by Georges van Hoegaerden



I was reminded again by how dumb capital has destroyed innovation by listening to Paul Kedrosky's interview with TechCrunch, in which he concludes that The Kauffman Foundation (which Paul represents as a Senior Fellow) may get out of Venture Capital altogether and deploy some of its monetary assets elsewhere.

Not an unexpected move, as I predicted a while ago many Limited Partners (LPs) as investors in Venture Capital (firms) would make, but a somewhat presumptuous conclusion from a respectable foundation that is supposed to be at the foreground and chartered to support the proliferation of innovation. Foolishly, I expected more intelligence from an entrepreneurial foundation than the intelligence displayed by a run of the mill pension fund stuck in a product of their own making.

Nevertheless I applaud the move based on how Paul described the foundation reached that impending conclusion. For we need to rid Venture Capital (VC) of Limited Partners who do not understand the foundational principles of innovation the sector depends on, and who do not understand the deployment of its unique risks. Probably for the same reasons why Michael Moritz of Sequoia Capital twenty years ago did not want to see pension funds enter the Venture Capital fray.

Take responsibility for you own actions (and in-actions)

First off, the reason why Venture has not and unchanged will not perform (at scale) is because of the financial system Limited Partners in Venture Capital have deployed, one that allows Venture Capital firms to take it for an all too comfortable ride.

With multi-tier bottom-level diversification (as described in 2010: The State of Venture Capital), a grab bag of other alternative investment options and ten additional levels of diversification once a VC firm is ready to invest, it should be no surprise that Venture Capital overloaded with derivatives and diversification has lost the merit it was once founded on.

We can now all easily blame 95% of the VC firms who do not produce any consistent returns for their Limited Partners, or Limited Partners can ask themselves the question why they created and participated in a financial system that enables such systemic underperformance.

We, as financiers of innovation need to take the responsibility of how we enabled a flawed governance of innovation.

Mired in "downstream thinking"

But our observations about Kauffman are based on the activities deployed by them over the recent years. The interview with Paul, the types of programs they support and a recent interview of Carl Schramm, Kauffman's current CEO with Charlie Rose all confirm who they have become. The beachhead for downstream thinking.

The entrepreneurial foundation, driven by the principles and money from a magnificent entrepreneur, seems to have made the mistake of confusing deep consensus driven hindsight with the proper definition of innovation; groundbreaking yet unrecognized foresight.

Perhaps not surprisingly since many of the key figures in Kauffman are economists who could not predict the demise of venture capital until it hit them in the face, and consequently have no idea as to how to fix it - as deep hindsight rarely translates into meaningful foresight. Hindsight and foresight are polar opposites.

Rather than to accept the outcome in Venture as a fait accompli, only a real entrepreneurial foundation would start to wonder what needs to be done to tap into the incredible entrepreneurial capacity in this country and model its financial constructs accordingly. Apparently not the Kauffman foundation.

Financial incompetence chokes our country

Now in the grand schema of things Kauffman is a drop in the Venture bucket, with a potentially side effect of dragging down other Limited Partners in Venture who are similarly clueless about how to reinvigorate the arbitrage of innovation. Such an atrophy of Limited Partners is actually a good thing (as it washes out those without proper investment discipline) as long as it is promptly replaced with new Limited Partners who have a more astute and disciplined interest in Venture aligned with the massive greenfield that lies ahead in technology innovation.

Problem is that beyond the danger that Venture as a scalable asset class could unjustly disappear, the malaise of the financial system in Venture may leave a large stain on the potential of the underlying asset, innovation. Already innovation in the U.S. has suffered from twenty years of subprime VC investing that by design can never scale innovative outlier capacity. The damage we already incur is a significant lack of faith, interest and distrust of technology companies by the public.

Because of the underperformance of the vast majority of Venture Capital firms many financiers now begin to think that the potential for innovation has decreased similarly. And that stain causes further mistrust in the sector, increases fear and catapults whatever is left in Venture even faster down the subprime spiral and our country into the lost leader of innovation.

Subsequently, the demise of VC creates some opportunities for alternative venture strategies, new Angel and micro-VC oxymorons that further perpetuate and fragment subprime investments and on average perform even worse than VC firms. Subprime at its best.

My recommendation to Limited Partners:

• We are at the beginning of the technology evolution. Keep in mind that less than 20% of the world's population has access to meaningful technology innovation to enhance their daily life and improve productivity. A fantastic investment horizon lies ahead and as the youngest asset class in your portfolio, technology Venture has the most attractive economics and if deployed correctly, phenomenal potential for massive returns short term.
• Venture Capital, the way deployed as a financial instrument today cannot support groundbreaking innovation at scale. Not because of a purported "Voodoo" of technology, but because of the systemic improper deployment of risk. Unchanged Venture Capital will continue to create self-induced risk, and therefor consistently produce deplorable returns for Limited Partners.
• You can't teach an old dog new tricks, so don't expect better LP returns from the existing crop of VC General Partners. For twenty years Venture Capital has been given virtually unlimited freedom to deploy their optimal investment thesis, with massive market pull and the ability to control all the strings with regard to the governance of innovation. Tightening financial incentives does not magically turn subprime GPs prime and does nothing but dissuade new prime GPs who want to clear the air (the subprime ones will hang on for dear life as long as possible, even if you tinker with their management fees).
• The deployment of the financial system that drives the deployment of risk in Venture Capital needs to be re-invented (we have). Investing in Venture unchanged is the definition of insanity. The solution is not a deeper understanding of Venture Capital's complexity, but a dramatic simplification and accountability of its foundational principles.
• Stick to your knitting. Get out of Venture if all of this is too much hassle for you. You may miss out on the incredible opportunity that lies ahead in technology Venture but your passive presence in the sector does nothing but perpetuate subprime and hurts the performance of our economy in the long run.

Tags: Kauffman, Limited Partners, Innovation, Angels, Sequoia

By Georges van Hoegaerden



To complete my affectionate series of "idiot" articles (idiot CEOs and idiot Limited Partners) I am adding idiot entrepreneurs to the list.

Idiots

Idiots are those people who continue to participate in a marketplace that was designed to marry the two most important assets in Venture, Limited Partners with money and entrepreneurs with ideas, governed by Venture Capitalists (VCs) to the dissatisfaction and under-performance of them both. Not even the public is interested (and certainly not for the right reasons, short sellers are not too picky and may artificially boost its initial IPO value).

We know that the real problems in Venture stem from how risk is applied to the creation of early stage companies, and that more discipline deployed by Limited Partners (the investors in Venture Capital) to a new Venture model will fundamentally improve the governance of innovation in the Venture marketplace.

Until then the only constituent in the Venture marketplace who cannot be called an idiot is the Venture Capitalist who without any personal downside can continue to apply the power of someone else's money to define what innovation is and continues to get away with feeble attempts to convince the public of their value for more than ten years.

Perhaps now you understand how the adjective "idiot" is a compliment of sorts. Rest assured, the behavior of and attraction to idiots can easily be fixed.

Life is hard when you follow

Life is tough for entrepreneurs, especially for those who continue to listen to the compass of Venture Capitalists, ignoring the miserable performance of that compass for the sake getting a little bit of money. With a continued dysfunctional deployment of Venture Capital many entrepreneurs continue to succumb to an arbitrage of innovation that, by default, will never lead to achieving groundbreaking upside. Even when the idea holds merit, the flawed deployment of risk by VCs is sure to suck the life out of it.

So, here is a list of attributes by which you do not want to be recognized as an entrepreneur. An idiot entrepreneur is someone:

• Who believes that technology creates markets, rather than facilitates an electronic distribution mechanism to serve existing macro-economic marketplaces and behavior.
• Who believes and accepts money to build a gating technology proposition in search of a marketplace or without a clearly defined attachment to macro-economic behavior and upside.
• Who believes that they or VCs can actually derive foresight from studying statistics and hindsight intensively, forgetting that unique foresight is the only differential and investible attribute to successful companies.
• Who believes that capital efficiency is a unique business or investment strategy available only to them or the VC and therefor delivers any differential business or investment value.
• Who believes that market execution makes up for a dysfunctional "driving experience" and takes little streams of money to keep trying.
• Who blindly believes that raising money is the first step to acceptance of his idea. Not realizing that the compass of most VCs (95%) does not lead to the creation of value to their investors nor the public, and therefor their willingness to provide money is likely to mean absolutely nothing (or quite the opposite).
• Who calls himself an entrepreneur simply because he follows VC governance of what a hot innovation wave is.
• Who thinks that raising money makes him an entrepreneur, not realizing that raising money is not a vote of confidence from the public.
• Who thinks that raising money is an asset, yet with defunct investor performance across the board and in no less than 95% of cases turns out to yield a significant deficit.
• Who takes money from a VC, without getting to know the investment partner (General Partner at the VC firm) personally.
• Who takes money from a VC, without knowing the vintage and performance of their current or stacked funds. Ignoring blissfully any irrational behavior and panic that is about to come their way soon.
• Who engages with an investor who communicates through the valuation and cap table that majority ownership by the investor is ever a good thing in an early stage company.
• Who engages in fundraising efforts without a good understanding of the product conversion rates and operating credentials, offering many opportunities to VC of shooting holes in the proposition, to say no to the deal or drop the valuation just so you lose control of the company the moment one of your predictions do not pan out.
• Who partners with a first venture investor who cannot lead the complete funding runway, setting himself up for excessive segmentation of rounds, fragmentation of ownership and increased dilution.
• Who believes that authentic IPO value can be built for less than $25M, and dicks around with micro-VCs and well meaning Angels.
• Who does not know the difference between micro private equity and Venture, praying to beat the simple economics of input and output.
• Who takes money to drive Venture growth, but has no $1B upside strategy defined.
• Who attempts to raise money from a VC without a real CEO, leaving the inmates to run the asylum and turning the company over to the VCs at the quickest pace possible.
• Who prefers to take $250K of subprime VC money in return for 30% of the company, instead of getting a line of credit on your $1.4M house in Palo Alto (with a median house price $750K in the bay area). By the way, neither one is a good idea.
• Who creates an iPhone application using Venture money, not realizing iPhone apps do not create venture returns and the top 1,000 applications on the AppleStore make no more than $350K average per year. You and your Venture investor deserve each other, including the idiot adjective.
• Who raises money from a (government) small business fund, not realizing that a venture trajectory is incompatible with small business funding.

What to do?

Truly groundbreaking innovation is no longer recognized by the majority of Silicon Valley investors. The Venture business has turned subprime more than 20 years ago and only the delayed response by Limited Partners makes it seem like it has some of its former gusto left.

Entrepreneurs are relegated to the investment thesis emitted by overwhelmingly subprime VCs (some refer to using the oxymoron: micro-VC, which in actuality is not Venture but micro Private Equity) and Angels who, each with their own performance issues, have turned innovation into a commodities business.

Groundbreaking innovation that taps into attachment of existing macro-economic behavior does not evaporate easily and has plenty of time to wait until a new Venture model capable of attracting prime risk (and rewards) is up and running again. That type of innovation can simply not be discovered by subprime VC (let alone Angels), plenty of examples in the past have proven that out. So, unless you know how to get to the 35 out of 790 VC firms that do know how to deploy risk and produce returns, of which we estimate 3/4 do so by deploying diversification, alternative investment strategies or similarly subprime gating tactics, you should keep your job until this subprime VC maelstrom has lost its strength -- or until our systemic fix to Venture is in place.

