Greater-fool Paradise

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A “2013 venture capital outlook” video interview with National Venture Capital Association (NVCA) President Mark Heesen posted on Florida Tech Journal reminded me why no self-respecting venture firm or institutional investor should be a member.

Especially when Mark blames the reason for the lack of IPOs on the role of government, not on the inability of the overwhelming majority of venture capital firms (some 99.4%), loaded with almost limitless diversification, wide investment-thesis drift and self-proclaimed best-practices of the industry listed in their pillar rescue plan 5 years ago, to select innovation worthy of the trust of the public.

To blame the government for the more than 12-year venture capital’s self-induced problems is nothing short of appalling. And a losers attitude that does not belong in the realm of groundbreaking innovation that is supposed to encircle and inspire the world.

 

Tell the truth

But it gets worse. Exactly the government who Mark claims has negatively affected the opportunities for innovation, has instead stepped up (along with angel investors) to spawn, grease and create new funding mechanisms, where venture firms dropped the ball and could no longer see the forest through the trees, of the subprime fog they themselves created.

Venture capital has turned itself into mediocrity by avoiding the formative embryonic stage of startups and morphing into micro-private-equity. Forcing entrepreneurs to prove on their own dime or with dislodged angels that they can build technology, while that is the least important risk in the development of a technology company aiming for commercial success.

From speaking directly with both sides of the aisle in Congress and The Senate I can assure you not a single member wants to hurt the prospects of innovation. But in the reinvention of how we support and invest in innovation, venture capital as the arbiter with the NVCA in tow, may be subject to a renewal that replaces them all. Which explains the NVCA’s finger-pointing and tooth-and-nail resistance to change.

We need to tell our government the truth of how we screwed up, how we in the private sector failed to deploy the proper adolescent economics that would have allowed venture capital to grow in proportion to the 80% greenfield of technology adoption that eagerly awaits. That together with government we can build smarter economics in which the interest of private and public sectors are aligned, if and only if we are honest with ourselves.

That is what the role of the NVCA should have been.

 

First more danger looming ahead

The shunning of responsibility for venture capital’s multidimensional macro and micro-economic fallacies and underperformance, combined with a never-ending runway of false positivity to keep the “greater-fool” engaged, is a very dangerous bet for any of us to gamble on, and a grim prospect for the future of innovation. Arguably best described by the most famous innovator of all:

The world is a dangerous place to live; not because of the people who are evil, but because of the people who don’t do anything about it.
– Albert Einstein

Let’s again clarify the definition of a fool, in the context of “the greater-fool” (repeated in our blogs often) who invests in venture capital without holding its deep embedded risk, flawed macro-economics, nebulous private placement memorandums, fuzzy investment theses, liberal fund diversification and general partner merit to account:

Over the last twelve years venture capital has failed to outgrow corporate innovation (by a long shot), has failed to outgrow the organic pace of technology adoption, has cost its institutional investors more than $234B (in just one vintage in the U.S. alone), has yielded -30% two-year post-IPO performance and is playing russian roulette with public confidence. With CalPERS (the largest U.S. pension fund and institutional investor in some of the premium venture capital brands) calling venture capital, ”the most disappointing asset class over the past 10 years as far as returns”.

And venture capital will not auto-correct, because marketplaces in violation of free-market principles never do. And so the future of venture capital, along with its grip on innovation are doomed. Not because venture capital could not be reinvented but because, in Einstein’s theory, of the people (minus one) who don’t do anything about it.

 

Only losers depend on socialism

The really interesting question to ask ourselves is why an organization like the NVCA needs to exist.

Few associations are innovative, most are a self-fulfilling prophecy out to make an easy living for the organizers and bottom-feeders, who do not know how else to. But how many actually serve the authentic purpose they promised to uphold? I still clearly remember my effort to help disadvantaged children in San Francisco, only to bail out after my second chicken dinner at a posh hotel with lots of socialization, yet not a single child-program in sight.

In fairness to the NVCA, I can think of only one pointed reason for their existence. Yes, there are times in which the unique properties of foresight investing (venture), in groundbreaking innovations that are poised to change with world and builds billion dollar companies from scratch, cannot be put in the same blender by which investing in hindsight (private equity, etc. ) is regulated. And none of that would have happened if venture capital simply performed.

