The dark side of VC positivity

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False_positivity

I read an article by Bill Gurley (a General Partner at Benchmark Capital, a firm I respect for certain investments) about IPO anxiety in Fortune Magazine from November 16th which instantly reminded me of a great video by acclaimed journalist, author and political activist Barbara Ehrenreich who explores the darker side of positive thinking in this fantastic video.

Watch it!

The dark side of positive VC thinking

The key to assessing the viability and future of Venture is to determine how it can scale and thus deserves the attention from Limited Partners (LPs) who represent public money, and lots of it. An 80% technology adoption greenfield certainly suggests there is plenty of opportunity for more money to be put to work. Just not in the way it has been deployed in the last 20 years, as on average Venture has produced deplorable performance, despite previous IPOs. According to PEHub, $300B in VC investments has yielded only about $66B in IPOs in the last 10 years.

So, Gurley’s attempt to correlate the return of IPOs with the health of Venture is therefore a dangerous and presumptuous one. The mere existence of IPOs is no testament that Venture can scale, at best it proves that the overwhelming noise produced by subprime VC has not killed a few prime VCs. But to the vast majority of LPs not attached to the few prime VCs that is hardly a compelling message.

So, let’s diagnose the disease in Venture a bit.

Inexcusable Venture performance

First off, it is inexcusable that over the last ten years Venture has produced a negative return of 4.2% to Limited Partners (source: NVCA/Cambridge Associates), despite truckloads of money from LPs, more entrepreneurial capacity than ever before and a technology adoption greenfield of 80%. Juxtapose that with the performance of certain technology corporations (such as Apple, Google), that not only prove to be better custodians of innovation but also prove that none of the excuses uttered from the VC protectionist playbook hold any water.

And it gets worse, average technology adoption (7% market pull) over the last ten years has outgrown ten-year Venture performance. The fluffy Private Placement Memorandums (business plan of VCs) atop a broad VC diversification strategy should have offered plenty of opportunity and course correction for the collective wisdom of its General Partners to outgrow baseline market pull and come to fruition in one 10-year vintage.

But of course, if you are part of the current crop of VCs you will pull out all the stops and excuses to highlight why despite excessive diversification depressing Venture performance is really not your fault, and to reel in another 10 year of comfortable living from unsuspecting Limited Partners.

Check out more excuses on our VC roast.

Don’t take medicine before an expert diagnoses the disease

When corporate innovation continues to beat Venture performance, not the influence of external factors (both types of innovation face) but the workings of Venture Capital arbitrage (the intrinsic composition and value of innovation they select) should be held under the microscope.

So, it pays to take the many arguments as to why Venture has not performed with a grain of salt and become therefore very critical about the reasoning from those same people for its supposed positive outlook. Last thing we want to do is sell another set of empty promises to LPs some of whom genuinely believe in the underlying asset in the sector, the value and capacity of groundbreaking innovation.

Only 45 of 790 U.S. VCs make any consistent money for LPs (according to a reputable Silicon Valley money manager). So, Venture as a scalable asset class has failed completely, with debilitating impact to the many false-negative entrepreneurs who were discarded by the improper compass deployed by 95% of the “posing” VCs.

Is there a real doctor in the house?

So, only the correct diagnosis triggered by the now publicly available hard evidence can effectively cure the disease that plagues Venture Capital. And it does the patient no good to diagnose it with a cold and treat it with aspirin, when it really has cancer and requires chemotherapy.

Ten levels of bottom-heavy diversification (see The State of Venture Capital) by an impromptu investment cartel that underperforms over a ten-year period (and weighted twenty year) and in which it is outperformed by corporate innovation it is supposed to feed, is a solid indication that Venture suffers from a severe and systemic disease.

A diagnosis of a cold derived from the symptoms above will ensure the opportunity for scalable performance dies, and leaves a massive greenfield unexplored and untapped. That same incorrect diagnosis has also been responsible for the implosion of entrepreneurialism in this country, as picking so many false-positives takes precious money away from the false-negatives. Innovation intake by virtue of a defunct VC arbitrage has turned Venture Capital subprime. And the dark side of positive thinking continues the deployment of subprime investment risk and has turned away the real entrepreneurs who don’t come cheap, nor easy.

The resurgence of IPOs is crucial to boost the performance of Venture Capital, but only when they produce Social Economic Value, their cost to produce secures LP returns, and VC funds across the board perform in line with the massive opportunity that remains in technology adoption. Any other interpretation of the value of IPOs is a delusion of positivity. IPOs without some sustainable value beyond the lockup are worthless to the public, and will erode their confidence of technology innovation as a viable investment strategy (AOL anyone?). Already 20 years of technology valuations without real value has made the public distrust the sector.

The cure

The cure for Venture Capital is to reinvent it. To re-assess from the top what a scalable financial instrument should look like that can tap into its massive greenfield opportunity.