For those people who aim to follow the investment waves of the current investors, by all means keep trying. Maybe, just maybe your pot of gold will be at the end of a rainbow.

Tags: Entrepreneurs, IPhone, Innovation, Valuation, Angels, Subprime, VC, Venture, CEO

By Georges van Hoegaerden



Some people do not understand why I do what I do and why I bother, and underestimate my determination to fix Venture Capital. Certainly there are much easier ways to make money than to pursue the obliteration of an investment cartel, in which seemingly everyone belongs to the club. And some people's actions are distorted by my critical views of what goes on in Silicon Valley, and the increasing popularity of my views may slow down the chase for money that is dished out often so irresponsibly.

My story

Let me tell you who you are talking to when you ask me to give up. My story may also answer the irritable question "who is this guy" I overheard recently. I do want you to know who I am, and how I care about this country. My story is more than just a bunch of business titles slapped together. Ready?

I was born in The Netherlands, the youngest of three boys in a family with a lifelong teacher as a dad, and a gentler mother working to place elderly people in geriatric facilities built by the government. With our parents coming home late from work us three boys literally fought it out everyday. To get to or from school first after a one hour bike ride every day (rain or shine, in Holland that meant rain more often than shine), playing in tennis (while co-founding our new club) and basketball leagues, finishing our dinners first every evening or claiming the window seat in the back of the family car. Everything back then was a competition, and as the youngest I got the brunt of the attempted suppression. Silly stuff, but it honed our skills to compete and I became very good at it.

My Dad was an educated man without much empathy, as most men born his age were (see the Mad Men TV series on AMC). I got my interest in science from him, but not much else. His vast knowledge never seemed to extrapolate to reality and he made his frustrations trickle down to everyone around him. At age seven I realized my life with him was going to be short lived. I never wanted to become him or be around him. I learned from him an important lesson I am sure he did not intend to instill; how to ignore negative pressure. I left the house at around eighteen, the first of the three boys and never looked back. After a shaky start I blossomed.

My Mom was quite the opposite. Friendly, outgoing and always ready to support her children in whatever way she could. I remember vividly the many conversations we had as she put me to bed and we covered the important topics of the day. My love and respect for women grew out of that experience. My Mom's weakness was to let my Dad get away with too much, and nurtured her "blind" devotion often to the detriment of herself.

The most positive influence in my life was the patriarch of the family, my grandfather (my Mom's Dad). A self-made man he became a majestic business figure as one of the co-founders of "van Melle", the company that made the ever so popular Mentos candy (sold a couple of years ago to an italian confectionary) and the generous man who gave us, what we as children then thought of as worthless pieces of paper, real shares in "van Melle" and "Royal Dutch Shell" for our milestone birthdays. He had clear opinions and voiced them when provoked, but he was humble at the same time, always asking the factory workers for permission to test the candy from one of "their" machines. He could laugh at himself, remained a rebel and kept everyone in the family in check. Nobody knew how much money he had until he died. The merit of his actions stayed with us much longer than his few words.

I came to the U.S. on my own with some hard earned chunk of change in my pocket, invited by Marc Benioff (now Salesforce.com CEO, then Oracle VP) and Larry Ellison (Oracle's CEO) who wondered why I was able to sell their (then) emerging products while they couldn't. The difference between my approach and theirs was the business model, to which the new managers I was asked to report to had no clue, let alone respect. I left Oracle with fond memories as soon as my green-card was approved and jumped in Silicon Valley hoping to find more intelligence there. My first startup was a group of consultants with a horrible business plan, and I told them about my opinions in a way only I can. Instead of fleeing, they came back and asked for guidance (management incubation). We turned the company into a product company and raised a double digit series-A post 9/11. The company was sold in 2006 for triple digits. As a board member my encounters with Venture Capitalists quickly made me question their catalytic value. I went on to build a few other successful companies and had a brief part-time stint on the "dark side". A clear pattern of defunct VC governance and execution started to emerge.

To sum it up, I was brought up with an understanding of how to compete, how to separate rhetoric from reality, how to ignore distortion fields, how to be devoted to a cause, how to be clear in your convictions, how to do what you say, how to relentlessly pursue your goals, and how to do what is right even in the face of opposing popularity and extreme controversy. But most of all, I never bought into nonsense, not even when that nonsense is supported by the masses.

I put in my time to get to know every business I was in, and earned my way into becoming a systems manager, computer programmer, IT director, pre-sales engineer, marketeer, entrepreneur, serial CEO, Venture Catalyst and Venture Capitalist along the way. Nothing was handed to me (my parents decided to use my shares to pay for the private education they felt I needed), and my real world experience continues to be a priceless "bull shit" detector in every new endeavor I engaged in. After thirty years in technology (ignited by my addiction for the HP-41C) of which fifteen years in Venture, I have witnessed the workings of the Venture business like no other.

The importance of this story is not to emphasize a purported "micro celebrity status" but to highlight my convictions, as convictions drive consistent and persistent behavior. Everyone has a story like this and staying true to the convictions that are shaped by the past makes for more authentic human beings, and a more natural fit to our contributions in society.

Perhaps my story will help you understand why the odds of building great performance in Venture that will save entrepreneurialism are in my favor. My background including fifteen years of first hand Venture experience in Silicon Valley begs me to unleash the financial choke-chain around the innovator's neck.

Silicon Valley needs help from above

The startling revelation, as proven out by the empirical evidence I have delivered for quite some time now is that according to a renowned money manager 95% of Venture Capital (VC) firms are not making any consistent money for their investors (Limited Partners). And that means Silicon Valley is at the brink of a serious implosion. Imagine what would happen if only about 35 of 790 VC firms were to survive in ten years from now.

Alarm bells should be going off by now, but few appear to be paying attention. Why not, you say?

Well, much of the money pumped into VC firms comes from Institutional Investors (pension funds, endowments, insurance companies etc.) with bulk loads of cash reserves they want to put to work. They dedicate a predetermined amount (usually by board consent), between 10% and 15% of those reserves to alternative investments of which a portion is then allocated to Venture Capital. To make a long story short, a tiny portion of assets from Limited Partners (even the non-institutional ones) is devoted specifically to Venture and a loss or break-even of less than 5% of total assets does not evoke a lot of emotion. Hence optimization discussions with Limited Partners about Venture turn with the agility of a big freight ship.

The alarm bells are getting muffled even more. Institutional Investors have built majestic constructs supporting the deployment of their Venture Capital assets. Many invest in Venture Capital through fund-of-funds with a "specialization" in alternative assets, a fuzzy term for anything that is not mainstream. And thus the actual performance of Venture is hidden behind the performance of the grab-bag of other financial instruments that resides in those fund-of-funds.

And it gets worse, VC firms themselves have been allowed to diversify their risk by embedding alternative investment strategies within the firm, and in worst cases even within the same fund. In short, Institutional Investors have stacked derivative, upon derivative, upon derivative (with of course zero marketplace transparency) and appear surprised performance of Venture Capital has lost the fantastic upside that made them all want to get in some 20 years ago.

And the mess does not end there. The mushy multi-tier asset allocation constructs allowed many General Partners entry to the Venture Capital business who have no credentials of being there. Their lack of experience and foresight has turned into fear and with it the implementation of Venture Capital risk has turned predominantly subprime. As a result Venture Capital risk has produced over the last ten years no more than micro Private Equity returns (less than 10% IRR), squandered about $1.7 Trillion in funds and eroded public trust in companies that never had any social economic value to begin with.

That fear from inexperienced General Partners in VC firms further exhibits itself by the deployment of 10 levels of diversification of risk when a VC firm makes an investment into a startup. Extreme fragmentation of assets and risk protects VC downside (making good money off management fees for 12 years) more than it protects upside, and thus Limited Partners are poised to lose out again, regardless of the economic circumstances. Improper deployment of risk cannot be mitigated by economic recovery.

Venture needs a reinvention from the top. But who cares?

Who cares?

Everyone in or around Venture should. The worst thing that can happen to a sector is that investors stop caring, and many have. Many Limited Partners will not renew their commitments and simply get out, and allocate their 5% of Venture Capital elsewhere. A speaker at a recent conference claimed the demise in VC firms to be as large as 30% over the last 10 years, with as much as 50% of venture folks already affected. New Limited Partners to the sector I speak with simply see no reason for getting in, given its deplorable performance.

And Venture Capitalists don't seem to care too much because ten years of a cushy management fee from a sizable fund with no way for the public to establish their merit gets them setup for life quite comfortably. Under the cloud of economic insecurity and with micro private equity returns in hand, it is still easier to raise another fund (and thus another ten years of fees) than to admit that not the economy is at fault, but their deployment of risk in it. Many idiot Limited Partners have fallen for their arguments again and Venture continues to spiral further down the slippery subprime slope it has been on for a while. To VC, survival of the fittest has turned into survival of the shrewdest. Or as a General Partner from Sequoia Capital allegedly stated: "We used to have a club, now we just club each other".

But the real impact of all this ignorance has already affected entrepreneurialism. Defunct VC governance has led to a dumbed down investment thesis that will only attract entrepreneurs that submit to that thesis. Hence the quality of innovation that surfaces is limited by the quality of the thesis that is projected. Subprime entrepreneurs, willing to be enslaved by subprime VC governance continue to tear down the potential of social economic value groundbreaking innovation is supposed to ignite.

Today, glorified programmers and VCs are the inexperienced partners in a dance that only a small audience (not the public) wants to attend.

Opportunity cares

With 80% of the world's population still not having access to meaningful technology applications, the opportunity to spawn new groundbreaking innovations remains enormous. Technology adoption keeps growing, even when Venture Capital declines in its ability to govern worthy innovation. So, the opportunity dictates that there is much more room for Venture Capital firms to grow, just not for ones that cannot establish a proper investment thesis of innovation.

Governance of innovation is improperly aligned with the opportunity of innovation, and thus any calculation of the size or number of VC firms based on its current workings is witchcraft, irrelevant and inaccurate (up or down) by default.

There is no valid reason why 100 VC firms with a single $100M fund cannot generate a six times return each, except for the improper deployment of risk. Certainly the gaping opportunity in technology dictates that there is also no reason why the total number of Venture firms in the U.S. could not reach 1,000.

The grim impact of doing nothing

The most powerful assets in the Venture ecosystem (see our Venture Primer) are the many entrepreneurs with groundbreaking ideas we have bred in this country. Yet, those outliers of innovation have systemically been ignored by a dumb financial system that favors those willing to be enslaved by subprime risk. Groundbreaking entrepreneurs have already left the party and quickly become extinct. Lured by lucrative offers they chose to find solace with better custodians of innovation, larger yet agile companies that simply took better care. Many returned home to their country of origin with an Ivy League diploma in their pockets. Silicon Valley, for what it once represented, has begun to implode.

With more than 50% of moneys spent in certain areas of Silicon Valley dedicated to startups, a 90% erosion of that money (from cutting down the systemic underperformance of 95% of VC firms and retrenching of disappointed Limited Parters) leads to an estimated 45% decline in overall jobs. That in turn creates massive economic deflation to the region and exemplifies why governmental intervention without fundamental reform (the current band-aids will be circumvented quickly) of financial systems in Venture does nothing to prevent the slide it is on. Our local and federal governments should be all over this case, to prevent a further systemic slide that could turn California into a grave-yard for what has been, and our country from becoming the lost leader of innovation.

Our government has simply not connected the dots between systemic failure in Venture and systemic failures in the economy, just yet. The pain and destruction probably need to become more obvious first.

