I bother, and underestimate my determination to fix Venture Capital. Certainly there are much easier ways to make money than to pursue the obliteration of an investment cartel, in which seemingly everyone belongs to the club. And some people’s actions are distorted by my critical views of what goes on in Silicon Valley, and the increasing popularity of my views may slow down the chase for money that is dished out often so irresponsibly.
Let me tell you who you are talking to when you ask me to give up. My story may also answer the irritable question “who is this guy” I overheard recently. I do want you to know who I am, and how I care about this country. My story is more than just a bunch of business titles slapped together. Ready?
I was born in The Netherlands, the youngest of three boys in a family with a lifelong teacher as a dad, and a gentler mother working to place elderly people in geriatric facilities built by the government.
With our parents coming home late from work us three boys literally fought it out everyday. To get to or from school first after a one hour bike ride every day (rain or shine, in Holland that means rain more often than shine), playing in tennis and basketball leagues (while co-founding a new club), finishing our dinners first every evening or quickly claiming the window seat in the back of the family car to escape the billowing second-hand smoke emanating from the front. Everything back then was a competition, and as the youngest I got the brunt of the attempted suppression. Silly stuff, but it honed my skills to compete and it formed the early realization that freedom requires a fight or two.
My Dad was an educated man without much empathy, as most men born his age were (see the TV series Mad Men TV on AMC). I got my interest in science from him, but not much else. At age seven I realized my life with him was going to be short-lived. I never wanted to become him or be around him, and my need to escape became the most likely road to freedom. I left the house at around eighteen, the first of the three boys and never looked back. After a shaky start I blossomed.
My Mom was quite the opposite. Friendly, outgoing and always ready to support her children in whatever way she could. I remember vividly the many conversations we had as she put me to bed and we covered the important topics of the day. My love and respect for women grew out of that experience. I attributed the Stockholm syndrome to my Mom’s sometimes “blind” devotion to my Dad’s antics, which for me acted as a daily reminder in the buildup that no price is too big for freedom. Leaving the house with literally nothing was the small price I paid.
The most positive influence in my life was the patriarch of the family, my grandfather Simon (my Mom’s Dad). A self-made man he became a majestic business figure as one of the co-founders of “van Melle”, the company that made the ever so popular Mentos candy (sold a couple of years ago to an Italian confectionary). He was also the generous man who gave us, what we as children then thought of as worthless pieces of paper, real shares in “van Melle” and “Royal Dutch Shell” for our milestone birthdays. Simon challenged authority, had clear opinions and voiced them when provoked. But he was humble at the same time, always asking the factory workers for permission to test the candy from one of “their” machines. He could laugh at himself, remained a rebel and kept everyone in the family in check with his presence. His example stimulated the endless possibilities in my head.
From playing with a borrowed HP-41C calculator to launching my own career in the technology business, I arrived in the United States of America on my own with some hard-earned chunk of change in my pocket. Invited by Oracle executives and signed off by Larry Ellison (Oracle’s CEO) who wondered why I was able to sell their (then) emerging products in Europe while no one else globally appeared capable of doing the same. The difference between my approach and theirs was my focus on the need to create a new business model for emerging technologies, to which the new managers I was asked to report to had no clue, let alone respect. I left Oracle thankful and with fond memories as soon as my green-card was approved and jumped into a booming Silicon Valley.
One of my first startups was run by a group of technology consultants with a horrible business plan, and I told them about my opinions in a way only I can. Instead of fleeing, they came back and asked for guidance. I incubated the management team, and together we turned the company from a services into a product company and raised a double-digit first round of funding post 9/11. The company was sold six years later (in 2006) for triple digits (millions that is).
As a repeated board member in early stage startup companies my encounters with Venture Capitalists made me start to question their catalytic value. I went on to build a few other successful companies and had a brief part-time stint as a Venture Capitalist for a small fund. As a part-time Venture Partner with an insider perspective of the wheelings and dealings on Sand Hill Road in Menlo Park, the epicenter of Venture Capital, an even clearer pattern of defunct innovation governance and execution started to emerge.