 

A bridge too far

The NVCA went a few bridges too far in their downside protection of venture capitalists, in suggesting openly that the ailing performance of venture capital will be recovered once the government loosens the restrictions on IPOs.

Can you really claim with a straight face that the reduction of IPOs the last twelve years were the cause of regulations like Sarbanes-Oxley? That the upside of an average technology company (if there is such a thing) with a $25M+ investment runway would be halted because of a purported $1M in compliance fee. Any sane venture capital investor would gladly take on $1M in late-stage pre-IPO equity to make up the difference. As they did for LinkedIn, Zynga and Facebook.

But despite the all-inclusive cost of going through an IPO, the actual value of the company pushed through the IPO after two-years is on average -30%. Meaning that not the excuses of the NVCA, nor the restrictions put on the IPO process have had any positive impact on the realization of its promised value. And hence, not the many excuses one could throw up in the multi-year process and cost to reach IPO is in question, but rather the selection of what type of innovation creates authentic socioeconomic value and public trust.

Venture capital therefore needs to look inwards to find answers in how to resurrect venture performance. Today the excuses of the NVCA are akin to those of a child sent to Harvard, making excuses for failing for twelve years in a row, without the realization that maybe, just maybe he does not belong there.

No one should blame the government for wanting to protect the public, from a rush of overzealous valuations of hyped companies without any tangible socioeconomic value bound to mistreat the public (as a buyer and investor) as the greater-fool once more. But no one should also be surprised that our government will fail, given the misinformation they are fed by exactly those people who created the problem in the first place.

 

Shame on NVCA members

Finance is held to a different set of standards than the meritocracy faced by entrepreneurs. Perhaps that is why it is overrun with people who, without the imagination to reinvent themselves, seek a job there. And helped by the bulging collusion and socialism of eleven times the size of production (as a contribution to U.S. GDP), they forget that the only reason they have or keep a job, is because of the existence and resilience of groundbreaking entrepreneurs with an unrelenting passion to deliver authentic and lasting value.

I would be very ashamed to be associated with the NVCA in any way (under its current leadership). For by virtue of its purported stale-mate with the government it has dropped the ball on reinventing itself, has turned the asset class and the innovation it attracts subprime, and is directly responsible for the attrition of 20% of GDP.

And you have to wonder about its current members:

  • If general partners would be experienced (former) entrepreneurs (as they so often claim), worthy to sit, advise and decide on a startup board, why then would they need or wait for the “best-practices” of the NVCA to invent their own recovery?
  • If general partners are seeking outlier innovation, why then do they seek refuge in the bosom of investor socialism of the NVCA? Did they miss the economics class in which history has proven socialism to be incompatible with finding the outliers of innovation?
  • If general partners are worthy to guide entrepreneurs, why then do they not understand the macro-economics, meritocracies, transactional transparency that drives winner-takes-all value for a startup or a venture fund, and realize that to become an outlier investor you need to start to behave like an outlier?

It is also astounding how limited partners as the investors in venture capital indirectly pay for the membership fees to the NVCA of their general partners. So the NVCA can help general partners deliver to the limited partners, using the above outlined flawed rational and excuses as to why their under-performance should continue to be tolerated without serious reconsideration. A perpetual cycle of greater-foolishness.

 

Entrepreneurs beware

So, I will think twice to send a groundbreaking innovation I come across to an NVCA member (yes, I have the membership list). Because a venture firm with an NVCA membership badge on their website, without the disclaimer (image included) that formulates explicitly that the opinions expressed by the NVCA are not necessarily the opinions of their members, is the flag of mediocrity and creepy socialism that will turn not only a fund, but also the innovation they select subprime.

Yes, we can reinvent venture capital and the innovation it attracts. Not by deploying more subprime risk through a plethora of flash-in-the-pan alternative distributions (crowd-funding, incubators etc.), or to have government play the role of venture capitalist to fill the void and mess venture capital left behind.

Instead, we can fix venture capital once-and-for-all by deploying grown-up and proven Renewable Economics™ of prime.

 

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.