U.S. Commerce Secretary Gary Locke did the usual politically correct thing by inviting members to his National Advisory Council on Innovation and Entrepreneurship with large statures in the old system, yet none in the new. The outcome of that exercise will be as expected, more of the same (yet no one will be able to politically accuse him). More importantly, Locke's agenda is flawed. The problems in Venture are not with the method of innovation, but with those who govern it.

Venture is the poster child for financial reform

As a reader of my blog, you may not be surprised to learn that the problems in Venture have nothing to do with some deep rooted and mysterious "Voodoo" of technology or innovation. We have an outdated financial system that does not need more regulations of its complexity, but a dramatic simplification and flattening of its marketplace behavior. The Venture business is the poster child for creating such a new financial system, as its current performance can nothing but improved on.

Innovation can only be saved by a financial system that is truly a free-market system, away from the existing cartel that offers no marketplace (transactional) transparency and is void of real competition that lies at the capitalistic fundamentals this country was founded on. Merit attached to money changes the bold lie capitalism is without.

So, my self-imposed journey to save America from itself continues, for I have seen its potential.

We can save the fantastic innovative capacity in this country and elsewhere when we apply the same intelligence of the way entrepreneurs build innovation to the way we fund it. Without a new free-market financial system in Venture be sure to strap in for a massive implosion in Venture that will take ten years for many to discover had been predicted by this annoying whistle blower all along.

At least now you know who he is.

Tags: Subprime, Limited Partners, Entrepreneurs, VC, Innovation, Integrity, Investment, Government, Growth, Arbitration, Capitalism, Cartel, Diversification, Economy, Experience, Free-market, Funds, HP, LP, Organic growth, Private Equity, Risk, SalesForce.com, Silicon Valley, SocialEconomicValue, Transparency, Venture, Oracle

By Georges van Hoegaerden

I could not leave my previous two "depressing" blog articles out there on a limb for too long without offering a solution. Even though I know that those articles are only depressing to those who cannot see the new opportunities created by the systemic Venture malaise.

Let me be clear, I see a grand new opportunity for Venture investing.

The current VC model can never attract disruptive ideas

Venture is on fire and not in a good way. So agreed with me one of the top money-managers who I met with last week in Palo Alto, and manages over $40B in Private Equity, including Venture. Especially since the Venture asset class is so young and has such a bright future ahead, the deplorable performance of its financial instrument Venture Capital (VC) with minus 10% returns across the board has failed, and proves its governance is fundamentally flawed as its recognition of entrepreneurial ideas has not (even) outgrown the technology adoption baseline it rides on.

The financial system atop of innovation has failed, not our capacity as a country to innovate. The primary reason for the systemic malfunction (described in 2010: The State of Venture Capital) is the incompatible market model created by VCs (and bought into by Limited Partners) that allows for and continues to stimulate the creation of an investment cartel, a single investment thesis that by definition can never find the outlier of innovation.

According to the aforementioned money-manager only 35 of 790 venture firms in the US consistently produce some positive returns (not necessarily venture returns as a return of the deployment of venture risk). That means less than 5% of all venture firms, consistently produce a return. And we can only wonder at this time how many of those 35 actually produce a viable Venture return, as opposed to a micro-Private Equity return, especially since out of fear Venture has turned subprime more than 10 years ago.

That result makes for a pretty depressing outlook for Limited Partners for Venture, with many avoiding or fleeing the asset class altogether. I too would worry about the future of cash infusions in innovation if as an innovator I did not know market fundamentals better.

It takes an entrepreneur to see financial opportunity where none exists today

Regardless of what business you are in, entering a market that relies on a hungry 80% greenfield, that continues to consume rapidly despite the worst of economic fear is an interesting endeavor.

Technology adoption continues to grow rapidly, yet much of it is coming from more effective curators of innovation, including from corporations such as Apple.

The rhetoric from the current intermediary Venture Capital, whilst supported over the last twenty years by truck loads of money from LPs (demand) and in which entrepreneurial capacity is larger than in the last 14 years (supply), and still cannot perform despite optimal circumstances should simply be tossed aside.

Governance of innovation (between the assets of LPs and assets of entrepreneurs, see our Venture primer) is broken, not innovation itself. Deflation of risk has turned the Venture business subprime and all metrics (with numbers that cannot be counted on by Dow Jones, Thomson Reuters, PWC MoneyTree, the NVCA and the likes) of that micro Private Equity deployment is therefor not representative of the opportunities nor the projected demise of Venture Capital.

I agree wholeheartedly with Michael Moritz of Sequioa that we have not deployed the Venture Capital risk profile in the last twenty years, and we rely on a handful of success stories (like Google, Facebook) who in one way or the other have managed to escape the defunct Venture Capital governance (and still got their money) to become successful. Those success stories are the ones that fell through the cracks of the Silicon Valley cartel, they were not the positive outcome of the stifling governance of the cartel, albeit success attempts to claim many fathers.

The opportunity in Venture is to replace governance

Lets try an analogy to cooking to clarify the opportunity in Technology Venture.

It does not take much to imagine that technology is like water. And water is the substrate to which many dishes are produced. But if the only recipe a Venture Capitalist can recognize and cook up is a soup (and based on the results, very few of them are good cooks at that), the measurement of success and the taste of the soup only matters to those who care about consuming soup.

Technology is at the beginning of its discovery that it can be used for much more than just the monolithic production of soup, and that it is a vital ingredient to make bread, cookies, rice dishes and almost everything else we consume. Hence the reason why the number of soup lovers or their enthusiasm is no indication - up or down - to the scale of the potential use of water.

The point being that a close look at the performance of subprime Venture will not lead to a viable conclusion whether or not Technology Venture has room for growth. For that we need to look at the absolute opportunity in technology and wonder why, with all this money spent, 80% of the worlds population does not currently have access to a meaningful technology application.

So the trick in Venture is how we define innovation and what risk we apply to it that reaches a broader audience with meaningful social economic value. That we build an economic model in Venture that stimulates the creation of a variety of innovations (dishes in the cooking analogy), and that can only happen once we break up the cartel that has turned Silicon Valley into a monolithic and therefor extreme risk to Limited Partners.

Time to re-invent Venture investing

The best way to innovate is to ignore everything that has happened in the past (especially when performance dictates so) and imagine how Venture should work if you could design it from scratch today. No right minded individual would design it the way it works currently.

With the Limited Partners' interest in mind we would not design Venture with ten levels deep bottom-heavy diversification, a single investment thesis deployed across most VC firms, extreme fragmentation of assets and risk, and lack of verifiable merit. To support groundbreaking entrepreneurs the financial system needs to reward the outliers in Venture Capital that have the unique capacity to find outlier ideas, and take the prudent risk that reaches massive upside, rather than to engage in risk aversion that secures (often personal) downside.

The grand opportunity in Venture is that such a system is relatively easy to build (I have), with minimal burden to Limited Partners. But even if we do not have a chance to rebuild Venture completely, a single Limited Partner (or a syndicate) can turn this new system in a competitive advantage and reap the benefit of harvesting the enormous greenfield opportunity that is currently ignored. A single VC can turn the deployment of the new model into a unique investment thesis that competes with the complacent investment thesis of the cartel.

Take no prisoners

It is however unlikely that the new VCs will come from the same stables as the current ones. The aforementioned money-manager also expressed his frustration with how many VCs have completely avoided risk and continue to hobble after the me-too deals, a subject we have written about often with regard to subprime VC.

But that should come as no surprise given the limited relevant experience many General Partners have in entrepreneurship (you cannot learn this stuff in school), many have never been an early stage CEO, have never taken companies from the left-side of the chasm to the right-side, and lack the foresight and vision (attitude) that would separate them from pure financiers. Venture may be part of the Private Equity asset class but its demands on General Partners are completely different, given the unique qualities it takes to build successful early stage companies. And insufficient relevant experience of General Partners leads to fear and improper assessment and deployment of risk, a logical outcome of Limited Partners' commitment to the wrong people.

The impending cannibalization of the new model is what gets the National Venture Capital Association (NVCA) protecting the interests of its members, all in a tizzy. It feverishly deploys every asset it has to blame deplorable Venture performance on anything but its own responsibility, steadfastly ignoring its own responsibility. It uses Limited Partner money to protect and defend their stance to politicians, who seem to accept the rhetoric from exactly those people who created the Venture malaise in the first place. Insufficiently informed, those politicians appear willing to cut them even more slack. Yet subprime VCs will never have enough resources (governmental or otherwise) to produce healthy Venture returns, and their clock keeps ticking.

The simple solution to better performance in Venture is to build a financial system that stimulates the creation of new investment recipes, so its deployment can reach the popularity similar to the consumption of rice and bread, and the world will be our oyster.

Tags: Limited Partners, VC, Entrepreneurs, Innovation, Apple, Private Equity, Monolithic, Performance, NVCA, SocialEconomicValue, Experience

By Georges van Hoegaerden


Some days I look at people and feel pity, with as much pity as Captain Paul Watson from the Sea Shepherd felt when many years ago he looked straight into the eye of one of the whales he was trying to rescue, while a harpoon flew over head. He felt pity for humanity. The same pity I feel for people who take the innovations business for an easy ride and kill it by sucking it dry.

Ways to work Silicon Valley

In my thirty years of the emerging business of technology I have seen product marketing managers at one of the fastest growing software companies pick products that sell themselves, and turn them into "geniuses". I have seen sales people at the same company make tons of easy money for the same reason, only for them later in their career be faced with a more sober reality. I have seen people in another Silicon Valley bellwether hop from one division to another, never to be confronted with the outcome of their guidance in each. I have seen people hop from one Silicon Valley company to another, only to pick up valuable equity in each along the way. I have seen people make friends with pivotal "gatekeepers", only to become employed for long enough to get a piece of equity their merit would have never earned them. I have seen those gatekeepers provide endless references to each other, securing them cushy positions through those who get in first.

Too many times have I seen investors loan-shark companies and dilute unsuspecting entrepreneurs into powerless share holders. I found out too late that an angel investor employed, travelled with and otherwise befriended the wife of the company founder, who I was going to straighten out because of his consistent underperformance, false promises and blatant lies. I should have known when I heard the angel was previously dating a friend's best friend, and allegedly forcing her to break up their relationship. I have seen entrepreneurs pitch to "living-dead" VC firms, crushing their dreams. I have seen Venture Capitalists straight out of business school force CEOs to adopt their misguided agendas or otherwise be sandwiched and squeezed out between investor and founding ownerships. I have seen VC artificially segment the industry, putting off outliers of innovation. I have seen VCs lie about the value I, not they created. I have seen VCs work the books so their investment thesis can never be held to account. I have seen Limited Partners play nice with Venture Capitalists knowing that someday they too will join the club that slides them into a much more lucrative salary.

I have seen it all. The foundation of the venture business is a bigger mess than I could ever attempt to describe here, and much more systemic than temporal.

Proud to be difficult and different

For many of the people described above I am difficult work with. Because I simply refuse to erode what I stand for by playing games (that sadly have become so popular). My passion is to build social economic value that touches real people and as a results builds attractive monetization (in that order). I care a lot about money, but only when I feel my participation deserves it. I do what I say and I say what I do. And every product strategy or company I built became an outlier as a result.

To do so one must challenge everything, including oneself.