Unwavering in my passion and support for the preservation and growth of groundbreaking innovation, I realized that the freedom at the foundation of our economic principles had been abused. And, that if we wanted to stay at the forefront as an innovation super-power not the way we innovate needed adjustment, but the way we detected and governed it. And thus began my investigation into the financial system and economic model that held innovation hostage.
And so the fight for freedom continues
Perhaps my story will help you understand why the odds of building great performance in Venture that will save entrepreneurialism are in my favor. My background including fifteen years of first hand Venture experience in Silicon Valley begs me to unleash the financial choke-chain around the innovator’s neck.
Silicon Valley needs help from above
The startling revelation, as proven out by the empirical evidence I have delivered for quite some time now is that according to a renowned money manager 95% of Venture Capital (VC) firms are not making any consistent money for their investors (Limited Partners). And that means Silicon Valley is at the brink of a serious implosion. Imagine what would happen if only about 35 of 790 VC firms were to survive in ten years from now.
Alarm bells should be going off by now, but few appear to be paying attention. Why not, you say?
Well, much of the money pumped into VC firms comes from Institutional Investors (pension funds, endowments, insurance companies etc.) with bulk loads of cash reserves they want to put to work. They dedicate a predetermined amount (usually by board consent), between 10% and 15% of those reserves to alternative investments of which a portion is then allocated to Venture Capital. To make a long story short, a tiny portion of assets from Limited Partners (even the non-institutional ones) is devoted specifically to Venture and a loss or break-even of less than 5% of total assets does not evoke a lot of emotion. Hence optimization discussions with Limited Partners about Venture turn with the agility of a big freight ship.
The alarm bells are getting muffled even more. Institutional Investors have built majestic constructs supporting the deployment of their Venture Capital assets. Many invest in Venture Capital through fund-of-funds with a “specialization” in alternative assets, a fuzzy term for anything that is not mainstream. And thus the actual performance of Venture is hidden behind the performance of the grab-bag of other financial instruments that resides in those fund-of-funds.
And it gets worse, VC firms themselves have been allowed to diversify their risk by embedding alternative investment strategies within the firm, and in worst cases even within the same fund. In short, Institutional Investors have stacked derivative, upon derivative, upon derivative (with of course zero marketplace transparency) and appear surprised performance of Venture Capital has lost the fantastic upside that made them all want to get in some 20 years ago.
And the mess does not end there. The mushy multi-tier asset allocation constructs allowed many General Partners entry to the Venture Capital business who have no credentials of being there. Their lack of experience and foresight has turned into fear and with it the implementation of Venture Capital risk has turned predominantly subprime. As a result Venture Capital risk has produced over the last ten years no more than micro Private Equity returns (less than 10% IRR), squandered about $1.7 Trillion in funds and eroded public trust in companies that never had any socioeconomic value to begin with.
That fear from inexperienced General Partners in VC firms further exhibits itself by the deployment of 10 levels of diversification of risk when a VC firm makes an investment into a startup. Extreme fragmentation of assets and risk protects VC downside (making good money off management fees for 12 years) more than it protects upside, and thus Limited Partners are poised to lose out again, regardless of the economic circumstances. Improper deployment of risk cannot be mitigated by economic recovery.
Venture needs a reinvention from the top. But who cares?
Everyone in or around Venture should. The worst thing that can happen to a sector is that investors stop caring, and many have. Many Limited Partners will not renew their commitments and simply get out, and allocate their 5% of Venture Capital elsewhere. A speaker at a recent conference claimed the demise in VC firms to be as large as 30% over the last 10 years, with as much as 50% of venture folks already affected. New Limited Partners to the sector I speak with simply see no reason for getting in, given its deplorable performance.
And Venture Capitalists don’t seem to care too much because ten years of a cushy management fee from a sizable fund with no way for the public to establish their merit gets them setup for life quite comfortably. Under the cloud of economic insecurity and with micro private equity returns in hand, it is still easier to raise another fund (and thus another ten years of fees) than to admit that not the economy is at fault, but their deployment of risk in it. Many idiot Limited Partners have fallen for their arguments again and Venture continues to spiral further down the slippery subprime slope it has been on for a while. To VC, survival of the fittest has turned into survival of the shrewdest. Or as a General Partner from Sequoia Capital allegedly stated: “We used to have a club, now we just club each other”.
