Venture Capital is supposed to drive groundbreaking innovation and minus 4% 10-year average IRR despite built-in diversification and flexible Limited Partner arrangements, proves it has systemically failed.
Cold on Venture Capital
Key in that assessment is that not the potential to innovate has diminished but the arbitrage of its financial system has failed to detect it. As a result the wrong entrepreneurial ideas are classified as innovation, with the public caring less. A Venture Capital pipeline stuffed to the gills with subprime innovation continues to demonstrate how Venture Capital has lost its ability to align with the needs of public markets, from a buyer, institutional private and public investor perspective.
Red hot on innovation
And because of deplorable Venture Capital performance the void to innovate has grown larger. More than 80% of the world’s population still does not use technology to enhance their life, which offers groundbreaking innovation a tremendous greenfield without competition. More entrepreneurial capacity than ever in the last twenty years (according to Kauffman) is looking for the best avenue through which to recognize and propel that innovation. And Venture Capital with its overwhelmingly subprime thesis has become a poorer and less attractive custodian of innovation than the corporate innovation it is supposed to feed.
Venture Capital proven wrong
As consumer market pull for technology and corporate innovation outgrow Venture Capital performance during the same period, it is clear that the excuses of its underperformance hold no water. Frankly, the only cyclical nature in Venture Capital is for it to raise another fund every four years, so it can stay in business and reap its generous management fees. Early stage innovation not only cares less about the state of the macro-economy, it benefits from economic demise by providing new more valuable economics to its buyers.
Investor socialism kills innovation anarchy
But apart from that empirical evidence, the performance of Venture Capital is restricted by economic principle. Simply put, a financial system built on the principles of socialism (deal staging, syndication, collusion, price-fixing) has a hard time being attracted by the anarchy promoted by groundbreaking innovation. In the same way the United Nations has a hard time deciding on how to counter world anarchy, Venture Capital has a hard time arbitraging disruptive innovation because of its fragmentation and interdependence.
Economically incapable of finding outliers
An economic system that gravitates towards socialized investment themes by interdependent investors is by definition unable to find outliers of innovation. So, without regard to the individual competence of Venture Capital investors, economically the interdependent model can never yield scalable returns for Limited Partners.
Not a free-market system
Venture Capital scores extremely poorly on the adherence of free-market rules, in fact upon following the money-trail Venture Capital is an impromptu investment cartel that operates as a black box. We object against that purely from an economic perspective, as lack of investor competition, and in-transparency to all marketplace participants makes it virtually impossible to align the outlier entrepreneur with an outlier investor. And as such the arbitrage deployed by such a system will and has favored those “entrepreneurs” who submit to the common investment philosophy of the populous investors. The economic system under which Venture operates therefore commoditizes investments and therefore implicitly restricts the innovation it attracts.
Not the cream of the crop
Venture Capital is supposed to be the cream of the crop of the private equity asset class. It can produce extremely viable returns quickly, if the people who run Venture Capital funds have the experience to adequately support the foresight of entrepreneurs. Yet many GPs themselves have never done anything entrepreneurial nor taken a company from the left side of Geoffrey Moore’s chasm to the right side, and thus lack the crucial decision-making skills to properly advise early stage companies of how to do so. The economic viability of a company is severely restricted by that lack of experience and is the main source for the many false-positives and false-negatives in Venture.
Since Venture Capital is currently the only way to support the, on average $25M+ runway it takes to create a meaningful technology company, the vast amount of empirical evidence of its collusion and price-fixing should be enough to render it illegal by the antitrust department of the SEC. As someone who has witnessed dealmaking in Venture Capital from the outside and inside, I could probably personally provide sufficient evidence to suggest the sector’s illegal activities. But more important than accusing the sector of malpractice is the realization that such an investment cartel can never scale, and therefore never provide the investment returns Limited Partners are pining for. As one attorney recently agreed with me, “Venture Capital is the most blatant Ponzi scheme in American history”.
The solution to resurrect Venture Capital is not the boost its economic ineffectiveness with government consent but to construct a modern economic model that connects the outlier of innovation with the outlier of arbitrage that recognizes it. An economic model that allows for ten levels of bottom-heavy diversification, extreme risk and dollar fragmentation, investment commoditization, anti-competitive investor collusion and price-fixing will do nothing but extract life and money from the innovation ecosystem and never get us to build viable returns for Limited Partners, and in turn the public.
Either we build a new economic model in Venture (like the one we promote) that supports a meritocracy (of all participants) or we create individual Venture Capital firms that invest fundamentally differently. But to turn Venture Capital more subprime because of its deplorable performance from the past is the kiss of death to American innovation. Unchanged, Venture Capital can by economic principle only deliver subprime returns.
Not entrepreneurs need help, but the financial system atop that artificially restricts the innovation intake. Investing unchanged will turn innovation into the caged and bored animal that is currently already at the brink of extinction. It is time to remove the cage.