The hard part is to walk away from investors and entrepreneurs. I have halted an investment at the last hour from a very wealthy family I have know for more than ten years, after I just discovered a string of misconduct and violations of fiduciary obligations of previous board members. The company would have been a blowout success under my leadership. I also declined an investment from another angel and a friend of the lead investor, after I found out that his reasons for investing where not in line with the business strategy I had laid out and executed on with great success as the CEO. In both cases the original founding board could not see beyond some quick money, and are now suffering from significant dilution in ownership and performance, if they are to survive. I challenged my own position from the decisions I made, a clearly different strategy from the self serving and pleasing route most in our business would have taken.

Technology innovation has become the Wild West who's easy days have past and where gold no longer simply washes ashore. We are now stuck with an overhang of gold diggers whose verifiable merit to locate gold hidden a little deeper has become inadequate. The actions of many in our industry have been too self serving, and therefor by default unsustainable.

Doing the right thing is more important than doing what is most popular. Yet doing what is right conserves a unique species we all rely on.

Conservation of a unique species

Whaling has been banned by most governments, but the Japanese keep hunting whales under the "research" exemption and continue to threaten the important role of an endangered species in the ecosystem. The wrong thing to do that will impact us all.

The endangered species in the technology industry are the real entrepreneurs who with great ideas and with diligence and persistence, together with experienced business managers and visionary investors have the integrity to produce groundbreaking social economic value and thus fantastic investment returns. Many VC investors, too busy protecting their own interests and busy concocting elaborate diversification strategies, have lost their ability to recognize and attract those entrepreneurs. And a reduction of VC investors will not fix its dysfunctional investment thesis, and will not cure its systemic disease in which the improper deployment of risk of micro Private Equity has displaced and dislodged venture capital. And don't be fooled again, VC spinning their wheels just like the last ten years with the improper risk deployed will not lead to the recovery of public trust the sector needs.

Circumvention of government regulation proves in whaling and venture capital that government regulation is not the panacea. The only way to prevent the extinction of a unique species is to provide incentive (or de-incentive) for supply and demand, which in technology innovation can be driven directly by the investment discipline of knowledgable Limited Partners.

So, the conservation of groundbreaking innovation is solely in the hands of Limited Partners, who if they open their eyes and get to know their ecosystem still have time to correct course and can continue to reap generous rewards from the massive opportunity in technology innovation that lies ahead.

On most days I still believe I can help Limited Partners fix venture (although some people have discouraged me), just like Paul Watson believes he can still save the whales. I remain optimistic we can save ourselves, but we are running out of precious time.

Tags: Entrepreneurs, Venture, Limited Partners, VC, Silicon Valley, CEO, Innovation

By Georges van Hoegaerden


Is the little "fun fact" that occurred at the beginning of this year which Dick Kramlich, General Partner and co-founder at New Enterprise Associates inconspicuously threw into his acceptance speech of the special achievement award from IBF's Venture Capital Investment Conference last week. I told you so...

VC governance is broken

That is a serious message which rebuts all the relativity theories from Venture Capitalists (VCs) and highlights how broken Venture as a financial instrument really is. Especially in light of the fact that entrepreneurial activity according to the Kauffman Foundation is now higher than in any of the last 14 years and VC funds have been fully loaded with commitments from supportive LPs over the last ten years. Short term, even NASDAQ performance beats 2009 performance in Venture.

What it means is that in the marketplace of innovation in which supply and demand are performing well, the governor of innovation (the VC) failed to make financial sense and its arbitration fails to produce merit.

The Limited Partners (LPs) who unchanged keep pumping money in a decaying financial instrument truly deserve to be called Idiot LPs. But we do not want LPs to flee as technology venture remains a highly rewarding investment sector for LPs, just not with the current market model and the current financial derivative. Just because governance is broken does not mean the marketplace is.

Checks and balances

According to the panels at the event, the contraction of VCs has started and venture firms are down some 33% with practitioners down 30-50%. Funding rates are currently at about 900 companies per year, leaving about 3,000 companies with previous investments without extended funding runways. The risk profiles tumble further down the subprime slope with early rounds fetching about $1.5M and $70-90M exits on average. Heavy reliance on syndication is the model going forward and VCs are hoarding liquidity.

Even though net returns for investors (LPs) are missing some panel members predict (or wish) no fundamental change will occur. Many LPs unjustifiably appear afraid that if they turn the screws on VC too much, those VC will not let them participate in their next fund. With a new market model we are more than happy to find them more competent replacement for each. Many LPs just stay away from VC, 2x returns on $20M investments is not a great way to deploy Venture risk for many. No v-shape recovery in venture fundraising is expected anytime soon.

Better understanding of underlying assets

Many LPs appear more open to a "forensic analysis" of the Venture ecosystem (get it here), to better understand the asset class and be able to "touch" the companies to which assets are being deployed. Transparency issues are being discussed. Early stage investing requires a unique thesis and LPs are (eagerly) looking for them, with placement agencies sending many VC firms back to the drawing boards. Venture overhang is getting smaller, turnover in LPs is increasing. Empirical evidence of a recent $3B VC fund distributing only $100M back to the LPs makes the IRR's (Internal Rate of Return) calculations quickly lose their value in determining the health of the LP commitments. A stronger emphasis on money-in versus money-out is what now drives LP agendas moving forward.

Making sense

My observation from discussions with pension funds, private equity firms and treasuries is that many Limited Partners are confused. On one hand they want to get out because of unsatisfactory returns and on the other hand they do not want to miss out on the massive opportunity in Venture they know still lies ahead.

A conversation with an LP at the event brought home what that confusion looks like (forgive the brevity on either side, we both sat through the last panel session of a packed two day event - me lingering for a cocktail appointment with another LP).

...before the panel session...
LP: What do you do Georges?
Georges: I am a Venture Economist.
LP: Huh, what is that?
Georges: I help LPs make sense out of their venture strategies.
LP: We should talk.

...after the panel session...
LP (before we can leave the room): So tell me.
Georges: Venture cannot and will not perform using the current model.
LP: Well I know Venture is broken
Georges: Yes, but it is important to know the difference between a cancer and a fever.
LP: Fair enough, but I don't have a problem.
Georges: Really? So, why are we talking?
LP: Uh, I think it is broken too. But my returns were okay.
Georges: Really? You deployed Venture risk and you've gotten micro-Private Equity returns, why is that okay?
LP: Uh (blushing), you are right.

Finance is easy

It amazes me how common sense has prevented to enter the minds of LPs who (in some cases) continue to be swayed by convoluted fairytale stories of a better future. A solution to the Venture malaise needs to include not just a market-model that deploys Venture risk more appropriately, but should also include the canvassing of new general partners with the confidence and capabilities to produce merit in that new system. Both are included in my systemic fix to Venture, a prelude of which (the detection of the disease) can be found in 2010: The State of Venture Capital.

Obviously I will not paraphrase every discussion I have with LPs, and continue to treat them as the other asset holder (like entrepreneurs) in the Venture marketplace with the utmost respect. But LPs should not just listen to VC rhetoric and expect them to come up with fundamental improvements (or perhaps required cannibalization) in the Venture business that jeopardizes their cushy, no downside, protectionist stance. For LPs, I am the resource and the voice-of-reason for those who want to challenge "best-practices" of VCs that have not and will continue to fail to produce proper returns.

But, dear LP, if you aim your frustration with Venture at me instead of the VC, I will kick you out off my process for a much better future in Venture. After all, Venture performance is really your problem, not mine.

Tags: Limited Partners, VC, Venture, Marketplace, Funds, Fundraising, Arbitration

By Georges van Hoegaerden

Almost one year ago I wrote a wildly popular Idiot CEOs article that highlighted my affection for the crucial role of visionary CEOs at early stage companies, and how instead they are foolishly made/forced to believe that the directives from the company's board (mostly VCs) will guide them to success.

That article was meant to protect CEOs from making mistakes and set things right from the start. So it is now a year later in which my understanding and affection for the role of Limited Partners (LPs, the investors in Venture Capital firms) is voiced in contrast to those LPs who continue to support the dysfunctional VC arbitrage in the Venture ecosystem (see our primer).

This article is meant for those LPs who do not want to earn the adjective "idiot".

Invest at "your own" risk

More important than the easy harping on "the money-men" is the serious realization that investing in venture by LPs, knowing how the VC arbitrage works today, is truly the definition of insanity. Simply put, the way VC works today cannot and will not lead to scalable performance the LPs are betting on and worse, implodes our ability as an economy to create sustainable innovation that can improve our lives, and will erode the dominant role of the United States in it.

Limited Partners (and their boards) and the Public markets are lulled into a false sense of security by Venture Capitalists (VCs) who primarily blame deplorable venture performance on the malaise in the macro-economy, which we have debunked many times. And so Limited Partners should heed the warnings in this article, and if they do not take deliberate action to investigate their actual deployment of risk are going to lose much more than they already have.

Change you must believe in

As many aspects of the technology sector have changed and having met as many VCs as I have over the years, you will realize they have not changed along with it.

- Market access has changed
About 30 years ago, Venture relied on a small and proprietary market model to drive insular innovations that each relied on nothing but itself to carve out a market. A lot of critical success factors have changed since then, and the Internet has all but evaporated the luxury of monolithic access to markets and a straightforward and private way of addressing it. Today's buyers of technology have many more (often jarring) options, which has dramatically increased competition and forces VCs to understand and support the complexity of hybrid market models, unique product experiences, social economic value and a clear understanding of what drives value beyond simply being there first.

- The technology stack has evolved
Technology has become more pervasive in our lives, albeit more than 80% of the worlds population still does not use the internet for meaningful applications. Usage has evolved from the office to everyday lifestyle, with more demanding user experiences as the impetus to buy. No longer is the value of Intellectual Property (IP) simply defined by the ferocity of the many lines of proprietary software code, but by how the proposed user experience uniquely crosses (and hides) the complex boundaries of code, content, distribution, relationships, marketplaces and hardware. Simply put: no longer is the value of the spark plug more important than the value of the car. Producing code is no longer the sole testament of the ability to deliver groundbreaking value.

- Risk and returns have systemically deflated
As Paul Kedrosky (author of "Infectious Greed") alluded to at the Milken Conference panel, "old VC brands are dead". But not for the reason most people think. Counter to what VCs make their own investors believe, investing in Venture has become even more of a specialty and harder, not easier and certainly not cheaper. Fear and the inability of incumbent VCs to change, have forced many VCs to continue to invest using the old Venture model in a market and with technology that has fundamentally changed. Twenty years of VC resistance to change has already turned Venture investing into a subprime sector in which micro-PE (micro-Private Equity) risk deploys no more than micro-PE returns, regardless of the state of the macro economy. And worse, it has attracted developers who think of themselves as entrepreneurs when they feed the VC's micro-PE hunger.

- The VC demi-cartel has no way to detect innovation
As technology is getting more competitive, global and evolves faster than ever before, the current demi-cartel consisting of VCs with a single (outdated) investment thesis that heavily relies on syndication (i.e. consensus) with fragmentation of dollars and deflation of risk to support innovation is counter productive to the economic indicators that are pointing the other way. With ten levels of risk diversification and deliberate price-setting, Venture has become the systemic rollover of the car business, and in need of a overhaul of standards and requirements. Real innovators do not engage with venture anymore, and leave VCs alone with their self-induced and spiraling down subprime investment malaise, patiently waiting for it to break and reset itself completely.

- The grass is not greener
When life gets harder only mediocrity walks away in search for greener pastures. I too believe in a more responsible and greener world, just not with Venture Capital as the financial instrument to drive it. Mediocre VCs are exactly those VCs who successfully sell that the Venture model founded on the fluent economics of technology, blindly applies to every other "feel-good" growth sector, which subsequently lands more LP support and therefor a longer stay in the derivatives investment business. No other asset class than technology venture provides more immediate and effective economies of scale for creation, distribution and adoption of value, that is if as a VC you can define the compass of real value.

