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The most delusional man in Venture Capital

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I cannot speak about the performance of Dixon Doll’s DCM venture fund thanks to the lack of marketplace transparency that prevents most of its participants (and entrepreneurs) in the industry from actually deciphering and assessing the merit of each individual investor or general partner. But the message Dixon Doll sent me about IBF’s upcoming Venture Capital Conference (that I have attended in the past) is deserving of his new title of the most delusional man in the Venture Capital business.

Now Dixon may be a prime performer in Venture Capital and I won’t (and can’t) judge him on that, but in the e-mail pictured above he does his best to sell another pipe dream to clueless limited partners who in the slipstream of Facebook’s upcoming IPO see a renewal of technology promises that without tangible socioeconomic value will erode the trust from and by the public even further.

The problem with Venture Capital is that its performance is actually mediocre (from -4.6% to 2.6% in nebulous trailing 10-year IRRs, its “growth” we attribute to sector attrition), performs below the consumer adoption rate of technology during the same period, has its excuses proven wrong by corporate innovation, and yields -30% post-IPO performance the public better not be betting their pensions on. And with about 20 VC firms (according to a renowned asset manager) out of 790 original VCs producing any (not even Venture style) consistent return to limited partners, Dixon’s boasting of the role of Venture Capital as a viable asset class in the pursuit of selecting groundbreaking innovation is a gross mischaracterization.

As I explain in The State of Venture Capital, the financial system of Venture Capital is actually economically incompatible with the needs of innovation. And the only thing that keeps Venture Capital ticking (albeit in attrition) are the handful of entrepreneurs that succeed despite the debilitating role of (overwhelmingly subprime) VC, not because of it. Historically, not even the majority of companies that reached any socioeconomic value have been funded by venture capital as the first money-in. Neither did Facebook. So, if venture capital wants to claim the creation of successful companies it should do more than play the role of hangers-on to the real risk taken by those who align seed money to the creation of social economic upside.

Let’s dissect Dixon’s delusion piece-by-piece:

Venture capital is a unique force which fuels innovation and has historically enabled the US to be the global leader in creating, growing and building truly transformational companies.

Nonsense, the uniform and therefore subprime investment thesis deeply rooted in Sand Hill Road investor socialism is seldom the first money-in and many new investor mechanisms have been created (crowd-funding, micro-VC, Tech Stars, Startup America) to fill the void venture capitalists have left behind. The mere existence of these programs and the need for government to fund and support many of them is an indication of how venture capital has dropped the ball in the early detection of groundbreaking innovation. We calculate that the roughly 770 VCs who have failed, produced about 14,000 false positives and around 14 million negatives, some false, that did not fit their trendy and uniform investment thesis. The entrepreneurial capacity of the United States is choked to death by a venture capital arbitrage that is incompatible with the potential for innovation.

These companies have saved lives, improved life quality, created millions of jobs and produced significant financial returns for LP’s and GP’s who are the stewards of pension funds, university endowments, corporations, and other non-profits.

Nonsense, the socioeconomic value of the companies VCs have selected is mediocre as witnessed by minus 30% post IPO values (according to Capital Mind), and is evidence that the public does not assign much merit to companies the financial system pushes through the IPO funnel. Financial success for VCs and even limited partners is robbery if the public as the most important contributor to limited partner funds, a user or purchaser of early stage products and services, and a purchaser of post-IPO stock does not yield the ultimate value in the end. And now limited partners are becoming more discretionary towards VC, as some 80% of all capital committed to VC in 2011 went to just 7 large funds. Limited partners are starting to discredit venture capital as an asset class by eliminating their commitments and realize that the investor socialism on Sand Hill Road is not the proper arbitrage for the potential of the underlying asset (innovation).

But times are changing, both in the US and perhaps more importantly in the rest of the world. We must not be comfortable that continuation of past VC practices will continue to yield successful outcomes going forward. Our once collegial, domestically focused industry has become institutionalized, and concurrently globalized.

Really? Is that why despite more than 60 years of technology investing venture capital has not been able to feed 6.4 billion people on the planet with high-speed internet combined with 1 billion people deprived of fresh water and in deplorable health, deprives 92% of the global population from knowledge that can build a global meritocracy. Past VC practices have only one purpose and that is to perpetuate the promise of value and sell valuations to others, before the public finds out its bleak socioeconomic value.

In this process, many of the historical norms and best practices need to be revisited and revised.

Yes, the economic principles under which venture capital operates are the same as the oil cartel. Artificially restricted by flawed economic and geographic models of supply and demand, and in blatant violation of free-market principles. Why else would you deploy ten levels of risk diversification in venture capital. Free-markets simply would not allow that. And you cannot build a free-market of innovation if you restrict it by an arbitrage that violates free-markets. Dixon’s propensity to drive change is as reliable as an alcoholist’s desire to stop drinking who does not admit he is one.

Reports of my death are greatly exaggerated

The reports of the death of unchanged venture capital are still valid and the attrition of the asset class is evidence that support for it is narrowing. Only the unwavering entrepreneurial capacity lucky enough to prove venture capital wrong (hello Facebook) is the lifeline that keeps limited partners re-upping and allows venture capitalists to sell to the not so knowledgable public more pipe dreams of Facebook wannabes. We cannot wait until the current economic equivalent of Neanderthal Venture Capital dies, and outlier innovation can again blossom with support from outlier investors.

But there could only be one more delusional man in venture than Dixon Doll, and that is the limited partner who keeps deploying more money to venture capital and – economically unchanged – expects a different result.

No amount of money will make up for the massive deployment of uniform risk in the asset class. And as long as venture capital arbitrage is uniform, the companies they select will remain by economic principle subprime.

 

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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.

  • Andrew Eckerman

    I see a lot of critical thoughts and no counter arguments for where the funding for technological innovation will come from.  There will always be opportunities for investment in fledgling companies and new ideas.  Someone will fund them.  If VC is dying then where is that money coming from?  Not purely Angels.  Not enough capacity and they can’t scale in many cases.  Government is a laggard and we are yet to see if any valuable channels will come from Washington.  Banks are out.  Credit cards and family/friends only last so long.  VC’s will always be in play and will always have hits and misses.  To call the industry dead based on the last ten years of performance is just shortsighted.

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

      Andrew, I did not call Venture Capital dead but given the attrition by LPs and trust by the public waning, you have to agree it is moving in the opposite direction to the massive opportunity of innovation. I showed in The State of Venture Capital that the reason for that is not temporal but systemic, due to the massive avoidance of risk, steeped in investor socialism rather than the disciplined deployment of risk.

      I will introduce a new way to invest in Venture Capital (in my upcoming book), but that new way does not come from debating whether either aspirin or tylenol is the right product to cure cancer. We need to reinvent (from the top) the way we support the outliers of innovation and I will do so. We need to reinvent the way financial systems in general support their underlying asset. So stay tuned.

      Now, until that time I will continue to shed light on the deficiency of the current model of Venture Capital and the empty promises from those in it. I have nothing against individual GPs but despise the institution they have created that is economically incompatible with innovation and frankly chokes it by applying uniform and thus subprime risk.

      And given that after 60 years of VC investing, 6.4B people on this planet still do not have an application of technology that can improve their lives that prevents them from participating in a global meritocracy, I can’t wait for the current model of Venture Capital to be dead and I will apply the Kevorkian “drip of truth” to the current model wherever I can. Because as Steve Jobs correctly stated, death is the impetus of renewable innovation.

      Best,

      Georges