  • RCGray

    In this era of abundance of angels, VCs, plain cash, aggregators, communicators, why would it not all head down hill to some lowest common denominator? Everything else available in abundance has portions, if not majorities that get “wasted”. Why not innovation drivers? Underneath all the junk are probably some great innovations funded by great angels,and VCs and headed to great IPOs – but why are you expecting to see them floating near the top till they are ready? The old scarce capital model that provided an intake funnel is long, long gone. Here in Boston, it is a world of weekend hackathons with poor undergrads hoping to partner with some source of money with them both hitting the jackpot within months, if not days! A zero-return on capital is a perfect proof-point of the excess funds chasing the slimmest of ideas.

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

      The problem is that the lack of an investor meritocracy supported by a lack of transactional transparency actually turns the underlying asset subprime. Meaning, the economic propensity to create real prosperity is actually suffocated by incompatible economics that makes it seem like our capacity to innovate is dwindling. Subprime venture capital kills the opportunity for innovation, rather than allows it to grow in pace with an 80% adoption greenfield.

      So, the issue is not scarcity or ample supply of money. We’ve had both in the last 20 years. But neither produced renewable socioeconomic value in line with greenfield the public can trust.

      The reason why venture capital cannot function (the way it does today), is that it deploys subprime risk. And no amount of money, or lack thereof will change the economic consequence that subprime risk can only produce subprime returns (save for the pitiful fools that sell their false promises to the greater-fool).

  • Jean-Philippe

    as usual, a sharp, convinced and convincing diagnostic but.. what is next ?

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

      Thanks. What is next is that venture capital will further atrophy, it is now already in effective size as little as 40 years ago. With an ocean of ill-fated efforts (by government, incubators, crowd-funders etc.) to circumvent venture capital’s problems with well-meaning but even more granular deployment of subprime risk, and thus returns, than we have seen the last 20 years. Fashionable entrepreneurial wannabes will get increasingly entangled in a dance with equally subprime investors that are left, and continue to chip away at the erosion of trust of the asset class.

      Real entrepreneurs will (and already have) retreated to work for and hop to a few established corporations that have proven to be better custodians of innovation and risk.

      That is, if my book and my $1M investment so-far in the discovery, invention and implementation of renewable economics does not find the implementation it deserves. Of course, I have more in store than just to write a book, I can’t wait to implement it myself, and help make the dreams of disruptive entrepreneurs a reality again.

  • Yann N

    George, love your posts and swagger, and agree with your fundamental premise, but one cannot ignore the issues that have depressed small cap IPOs, whether its regulatory compliance fees, legal liabilities for d&o, lack of analyst coverage, inability for management to engage with investors freely….
    Having said that, I agree that vcs should act like value creators, not fee collectors. And a simple, really simple way to do this, is to ensure that GPs invest their own cash in the fund (they do already), make sure it’s at least 1/3 of their net worth after fees, and make sure their cash takes first loss if performance is negative…. Need to return symmetry in the comp structure, heads-we-win || tail-WE-lose

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

      No, the issue is not fees paid to whom, or other artificial hurdles meant to protect the limited partners or the public from more false promises.

      The issue in VC is the flawed construct by which we deploy risk. You cannot deploy risk effectively by dousing it in ten levels of embedded bottom-heavy diversification at the bedrock of the discovery of groundbreaking innovation. The embedded risk and pursuit of groundbreaking innovation are simply incompatible.

      That is why regardless of the remuneration you elect to pursue as an LP, venture capital will not recover until we fix the embedded risk at the foundation of their asset management strategy.

      Or financially less technical, you can’t hold entrepreneurs to a different standard of merit than you hold its arbitrage to account.

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  • azmi

    George, looking at the trend since the last 10 yrs or so, you are very right VC is in the process of atrophy and hypoplastic. Soon many investee companies need double dosing of expensive venture debt preceding dramatic necrosis and evaporation of LP investment… and GPs wont be happy as they are not sure for how long they can then keep their ferraris.

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

      Yeah, the propensity for innovation to produce returns is massive given the 80%+ adoption greenfield, while its arbitrage atrophies to a handful(!). So what we really need to wake up to is that venture arbitrage today is incompatible with innovation. I’ve made that point both theoretically and empirically on this blog abundantly clear.

      I do not mind the Ferrari’s, as long as they are driven by the general partners who are held to the same meritocracy as entrepreneurs. And today, amidst the unacceptable absence of such a meritocracy, we have good reason to look down on the owners of more than one mid-life crisis.

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