Super Pimps

To continue the corollary from Idiot CEOs and based on the fascinating HBO documentary Pimps Up, Hoes Down referenced in the article, idiot LPs are the Super Pimps who believe that the premise of investing in venture, knowing how VCs treat and detect entrepreneurs will continue to deliver outlier returns.

For intelligent LPs, who like many smart rich people continue to write their own checks and get involved in how the rubber meets the road, a wonderful future of returns still lies ahead in technology venture. LPs need to invest in understanding the whole venture ecosystem, and be able to challenge the risk models VC deploy in order to make the smart choices that come with great returns. And today's smart choices are not yesterday's.

But those LPs who by virtue of the deployment of a defunct venture market model, stale VC experience, and a venture cartel treat entrepreneurs like Hoes, will get and deserve nothing more than they have for the last ten years.

Tags: Limited Partners, Innovation, Investment, Marketplace, Private Equity, Subprime, VC, Cartel

By Georges van Hoegaerden



As I explained in "2010: The State of Venture Capital", our Venture primer and "How to fix VC once and for all", Venture Capitalists are the derivative between the assets of the Limited Partner (money) and the assets of the entrepreneurs (ideas).

Venture Capitalists, because they are equipped with the keys to the kingdom by Limited Partners (LPs) therefor claim they must know what is best for the marketplace to function properly, and deploy their best practices (read regulations) to identify investable innovation. And money hungry entrepreneurs bow down to learn from VCs how to build companies, approach investors, time the market, build scale etc.

In absolute terms Venture underperforms

The only problem is, very little of that has paid off. With fully loaded commitments from LPs, more highly skilled entrepreneurs than ever, an 80% technology greenfield with 7% growth in even the worst of economic developments, Venture Capitalists managed to perform below the technology sector it rides on. None of the financial relativity theories (such as IRRs, financial sector comparisons etc.) can debunk that Venture should have out performed the organic growth in technology and they should have tapped deeper into its virtually unlimited greenfield.

LPs are getting more frustrated by an exploding technology sector with imploding Venture returns and one recently communicated on PEHub what I have heard many times now in private:

The correlation between “well-regarded firm” and actually profitable (for its investors) firm is close to zero. I’ve spent the last five years meeting with “well-regarded” firms and it's the rare exception that has actually delivered returns.

Clearly the Venture Capital arbitrage, deployed as a demi-cartel in Silicon Valley and feverishly and foolishly copied around the globe, can no longer be trusted. It is time to renew the marketplace and reset the compass of innovation.

The public buys stock

As depicted on the included chart, the role of the public is crucial in establishing a healthy Venture ecosystem. If for nothing else, the most explosive Venture returns are realized in the process from turning a private company public (IPO = Initial Public Offering), and the threat of that investor independence can boost the company's merger and acquisition value. So, a solid understanding of the value of an early stage venture by the public (which we describe as Social Economic Value) is crucial in establishing authentic public stock value.

The public buys product

The best way to have the public understand the value of innovation is to have them use it. Without many people understanding the intricacies of social networking, it does not take a lot of imagination that Facebook would be a valuable public investment solely based on its user growth. Facebook tapped into an existing macro-economic need to reconnect with people who were too busy or too remote to stay in touch with otherwise, and now reaps the reward of deploying new monetization schemes to a large installed based with no lead generation cost.

Crucial for entrepreneurs is to realize that in building a product (product in the economic sense, so could be service) for the public, "capital efficiency" is not only a blatant lie, it is the opposite of what creates public trust.

The public needs technology that offers significant attachment to large macroeconomic value, a complete offering (spanning multiple technology silos) and a robust product experience. All the ingredients that are not dished up by the strategies deployed by so many of the subprime VCs who proudly plaster the blogosphere and technology "flea-markets" (you know which technology trade-shows I am talking about) with their spoon fed investment tactics and meaningless advice.

The public buys into Venture

Not only does the public purchase stock from companies that turn public, it also feeds the funds of Limited Partners who deploy a portion of those funds to Venture.

Pension funds, endowment, insurance companies etc. put their reserves from public cash to work to deal with fluctuations in their businesses. So, a Venture business that does not perform well, will not only put pressure on the output of Venture, but will have devastating impact on its input. LPs as the guardians of that money now increasingly are instructed (by their often public boards) to lay off on venture capital.

The highly inefficient financial instrument in Venture severely erodes the potential and trust in the future of innovation.

Treat the public well

The Venture business does not and will not perform significantly better if it, or our government, does not change the market model it deploys (we have an answer for that). As an LP, investing in Venture unchanged is the definition of insanity. Marketplace transparency (to all marketplace participants), that opens up private companies for public review (not investment) is paramount to establish public trust before the company is put on the public auction block by investment bankers.

Entrepreneurs should partner only with Venture investors who understand that Venture Capital is designed to protect upside, not downside. That corners cannot be cut in addressing the needs of those people who are expected to buy your public (or indirectly private) stock later on.

Treat the public how you want to be treated. After all, we are the public.

Tags: Limited Partners, VC, Entrepreneurs, Private Equity, Marketplace, Innovation, Investment Banks, Investment, Integrity

By Georges van Hoegaerden


There have been many debates (to which I contributed some of my viewpoints, see for example: peHub's coverage of Barney Frank's statements) as to the systemic risk of Venture Capital that is now dutifully looked into by our government to establish the amount of risk Venture Capital (as a sub sector of Private Equity) poses to our economy, and to embed impending regulations in the Financial Reform bill.

Venture Capitalists have dug their own political grave. Their disingenuous stance is formed by how on one hand they claim to be crucial to the economy (and falsely pat themselves on the back how they create thousands of jobs), and proclaim on the other hand that Venture Capital does not pose a systemic risk (because of its limited size, compared to other asset classes).

Neither of the aforementioned argument is valid, as you can gleam from my previous articles. Yet they deployed their lobbying organization, the NVCA as the ultimate protector of VC downside, into action and collected 1,700 General Partner signatures in an attempt to persuade the senate not to impose on Venture Capital the impending regulations put on big daddy Private Equity. A feeble attempt.

VC is the financial derivative, not the producer of innovation

Thankfully Barack Obama is smarter than most politicians and demonstrates his ability to separate financial derivatives from producers of value with a single statement: “We understand that start-ups and entrepreneurs are the key to leading the US out of the recession.”

Notice the subtle distinction in his statement to emphasize the value of innovation versus the value of its financial derivative. The distinction Barack alludes to is that for too long this country has valued the power of financiers higher than the power of the producers of product.

With our financial system eleven times the size of production, our financial system is simply too large, and our economy is too dependent on the fragile promise of gamblers. And while Barney Frank appears committed to protecting the financial derivative without really understanding the merit of that financial instrument, Barack Obama is vowing to protect the producers of value.

Related to Venture, the NVCA attempts to protect the power of VCs (as the financial derivatives), while I aim to protect the future of entrepreneurs. A crucial distinction.

VC has not made the point it deserves special treatment

The biggest problem with Venture today is that it has no political leg to stand on to demand an exemption from the rules imposed on Private Equity. Contrary to the self-serving rhetoric of NVCA members, Venture - fully loaded by commitments from Limited Partners the last twenty years - should have produced absolute returns that outpaced technology adoption (7% growth in the worst of our economy) and emptied out a greenfield of 80% of the worlds population that still does not use technology to its advantage.

Venture managed to produce returns below the carriage it rides on. Even by their own statistics, Venture produced less than 10% IRR, lost around $1.7 Trillion in opportunity cost, yielded fleeing numbers of Limited Partners, and embodies an in-transparent market mechanism (in-transparent to all marketplace participants) to which we can only fantasize what financial improprieties will surface when that pandora box is forced to open up.

Nothing ventured, nothing gained

Yet Venture Capital was created some forty years ago as a special sector. A sector that deployed significantly greater risk and rewards than Private Equity. Unlike Private Equity, Venture Capital was meant to take the early risk of a company before it has been proven to deliver market value, on the left-side of Geoffrey Moore's chasm and managed to move it miraculously to a massive deployment on the right side (see the chart at "Redefining Capital Efficiency"). That required a unique foresight only beholden to a specialized investor with relevant experience. A lot has changed since then.

On the whole, Venture Capital as the financial instrument to support groundbreaking innovation is dead. Today it can best be described as micro-PE or as we describe here often, as subprime VC (explained in last year's article in support of Vinod Khosla's assessment of the sector). Unfazed, General Partners still rake in cushy management fees (plus micro-PE carry, if at all) defined using rules from the early incarnation of the sector, and blame the lack of results on anything else but themselves. Meanwhile the key stakeholders in the Venture ecosystem, entrepreneurs with groundbreaking ideas and Limited Partners with a large commitment suffer from diminished deployment and return of risk.

So with Venture Capital predominantly operating in micro-PE mode, it is only natural for it to be painted with the same regulatory brush as Private Equity by politicians who do not see a significant difference in role, performance and economic relevance.

Venture born again

But to assume that innovation is dead because of an underperforming financial instrument that controls it is foolish. And to suggest that innovation will suffer from regulations put on VCs is even more ridiculous, where else would their GPs go where downside is more staunchly protected than upside? And it would be easy to replace most of them with better performers.

We have incredible entrepreneurial resources that once supported by a proper financial instrument will prove their value in gold again. Venture needs to prove its merit as a valuable financial instrument to support the outliers of innovation and the creation of real social economic value.

The way to escape impending regulations is to offer to the President a new market model in which the merit of the sector is appropriately and authentically represented. A market model that promotes taking Venture risk and promotes upside and punishes downside. A marketplace in which the merit of investors, as individuals can be openly challenged and their rewards appropriately and dynamically adjusted.

Manage our own "back yard"

The approach the NVCA takes is once again that of protecting downside, but doing literally nothing to promote upside. It makes nothing more than empty promises (based on futile arguments about extrapolation or cyclicality of a glorious past) for a better future based on the changing tide of our economy that is supposed to float all boats again.

Sure, IPOs will increase a little bit, but little Social Economic Value will be created which will yield disappointing post-IPO performance and a further erosion of public trust, let alone significant LP returns. The NVCA's protectionist stance therefor is actually hurtful to the investors, as the preponderance of evidence shows that Venture cannot operate in the same way it operated yesterday.

We need to step in and fix our own ecosystem, unless we want our government to step in and do it for us. The NVCA needs to change its agenda if it wants to preempt government intervention.

I disagree with the President's approach to financial reform

Most reading the above would therefor assume I agree with the President on financial reform, and I do with a twist.

I believe financial reform cannot be established by attempting to curtail all improprieties that occur in our current system that is not a free-market system.

Our financial systems (including Venture) are not free-market systems as they are not transparent to all marketplace participants, are artificially arbitrated, favor the deeply entrenched and do therefor not support a meritocracy. And that means no matter how many great products we invent, even under the "watchful eye" of regulations, the economic value of those products will be severely dampened by the complacency of incumbent investors.

So, the top priority of the President as the head of government (and supported by Larry Summers) is to construct the meritocracy of our financial system, so that all of its future participants can act as watchdogs (or better yet roman geese), establish investor merit and flag improprieties that need escalating and further refinement of law. Venture would be great sector to implement that new market system first.

Regulating the current market system is just a waste of precious time and money.