Any sound mind will understand that such an economic system will not consist of an old-boys investment cartel, without any relevant transparency, that shuns real competition and revolves around a tight-knit geographic location, with excessive diversification of risk and dollars that exists today.

So, save the positivity in Venture for when the average performance of VCs is in line with the massive opportunity that still lies ahead. Because the best of the worst is not a medal of honor, nor a parade anybody wants to watch.

Innovation first needs to be untangled from a defunct deployment of risk before it can produce the real socioeconomic value that the public (both LPs and public shareholders) can trust again. That is the cancer that is raging inside the body of innovation and only those who don’t care about the future of innovation will take aspirin in the hopes to prolong a most comfortable existence in it.

In memory of a dear friend and a gentle aunt who both lost their battle with cancer last month.

 

We encourage comments that are relevant to our observations, conclusions and the specific topics discussed in this blog, either in agreement or disagreement. Leaving your insightful comments here will ensure others can learn from them too.  Keep in mind however this is not a place to spew your own theories (go write your own blog), but the best place to question or approve our observations.

About Georges van Hoegaerden

Georges is a serial entrepreneur, venture catalyst, 4x CEO, board director turned innovation economist (by fate). His ideas have raised $14M in venture capital and produced over $100M in returns. More.

  • Vnbcinc@gmail.com

    against stupidity the gods themselves contend in vain

    • http://venturecompany.com/ Georges van Hoegaerden

      or put differently, stupidity yields massive new opportunity.

      Best,

      Georges

  • Paul Bevan

    The VCs I’ve come across or heard about understand neither innovation nor marketing. So, with a surfeit of delusional optimism (great video btw) they shower a little bit of money onto an entrepreneur who has a great idea but often little idea about how to take it to market, propel him or her back out into a competitive, fast changing environment with a business and sales plan based on even more delusional optimism…both in terms of size and timescale, and expect results. Tell me..how did marketing strategy acquire such a bad name??!!

    • http://venturecompany.com/ Georges van Hoegaerden

      Paul

      Yes, subprime risk can only yield subprime returns. And the numbers are in to indicate such subprime performance.

      Best,

      Georges

  • http://www.facebook.com/jameswm1 James Wallis Martin

    There is an interesting report from the Gartner Group called the Hype Curve which comes out each year. What fascinates me is that almost all the VC are looking at investing in companies that are in the middle of the hype curve, not those things that have yet really started to just hit the early radar. The reality is the VC are being more conservative due to their poor performance and therefore moving further along the innovation line to already tried and true products. This used to be the realms of the banks, not VC. So banks have become even more conservative to the point that the only two times they will lend money is a) when you don’t want it and b) when you don’t need it. VCs have moved into the bank role of only investing in what has a proven track record and existing market, and Angels have moved into the space that VCs used to play (and they played miserably in that area because of the same issue the Angels are experiencing; they lack the expertise the entrepreneur needs).

    Who is there to take the place in investing in seed and early stage companies? The answer so far has been the Oracles, Microsofts, and Googles of the world. They have the expertise necessary to take ideas to products and products to market. Is there any room left for VCs? Or is it time for them to hang up the towel and let those who have a better track record do the job. The VCs I have met think they are the only game in town, I have news for them, they aren’t and the real competition is the companies who have the cash and are looking for the next best thing to add to their brand.

    • http://venturecompany.com/ Georges van Hoegaerden

      James,

      The performance of Venture Capital is self-induced by way of the risk model it deploys. That includes the artificial staging of investments, which is the downside protection needed for VCs without vision. So the fragmentation of investments associated with innovation, is their self induced fragmentation of risk and has created holes that, with knowledgeable GPs do not need to exist in the first place. Subprime risk can only produce subprime returns.

      So, the point is not how to optimize the performance of VC beginning from its current deficiencies, but to reinvent VC from the top, including why and how VC works, invests, and manages risk of the deployment of assets from Limited Partners.

      Corporates so far have played an insignificant role in VC, usually nothing more than add-on capital to VC. Ironically with Limited Partners in VC looking to deploy more capital.

      Hence the only future to VC is to reinvent it (as we have) and find Limited Partners who with the appropriate deployment of risk understand that the future of Venture is not in the “Capital efficiency” nonsense VC has been preaching for 10 years (and yielded negative returns), but to deploy responsible risk that deploys Social Economic Value and real returns to Limited Partners.

      Best,

      Georges

  • SVE

    Sorry to hear of your recent deaths in the family. My steady colleague for 30 years and co-founder of my latest startup also succumbed to cancer this year, as did my mother-in-law. Best I can say is that I’m glad to be rid of 2010. And I look forward to a better 2011 and a new decade.

    • http://venturecompany.com/ Georges van Hoegaerden

      Thanks Albert

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