But the real impact of all this ignorance has already affected entrepreneurialism. Defunct VC governance has led to a dumbed down investment thesis that will only attract entrepreneurs that submit to that thesis. Hence the quality of innovation that surfaces is limited by the quality of the thesis that is projected. Subprime entrepreneurs, willing to be enslaved by subprime VC governance continue to tear down the potential of socioeconomic value groundbreaking innovation is supposed to ignite.
Today, glorified programmers and VCs are the inexperienced partners in a dance that only a small audience (not the public) wants to attend.
With 80% of the world’s population still not having access to meaningful technology applications, the opportunity to spawn new groundbreaking innovations remains enormous. Technology adoption keeps growing, even when Venture Capital declines in its ability to govern worthy innovation. So, the opportunity dictates that there is much more room for Venture Capital firms to grow, just not for ones that cannot establish a proper investment thesis of innovation.
Governance of innovation is improperly aligned with the opportunity of innovation, and thus any calculation of the size or number of VC firms based on its current workings is witchcraft, irrelevant and inaccurate (up or down) by default.
There is no valid reason why 100 VC firms with a single $100M fund cannot generate a six times return each, except for the improper deployment of risk. Certainly the gaping opportunity in technology dictates that there is also no reason why the total number of Venture firms in the U.S. could not reach 1,000.
The grim impact of doing nothing
The most powerful assets in the Venture ecosystem (see our Innovation Primer) are the many entrepreneurs with groundbreaking ideas we have bred in this country. Yet, those outliers of innovation have systemically been ignored by a dumb financial system that favors those willing to be enslaved by subprime risk. Groundbreaking entrepreneurs have already left the party and quickly become extinct. Lured by lucrative offers they chose to find solace with better custodians of innovation, larger yet agile companies that simply took better care. Many returned home to their country of origin with an Ivy League diploma in their pockets. Silicon Valley, for what it once represented, has begun to implode.
With more than 50% of moneys spent in certain areas of Silicon Valley dedicated to startups, a 90% erosion of that money (from cutting down the systemic underperformance of 95% of VC firms and retrenching of disappointed Limited Partners) leads to an estimated 45% decline in overall jobs. That in turn creates massive economic deflation to the region and exemplifies why governmental intervention without fundamental reform (the current band-aids will be circumvented quickly) of financial systems in Venture does nothing to prevent the slide it is on. Our local and federal governments should be all over this case, to prevent a further systemic slide that could turn California into a grave-yard for what has been, and our country from becoming the lost leader of innovation.
Our government has simply not connected the dots between systemic failure in Venture and systemic failures in the economy, just yet. The pain and destruction probably need to become more obvious first.
U.S. Commerce Secretary Gary Locke did the usual politically correct thing by inviting members to his National Advisory Council on Innovation and Entrepreneurship with large statures in the old system, yet none in the new. The outcome of that exercise will be as expected, more of the same (yet no one will be able to politically accuse him). More importantly, Locke’s agenda is flawed. The problems in Venture are not with the method of innovation, but with those who govern it.
Venture is the poster child for financial reform
As a reader of my blog, you may not be surprised to learn that the problems in Venture have nothing to do with some deep-rooted and mysterious “Voodoo” of technology or innovation. We have an outdated financial system that does not need more regulations of its complexity, but a dramatic simplification and flattening of its marketplace behavior. The Venture business is the poster child for creating such a new financial system, as its current performance can nothing but improved on.
Innovation can only be saved by a financial system that is truly a free-market system, away from the existing cartel that offers no marketplace (transactional) transparency and is void of real competition that lies at the capitalistic fundamentals this country was founded on. Merit attached to money changes the bold lie capitalism is without.
So, my self-imposed journey to save America from itself continues, for I have seen its potential.
We can save the fantastic innovative capacity in this country and elsewhere when we apply the same intelligence of the way entrepreneurs build innovation to the way we fund it. Without a new free-market financial system in Venture be sure to strap in for a massive implosion in Venture that will take ten years for many to discover had been predicted by this annoying whistle-blower all along.
At least now you know who he is.