Until we see the development of such a system, I side with many VCs and even the NVCA, albeit for less altruistic reasons. Without a real free-market system implementing regulations, the industry will quickly establish workarounds and no significant improvement in the support for groundbreaking innovation can be expected.

Subprime Venture Capital will not change to prime by simply adjusting the incentives or applying a plethora of regulations, it requires a market model that allows new investors with an authentic ability to spot groundbreaking innovation to join the marketplace and refresh those that have become stale. Even private markets should be transparent (just not publicly investable yet) so the merit of its inherent social economic value is established before the company transitions to a publicly investable entity (IPO).

With the proper free-market construct (as defined in 2010: The State of Venture Capital for our customers), no longer can over-inflated valuations, ramped up by VCs and settled on under the cover of darkness by investment bankers, erode the trust of the public.

So, dear President, stop tinkering with useless regulations and lets fix the systemic risk of our financial systems first.

Tags: Limited Partners, VC, NVCA, Innovation, Meritocracy, Free-market

By Georges van Hoegaerden

New slides added May 10th
The changed Venture Capital risk profile

Other slides added April 19th and Feb 22nd, 2010. Originally released to the public January 31, 2010.
Targeting Social Economic Value as the impetus of behavioral change for VCs
Confusing upside with downside is the reason why Venture does not perform
Unchanged, reinvesting in Venture is the definition of insanity
Who can solve the systemic issue in Venture today

More than 150 money managers (including some VCs) have received a controlled prerelease of the previously announced 2010: The State of Venture Capital on January 1st, 2010. Since then more than 5,000 others have reviewed the presentation online and has been generously lauded. Clearly the content is striking a chord.

What this presentation is not:

• This is not another numbers deck: clearly not everything that can be counted, can be counted on...
• This is not yet another self-written report card from venture capital lobbyists
• This is not a blind prayer for hope of a better future

What this presentation contains:

• This is a reflection of the effectiveness of Venture Capital from the point of view of a successful entrepreneur; first hand observations
• This is a top-down analysis of the Venture ecosystem for Limited Partners
• This is a permanent fix to Venture and a methodology for LPs and Fund-of-funds of how to re-commit (TVC customers only)

The Prelude to the permanent fix of Venture Capital is available right here (click Full for a full-screen version):


Feel free to make comments, ask questions by using the online form, e-mail us or contacting us by telephone.

The top-down fix to Venture Capital is reserved to Venture Company customers, embodies a new market system and provides fundamental differentiation to Limited Partners and Fund-of-funds managers and a permanent solution to the malaise in venture. Change is easy, we will implement it for you.

The world of monetizable innovation has changed, and we need to change with it. Venture should be and can again be, with a restructuring, the best performing asset class (sector) to money managers.

This presentation has received top presentation of the day recognition on Slideshare based on its content and perceived value by Slideshare staff and has been a top viewed presentation for many weeks.

Tags: Limited Partners, Funds, Venture, Meritocracy, Marketplace, VC

By Georges van Hoegaerden

[This article is a further expansion on the subject of Capital Efficiency of our article from one year ago, named "The trap of Capital Efficiency"]

I cannot tell you how many times I still hear Venture Capitalists (VCs) mention how they look for and "create" capital efficient companies, and how masterfully they continue to sell that "strategy" to their Limited Partners (LPs) as a viable investment thesis.

Those LPs subsequently must believe that they are now investing in a unique class of companies only they have access to (otherwise why is the mention of the specific denomination relevant), and instead of clambering to the old world of capital-inefficient companies, now have the opportunity to prance around in the formation of new, and sexy capital-efficient companies.

Sounds good, doesn't it? Perhaps for those not seeing through the tactics of the spin-doctors.

Let's dissect "capital efficiency" as deployed by most VCs:

First, putting less money into companies, or selecting innovation that supposedly needs less money is a strategy deployed in the last 10 years that has proven not to work. 790 VC firm investors who make - say - two investments per year on average (low ball), produced no more than a handful of IPOs and no more than 10% IRR over the last ten years, is no testament that an attachment to the "capital efficiency" category carries any special value. With our economy now also in dire straits, the chances of capital efficiency bearing fruit has diminished even further.

Second, with a fully loaded commitment from LPs the last ten years, VCs who look for capital efficient deals are dramatically fragmenting investment commitments by having to invest in more companies (to put the full capacity of the fund to work), and conversely increase the investment risk at a time when performance of the sector is already shaky. So the supposed capital efficiency of a startup, with uncalibrated VC fund sizing is actually capital inefficient to LPs.

Third, the cost of acquiring a customer on the Internet has not dramatically changed over the years (if not increased), and so to lower the input into early stage technology companies disproportionate to the dynamics of their output does not only make no economical sense, it again increases the risk of success, opposite of what capital efficiency attempts to promise.

Fourth, Internet technology companies deploy the same rudimentary economics to their customers as old-school companies, they are just using a low threshold (often immature) and a more immediate distribution channel (the Internet). But that immediacy combined with a little bit of money needed to enter into distribution significantly increases competition that in the end favors only those companies that provide relevant social economic value to its customers. And so not the lowest cost-to-entry defines the value of the company, but the quality of service it delivers to its customers. And quality of service is adversely affected by the improper implementation of capital efficiency and thus the reason why the current implementation of capital efficiency in venture capital is incompatible with building real value and public market trust (and therefor reliable IPOs).

Fifth, capital efficiency as deployed by many VCs today, forces startup companies to build technology first. Yet the gating technology proposition offers no indication that the company will ever achieve macro-economic value that has the potential to outshine competition for the next seven years or more. For example, building winner-takes-all marketplaces (such as iTunes, eBay etc.) requires a minimal investment incompatible with the capital efficient VC model, and as such we have not seen any since the popularity of the flawed implementation of that model.

Sixth, technology development is not the risk of a technology company, the application of the appropriate technology to a marketplace is. So, while it may have become slightly cheaper to develop a single line of code these days (I would argue that too), the amount of code needed to make a difference in a highly competitive market, forces companies to make more meaningful and robust products, which requires the deployment of a larger workforce with a cost that hasn't seen any significant reduction. So, just like in any production business, the people-cost is the most predominant factor of the success of the company, not the expense of technology it deploys.

So, yes, capital efficiency the way it is deployed by the demi-cartel of VCs is a big fat lie, that has not and will not deliver.

The ultimate subprime VC lie

Don't get me wrong, capital efficiency is a prudent way to build any company. But the way most VCs confuse capital efficiency lies in the difference between inexpensive and cheap. The way most VCs implement capital efficiency is cheap and lowers a company's ability to grow up, and makes it more difficult for the company to move from the left side of the chasm (Geoffrey Moore) to the right side, where massive user adoption awaits.

The currently popular deployment of capital efficiency spoon-feeds money to startups, which in most cases means the company cannot hire the much needed specialized expertise to turn it from a technology play into a real company early. Many startups can simply not hire a visionary CEO who protects their macro-economic agenda (and returns), and ensures the company remains owner-run (also favored by Warren Buffet) rather than investor-run. That means technology developers without sufficient business experience now run the asylum as inmates of the "investor prison", doomed to make the early mistakes that dilutes founding ownership and therefor - again - increases risk.

So, capital efficiency deployed by subprime VCs is a foolish prophecy. Any VC who uses the phrase capital efficiency as a sector differentiation has no clue what he is talking about. For me, having seen all sides of the venture equation, capital efficiency is the ultimate VC bullshit detector; it communicates they understand nothing about economics, investment risk, innovation, the workings of the technology sector, and business in general.

Capital efficiency today is implemented as downside protection by subprime VCs who look at venture investing as a commodity, and signals how they themselves therefor have become a commodity (and do not belong to operate in Venture Capital).

Capital efficiency should drive upside

Real capital efficiency in venture capital is defined by the cost to produce upside, as opposed to the cost to protect downside. Most companies become extremely capital efficient once they establish beforehand what the operating plan of the business looks like in detail, and as such plausibly define how they need to be "lubed up" to run as efficiently as possible to achieve upside early.

Contrary to popular Silicon Valley belief, technology does not create markets but has - at best - proven to support macro-economic and marketplace behavior that existed for many years. And real capital efficiency is easily achieved by identifying the behaviors that can be more efficiently supported or displaced with the help of technology as content and the internet as distribution. The selection of which marketplace (that is in timely need of efficiency) you pick as an investor determines how capital efficient an individual investment can be.

Capital efficiency, therefor is not a sector strategy, but a way of picking individual companies that have the potential to create extreme and timely upside.

So, from now on dear LP and entrepreneur, when you hear a VC mention capital efficiency, run the other way.

Tags: Subprime, Private Equity, Venture, Limited Partners, Entrepreneurs, VC, Fundraising, Funds

By Georges van Hoegaerden



I read a lot of iPad reviews before I found myself waiting in line to get a shiny new 3G iPad from the Apple Store last friday. Because WiFi is simply not pervasive (albeit more pervasive where I roam on the east coast than on the west coast, surprisingly I found even gas stations in North Carolina having free WiFi), the iPad without 3G is perhaps best suited for children who need a somewhat controlled access to the internet and for many of us who use their mobile device connected to the Internet primarily from home (according to a pre-iPad market study I recall).

From the many other reviews (including Walt Mossberg's valuable assessment) you can read about the early experiences with this great new device. I agree with most of Walt's assessment but wanted to offer some complimentary considerations (from a demanding early stage entrepreneur, Venture Catalyst, Venture Capitalist and Venture Economist) I did not see.
The iPad is a beautiful, easy to use computer that will serve the lifestyle, internet and computing needs of most people. You should get one at your earliest opportunity.
If you travel frequently, the iPad 3G is so well equipped and easy to use, you can actually peacefully leave your main computer at home. Even novice users will suddenly have the world at their fingertips.

Here are my remarks to make the iPad even better:

Strategically

The requirement to tether the iPad for the first time to a regular computer and activate it through iTunes is beyond a lawsuit waiting to happen (it does not state such requirement on the box), not the right strategy for consumer adoption of the iPad.

The iPad is a device that is likely to appeal to 5/6th of greenfield of the world's population that is not using a computer capable of running iTunes, and bound to find itself limited in market penetration by the tethered activation requirement. Apple should aggressively offer in-store and cloud based activation to combat this issue.

Positioning

Now, Apple is often referred to as a great marketing company, in my view because they don't do any positioning at all. Most of Apple's products are described by virtue of their beauty and their capabilities and just like with finding a woman with those attributes; you know instinctively when you want to be with her.

Most other technology vendors still foolishly deploy expensive marketing departments to preempt who its buyers may be, and Apple merely states what the device does (in terms of benefits), the number one thing I find myself explaining to interested onlookers is that the iPad is a (lifestyle) computer, not just an iPhone Touch with a bigger screen.

The iPad, also by virtue of which software capabilities are included (see below) suffers from a bit of public confusion and identity crisis, as witnessed by the complete lack of built-in printing capabilities.

Hardware

The shape of the iPad is perfect for a handheld device, yet the 3G is big enough to make you want to rest it on your lap or elsewhere and tap around with both hands. My 5-year old daughter with smaller hands juggles with the weight and requirement to move the iPad around while playing games, yet not enough to keep her hands off my iPad.

- The volume button
The volume button on the iPhone and iPad irritates me to no end, not where it is placed but which part of the rocker is volume up or down. Given that the iPad can be used in many orientations I would make the volume up and down switch sensitive to the context of the orientation. Meaning, no matter how you hold the iPad, the volume up and down coincides in direction with the visual clues on the display.

