I love this country. Full stop.
But when you love the United States as much as I do you need to be critical about how it is about to lose its position as the largest economy in the world and how even though it is still the most innovative economy (according to David Rubenstein), we need to secure the integrity of our financial systems so its performance can accurately trace and tap into the massive and acute opportunity in innovation that lies ahead.
Venture Capital has failed
Venture Capital as the primary financial instrument to innovation that takes the world by storm has failed to produce viable investor returns since 1998, has produced negative 4.6% 10-year returns, has performed below the consumer adoption rate of technology in the same period, is being outperformed by corporate innovation and capital, has lost public trust because of bad past conversion from valuation to value and does not make a dent in the 80% greenfield of technology adoption.
Only statistically perhaps rescued by the success of Facebook that managed to grow despite the traditional playbook of Venture Capital (not because of it) and a few others (Twitter, LinkedIn) that quickly jumped into Facebook’s valuation slipstream boldened by another bubble of followers that quickly ensues.
Innovation scales, so why not Venture?
Corporates prove that quality money applied to innovation not only scales, they also prove that Venture Capital has applied the improper arbitrage in selecting what constitutes innovation. Corporates have proven that investment categories previously considered by Venture Capitalists as dead (Online Music, Desktop software, Consumer technologies etc.) are alive and well under their stewardship. And few of the made-popular investment strategies of VCs have yielded the public’s trust that makes them want to come back for more.
The arbitrage of Venture Capital creates too many false-negatives and false-positives, with the collusion of Venture Capitalists desperately cheering it on.
They have been blowing smoke for a long time.
A new index for VC performance
So, as a Limited Partner (LP) to consider investing in Venture not the performance of the current players is relevant, but the massive size of an 80% greenfield in technology adoption becomes the new index you measure General Partners (GP) against. Which GP can identify the macro-economic drivers that yield viable technology investments, rather than push technology for technology or competitive sake. Valuations that convert to real public value creates the trust that builds rewarding returns for years to come.
The best way to improve performance in Venture is to redefine the index, in the same way Apple redefined “the index”, or requirements of the phone (alarm clock, email, computer, web browser, music player, address book) to become the leader of the new phone marketplace.
Venture Capital needs reinvention so the index of its performance matches more closely the greenfield opportunity for technology innovation that its current incumbents failed to recognize.
Gradual sub-optimization of Venture Capital is like attempting to turn the Blackberry Playbook into an Apple iPad competitor, which will fail because it is not designed from the ground up to target a new greenfield. The Apple iPad is successful because it targets a greenfield previously disenfranchised by the incumbent technology providers.
Venture Capital has failed because it still targets itself (and other not free-market indices) as the index.
The real risk in Venture
When LPs assess risk in Venture they immediately look down to VC firms, as if they are accurately able to identify the risk associated with such an infant and fluid technology marketplace. But the risk they forget about is the risk inherent to a financial system they deploy that is not a free-market system that is supposed to drive businesses that are free-market (and thus winner-takes-all) purveyors.
Put differently, Venture Capital cannot scale in line with innovation because as a financial instrument it is incompatible with the needs of the underlying asset. Venture fails before it reaches the Private Placement Memorandum of the VC funds.
- Deploy fund-of-funds Venture focus to the unique levels of risk deployed
- Reduce ten levels of embedded diversification of risk to four.
- Force GPs to deploy risk by providing full runway support to startups.
- Limit the VC fund size to deploy focus and responsibility.
- Deploy investment transparency which exposes merit and builds pre-IPO trust.
- Accept macro-economics not technology waves as the investment thesis.
Financial systems need to mimic the requirements of the underlying assets they invest in to perform optimally. Otherwise the limitations of the financial system will limit the opportunity available to the underlying asset.
Venture Capital itself needs to become a highly transparent and competitive free-market marketplace in which not collusion but investor competition drives merit, and automatically removes the under-performers so the marketplace of investors accurately mimics the changing opportunity in technology innovation.
As an LP you can no longer abstain from your fiduciary responsibility of deploying the right financial system for each asset class or sector, if you want to stay ahead. And Venture Capital still is the asset class with the most room for growth, if you as an LP will set it by economic principle free.