- The home button
The home button is visually undetectable in the dark, and can be left, right, up or down depending on the orientation of use. This button needs a slight backlit to identify itself under low-lit and dark conditions.

- Back curvature
On a completely flat surface such as a desk or kitchen counter the iPad has a tendency to spin around easily, especially when typing hands-free. A slightly less curved back, with more surface area touching the underlying surface would improve resistance and offer more stable usage.

- Speakers
The current speaker position, (on one side only) leads to frequent muffling and diminished volume and clarity of sound when holding the iPad in landscape orientation when hands are prone to cover up the speaker slots. This needs a different implementation, perhaps dual mono sound asymmetric to the orientation of the device.

- Display
The display, even though made from a special material smudges easily which when viewed from an angle and will make the owner look like a dirty animal. I am not an expert in display technologies to offer a solution, and these fingerprints are hardly noticeable to the user with a straight-on view of the device.

- The Base
The docking base for the iPad (sold separately) only supports a portrait display of the iPad while docked, not the most natural way to view widescreen videos nor the default orientation of the majority of photographs while charging.

- Touch
It is probably a software modification, but I found the iPad sometimes responding to fingers not fully out of the way of the touchpad causing some unexpected behavior. Some of those fingers do not need to touch the iPad, I found out, to cause an in-adverted detection and operation.

Software

Apple is clearly ahead of the pack in delivering a compelling lifestyle computing device we can all use and therefor will catch most of the wind in addressing the imperfections of the software provided. That does not mean I suggest you should not buy the device, but it does mean Apple has room to improve with software updates that make the iPad better.

I can tell (and know) that Apple is developing the software in corporate divisions with their own disparate decision making. As the first vendor to provide truly integrated desktop, mobile and cloud computing services Apple needs to reorganize itself amongst the development of IP (Intellectual Property) that spans those boundaries. No longer is the power of one capability on one platform important, but the lowest common denominator now defines the overall experience.

- Portable capabilities
With much of development efforts at Apple focused on newer devices such as the iPhone and iPad, the lack of development efforts on its OS X companions are affecting the (synchronized) reliability of data on the new devices. With the release of Snow Leopard (OS X 10.6) Apple has really dropped the ball on the stability of the address book, iCal, e-mail and others that affect the use of all devices in concert. With the latest release Apple changed the way it deals with address book imports, how it deals with duplicate contacts, how it syncs address book images etc, to the extent that you need to verify and make frequent backups of every part of the process to prevent unexpected behavior.

- MobileMe
MobileMe is a necessity to synchronize over-the-air many of the e-mail interaction, contact, calendar and notes to keep your information up-to-date at all times, and you should therefor subscribe to it (a $99 / year charge). But it took me two months to figure out how to use MobileMe for my business without showing that the e-mails I sent were coming from MobileMe (a long story). Every business owner who wants to take maximum advantage of the iPad and iPhone capabilities is in the same predicament. The cloud services provided by Google's gmail finally came to the rescue.

But it does worry me that to get and send e-mail using MobileMe a la BlackBerry demands the proper workings of no less than four e-mail servers. The same with calendar sharing where Google cloud services trump those of MobileMe, and for the first time my wife and I can now share a social calendar (using CalDAV) to which we both can add, edit and delete from the same calendar whenever we wish. These everyday capabilities should be supported by MobileMe monolithically by now, but are not.

Also, MobileMe's iDisk and Gallery applications are not (yet) natively available on the iPad and users need to use the iPhone derivatives to continue to use those features. I am expecting a beautiful new Remote application from Apple soon, that allows me to control the Apple TV in wonderful glory.

- AppStore
The Application Store (for the iPad) is supposed to support The Long Tail of applications plus the Torso yet it provides no intelligence (yet) to figure out what based on your interest is the best selection of apps available. That means you need to scroll tediously through thousands of apps icons only to have to start over once you installed one of them from that list (as the store does not remember your last position prior to install). That means you give up exploring the Long Tail of applications pretty fast, and the meritocracy the marketplace (and thus opportunity for app vendors) the AppStore intended to provide is severely diminished.

And while iTunes bravely installs all previously installed compatible iPhone apps on the iPad, the AppStore makes no attempt to then upgrade the Apps (read upsell opportunity) to its iPad native companion. So, it takes hours perusing the AppStore to figure out which of your favorite App has a more capable iPad cousin. I found myself abandoning iPhone apps and instead bookmarking their respective webpages with an icon on the home-screen.

It is also a bit of an embarrassment for AT&T not to have a iPad native iPhone account management app that also incorporates managing the 3G iPad subscription service.

- Dictionary
When entering text the iPad prefers to use capitalization in some weird places, insert spaces at other times (without "suggesting" it first) and in e-mail actually changed the from-address descriptor from "The Venture Company" to "The Company". It appears the dictionary used in the iPhone is more robust than the one used in the iPad.

- iWork
As a long-time iWork user (for most of my work) iWork on the iPad is a big disappointment. I was hoping to use my iPad as the device I could take to Limited Partners and present my now famous "2010: The State of Venture Capital", but I quickly found out that iWork on the iPad is not compatible (in many ways, it imports rather than opens OS X documents) with the version that runs on OS X. As stated before, parity of software capabilities between platforms should be of new importance to Apple as that will prevent people from re-evaluating other options. iWork (KeyNote, Pages and Numbers) are fantastically powerful apps on OS X, and in its infancy on the iPad. Novice users can still have fun with iWork on the iPad.

- Mail
E-mail on the iPad looks and behaves stellar, yet with a few quirks. It appears impossible to change the reply-to address, notes are not synced over-the-air by default, regular IMAP e-mail is pull only and you cannot set a polling frequency. Some e-mails (such as private equity online) previewed incorrectly, the rendering engine must be different from on OS X, where it showed up correctly. Some Word documents could not be opened in Mail, not even with the version of Pages (and part of iWork on the iPad). I hate the horizontal scrolling while you reply to an e-mail, making it impossible to review what you wrote in place.

- Calendar
The Calendar views are visually stunning and well laid out. But some of its functionality bothered me. One cannot change the calendar of an appointment after it has been created. I could not find an option to display the time in the week view (as on OS X), nor could I find a way to accept a Microsoft Outlook invite which it entered correctly in the Calendar.

- Browser
A version of Safari runs well on the iPad, but I miss a few capabilities including a pinning of favorite pages (as available on OS X). Some documents, including v-cards (address book information from LinkedIn for example) do not load into the appropriate application (address book in this case). Some of the new social call-backs designed to integrate social capabilities by Facebook and Twitter do not work well on the iPad browser, thankfully a onetime process that can be handled on the desktop as well.

- Long list navigation
Long list navigation needs a new indexing approach, plowing through 4,500 contacts on the iPhone or iPad is not fun, nor is scrolling through 2,500 photos (a hobby) really practical. Some of the new indexing capabilities of iPhoto on OS X (face, date, folder, theme) would be welcome on the iPad.

- Multi-user login
Even before purchase my daughter "claimed" certain usage rights to my iPad, which to keep things safe, really requires a multi-user login with separate menus. I am hoping that becomes part of the unannounced features pending for the iPhone4.0 release for the iPad slated for the fall.

A new dawn

I may discover more things that are not perfect on the iPad, but so far I have been inseparable from this nifty lifestyle device that manages to take on a much larger part of my business requirements as well.

The continued development of the iPad will change the face of computing forever, and as a result people are no longer beholden to the lazy innovation and complacent attitude of Microsoft, joined by the mediocrity of cheap and ever commoditizing hardware partners.

Apple has singlehandedly changed the computing agenda from business to lifestyle, and managed to serve its fast growing customer base with an experience that truly meets their every day needs.

The iPad has become the third "woman" in my life (in the aforementioned analogy), who is bound to become more capable and more beautiful every day.

Tags: iPad, Apple, IPhone, ITunes, OS X

By Georges van Hoegaerden



It is time for a Venture Capital (VC) roast, as I continue to see so many of its General Partners spread the rhetoric that Venture hasn’t performed all that miserably and that it will all rebound, ignoring that the opportunity-cost incurred by a systemic slide from Venture into micro-PE (or what we prefer to call subprime VC) is larger than not investing in Venture at all.

The VC roast

So, let's have some fun and show you what to do when you are a Venture Capitalist and do not want anyone to get suspicious:

- You graduated cum laude from one of the top Ivy League business schools in the U.S. that also invested in your firm as an LP, and discover that none of them have been able to make their endowments in Venture produce a decent return for the last ten years. Oh well, at least your parents loved you enough to give you a great start.

- You copy the Private Placement Memorandum (the business plan of a VC) from a brand-name VC, enter new General Partners in the about section and voila, another VC star is born that Limited Partners (LPs) cannot possibly say no to.

- You start raising new money, four years after your first, making it impossible for your LPs to establish the real merit of your initial investment thesis. You’ve just added another 12 years to your already comfortable existence and enjoy the stability of a more secure job than anyone else in government.

- You are vague in the actual deployment of your investment strategy so you can balance early and later stage investments based on how the vintage of your fund should look on paper and what the marketability of your second fund is four years into your first.

- You tell the world about how holistic your job really is, and how you as a member of the Venture sector are responsible for generating all these jobs, forgetting of course that you are mainly the matchmaker in the process (between the assets from LPs and Entrepreneurs) and it is not your money you put to work but the public’s money (dispersed through LPs to VCs).

- You tell the world that you really need to exist because innovation is crucial to this country. Forgetting that anyone with real entrepreneurial experience and verifiable merit will gladly take your place the minute you get out of the communal hot-tub you refer to as a unique fund.

- You become a member of the NVCA, whose protectionist agenda and lobbyist resources will provide you with plenty of ammunition to LPs and the government as to why your investments thesis, that is so similar to your peers in the industry should be protected at all cost for the sake of innovation.

- You decline to discuss publicly any rounds of funding into portfolio companies and its valuations, because at some point that may actually lead to the discovery of your real knowledge, vision and merit of decision making in Venture, or what a fool you really are.

- You build out your investment firm to a wide global network, so you can have the unique ability to smooth out investment returns and strike up generous stacked management fees in all.

- You tell the LPs that you are investing in “Capital Efficient” companies, omitting that capital efficiency is defined not by how much downside you protect, but how you enable upside.

- You make the world believe that the best companies to invest in start with the discoveries from white males, under thirty, only a technology proposition, twenty miles from Sand Hill Road and built in a garage where you spoon-feed them $250K tranches, minimizing investor downside risk. Ignoring comfortably that the long-tail of viable ideas should just no longer be explored.

- You tell on your blogs how entrepreneurs need to get better in building companies or how to navigate venture constructs, as opposed to spending all your time on finding groundbreaking innovation with enough upside that helps them hire the best.

- You tell entrepreneurs nothing about your knowledge, performance and merit (and ability to invest or not) but expect to the entrepreneur to be fully transparent.

- You demand from entrepreneurs that they realize you will bring more than money, while you will not talk to them directly and provide no substantial differentiation of your investment thesis on your website. It is maybe because you are not that special to begin with?

- You sit in your office searching through piles of business plans, waiting until technology walks in the door that strikes your fancy. How come the visionary in you cannot proactively induce groundbreaking innovation?

- You preach at the many technology “flea-markets” about what constitutes innovation and how to find the outliers, making no one wonder what you are doing at this “flea-market” to begin with.

- For ten years you pushed valuations through the IPO funnel with little value and now, after you’ve squandered public trust, and struck by the impending retribution, you now defer all early risk to entrepreneurs and wait as long as you can to see if something miraculously pops up.

- You add different investment vehicles to your firm, such as PIPEs, annex funds, buyouts so as to further hide your real merit in the demanding venture sector.

- You give speeches to the world about free-markets from atop a comfortable perch of the most closed, dark, unregulated, in-transparent and proprietary market mechanism in the financial industry.

- You write on your blog that Venture is all about relative performance and then compare Venture indices with those of 100-year old asset classes (with nominal greenfield and growth), so Venture still looks like a “star”.

- You act confident that when the economy recovers all boats in Venture will rise again, delivering the evidence that you do not understand that groundbreaking innovation is resistant to economic aberrations, and your boats should be sailing the skies by now (as other custodians of innovation have proven).

- You cry on stage (like a real man) about the nobel cause of improving our climate, after you realize technology investing does not make turkeys fly anymore and you are looking for greener pastures. Giving you the out to turn your venture firm even faster into a private equity firm (compatible with making greentech investments), a perfect slow paced Venture retirement strategy that makes everyone feel warm inside.

- You tell the world that the Venture business is still "the envy of this world", forgetting that the financial system does not create the value, but the unwavering drive of the groundbreaking entrepreneurs you are choking.

- You tell the government that regulation will kill innovation, forgetting that - at most - regulation will kill venture capitalists who cannot stand to have their merit exposed publicly.

- You convince the senate that innovation is not at risk in our country, based purely on the size of its financial system being larger than that of all other economies combined, forgetting that a financial system eleven times the size of production is a very unstable foundation to begin with and how we’ve become a nation of gamblers rather than producers. Act surprised when other nations slowly start to eat our lunch.

- You tell congress that there is no systemic risk in Venture, convincing congressmen that the sum of all investments in Venture (about $2 Trillion the last ten years) should really not have yielded more than 3% ($66B) in IPO value.

- You tell the world that the malaise in Venture has everything to do with the economy, while venture funds have been fully loaded and startups (at best) produce discretionary revenue that is a minute portion of the overall market and thrives on the pressures of change in economies.

- You tell your LPs how you invested responsibly by chopping up available funds into ten levels of bottom-level diversification and get them to nod favorably about the elimination of risk, rather to embrace the risk that separates Venture returns from Private Equity.

- You tell your LPs afterwards that investing is cyclical and that they should have factored that in their equation, especially now that venture capital has turned into micro private equity. You do not need to tell them that Venture has become more risky because the risk you created as a member of the VC demi-cartel.

- You tell others, shhhh..., how LPs are really not the brightest people on the planet and that they should take part responsibility for the demise of Venture. Because you are simply executing on the same “proven” strategy as your peers in the VC business.

- You tell your LPs that your performance is top-quartile, allowing you to specify who you want to be compared with. What better job than to get away with with writing your own report card.

- You say goodbye to Venture based on the lack of liquidity opportunities in Venture, dumping a sector from which you have extracted a “glorious reputation” and income but do not want to be bothered with the hard work of fixing it.

Causal connection

As with all roasts, the underlying message is a serious one. I can write and speak for days about the empirical improprieties in Venture I discovered as an entrepreneur, venture catalyst, CEO and venture capitalist in Silicon Valley. But rather than to debate each one it is more important to realize that they occur because of an incompatible financial system that allows so many people to take it for a ride.

"Mistrust of every kind of authority grew out of this experience, a skeptical attitude toward the convictions that were alive in any specific social environment — an attitude that has never again left me, even though, later on, it has been tempered by a better insight into the causal connections" -- Albert Einstein

We need to fix, simplify and make our financial systems more accountable, in order to erase the behavior that stifles it. Our government needs to play a role in establishing marketplace transparency and instead of trying to curtail the symptoms, fix the disease that produced it in the first place. Limited Partners need to deploy more discipline with people who know the Venture Ecosystem inside-out and better yet, how it should work.

Financial systems are a systemic threat to our economy

The behavior in Venture is very similar to the many improprieties of other financial markets, and simply less overt because of its complete lack of transparency to most marketplace participants. But improper behavior in Venture is like "child abuse" of our growing economy; it cuts off the spirit, zest, fortitude, and vision of young groundbreaking entrepreneurs who have the opportunity to become the new business leaders of our world. We will never be able to recover from the Venture malaise if it persists for too long, other nations are not sitting still.

The real optimist in the face of the malaise in Venture is not the one who continues to milk the dysfunction or walks away in search of greener pastures, but the one who builds a systemic fix for the failure in Venture and helps groundbreaking entrepreneurs define a new compass of innovation.

I have done both.

Tags: Free-market, Limited Partners, Growth, Government, Economy, Einstein, Marketplace, VC, Entrepreneurs, Innovation, Investment, Macro-economics

By Georges van Hoegaerden

The Venture business has got the world upside-down, is what I wrote in a recent comment to a VC and I meant it.

Just as upside-down as many people who buy a house and get a mortgage confuse a liability with an asset. A great example I heard Robert Kiyosaki (from Rich Dad, Poor Dad) refer to in an infomercial in the background while I was doing work on a quiet sunday.

Venture should perform much better

From many discussions, publications, public statements and strategies discussed in new Venture videos it is clear how a large part of the Venture community struggles and puts up relative performance metrics (such as meaningless top-quartile definitions), and pad themselves on the back that Venture is still outperforming public markets. All while technology Venture performance should have blown other asset classes and public markets away, by virtue of its massive greenfield (5/6 of the worlds consumers) and continued growth in technology adoption (even through the worst of our recent economic downturn).

But Venture is looking at the wrong metric of success.

Focus on upside

The real issue in Venture is that the innovations Venture Capitalists select, barely have any Social Economic Value (SEV) and therefor by definition have severely limited upside potential. On a scale from Technology to Market, to Execution, to M&A, to IPO, to SEV (as depicted in the enclosed chart), most venture investors today look for technologies and apply their risk thesis to the lefthand-side, or downside of the scale, hoping and praying to ever reach the righthand-side.

Frankly, most investors have upside and downside confused, which is the source of their deplorable performance. Technology development is not a testament to ever reaching Social Economic Value. And to demand from entrepreneurs that they build technology is a sign of how they further defer the majority of even downside investment risk to entrepreneurs ("show me what you have built") as a prerequisite to investing (as we explained in the reference to Vinod Khosla's perspective in 2010: The State of Venture Capital).



What we have lost over many years of irrational exuberance in Venture is our ability to spot and target large Social Economic Value. Social Economic Value defined by the trust of the public as a customer, not to be confused with an IPO, which is defined by trust of the public as an investor (preempted by an investment bank).

In the 90s venture investors pushed valuations without value through the IPO funnel, which led to a loss of faith and a retraction of IPOs post 9/11. The way to regain trust with the public is not to sell them another lie, that is based on nothing but the hope and rise of the economy that is supposed to float all boats again, but to have the public use the product as a customer, and let them make up their own mind about its value as an investor. Hence the definition of upside in Venture defined as the creation of Social Economic Value as opposed to an IPO. IPOs will flourish once that public trust from consumers is achieved.

Reverse engineering upside

A fundamental difference in the investment thesis is that as a Venture Investor, instead of looking at the gating technology proposition, you assess an innovation based on the merit of its ability to change the world (where it is likely that no prior implementation exists). But you as the investor can align with the entrepreneur based on a shared vision, compass and the likelihood that the support of that Social Economic Value will feasibly occur within the next five years.

And that means that both the entrepreneur and investor share the predictions of the trajectory that builds Social Economic Value, a much better equilibrium between entrepreneur and investor. One in which according to Warren Buffet, the “owner oriented attitude far outweighs the periodic downside". No longer are entrepreneurs pestered with demotivating rounds of ownership dilution based on unpredictable microeconomic aberrations and, no longer do investors waste time worrying about the minutiae that do not affect the Social Economic outcome.

Rather than forward planning from a technology starting point, Social Economic Value is created by back-planning or reverse engineering upside. Meaning, in order to create large SEV a certain IPO range needs to be achieved, which can be swayed by M&A interest, which is created by great execution, which stems from understanding the behavior of marketplaces, which can be served by technology. Technology is the derivative, not the goal.



The distinction between prime and subprime innovation is simple. Prime innovation is attached to existing macro-economic behavior (and usually the absence of technology previously) and relatively easy to predict (I would be happy to share examples), while subprime innovation is attached to a technology wave with a short expiration date and little macro-economic value (a main reason why many acquisitions perform so poorly) that has a minute chance of ever producing viable returns.

Investing different leads to different entrepreneurs

Upside investing applies the proper risk to an early stage Venture, it applies it to the assessment of anything else but technology. Because, as technologists the creation of technology is the least of our risks. But it requires a VC fund that can carry most of the $25M runway needed to create the success of any disruptive Venture today (yes, "capital efficiency" is a lie). The small funds can continue to deploy their subprime risks, while the larger funds have the opportunity to separate themselves macro-economically, by spawning real innovation.

The minute you as an investor set a different compass and focus on the creation of Social Economic Value, different entrepreneurs come out of the woodworks that subscribe to that investment thesis. Suddenly you will meet the entrepreneurs that through years of experiencing macro-economic deficiencies, have a vision of how to change the world for the better and as a result generate the large outlier fund returns Limited Partners need to see to stay confident.

Change is inevitable

We may see a slight upswing in IPOs this year, as the economy recovers, micro-PE deals are the best game in town, and those with money to play regain some confidence. But if we as investors do not change our investor tactics and produce real Social Economic Value, it is inevitable that Venture will descent even further to micro-PE than it already has, and continues to suck the risk and returns out of performance.

And that would be the kiss of death to Venture and to the wide-open opportunities in innovation that still lie ahead.

Tags: Innovation, Fundraising, SocialEconomicValue, Macro-economics, VC, Entrepreneurs, Limited Partners, Marketplace

By Georges van Hoegaerden

I am perhaps the most well known (so they say), open and prolific contrarian of the complacent attitude, role and performance of Silicon Valley's most notorious Venture Capitalists (VCs), and frequently I get the question from entrepreneurs suggesting that those VCs must just hate me with a vengeance.



My consistent answer to that question is;

• Very short: "I don't care, the truth needs to be told",
• Longer: "I don't care what the many subprime VCs who underperform think of me",
• Even longer: "I would not raise, nor suggest other entrepreneurs to raise money from VCs who cannot be challenged on their merit, methods and madness",
• Longest: "If they hate me so much, why are many then in conversation with me - my arguments are apparently crisp and tantalizing enough to engage in the debate for a better future"

Tough and fair, yet balanced

The reason why many VCs continue to talk with me is that I've known many for a long time (as a former part-time Venture Partner trolling, eating and networking with them on Sandhill Road) and that my observations are tough but fair and stem from an authentic desire and urge to fix Venture.

Honestly, I like many General Partners personally, I just despise the institution they have created - in the same way many of us like their congressmen but hate congress. But smart people can be wrong (and use their smarts to protect their self interests), and many VCs are seriously wrong.

The Venture ecosystem (the way it works top-down) is structurally flawed to which blame could and should be directed to Limited Partners who do not deploy sufficient investment discipline to such a specialized sector, to VCs who have taken the liberty to take the system for a personally prosperous ride, and also to massive volumes of would-be-entrepreneurs, who attracted by the predominantly subprime investment thesis made it significantly harder for VCs to separate subprime from prime innovation.

My observations are also balanced in the sense that I do not subscribe to new mechanisms that treat entrepreneurs unfairly (we just launched a new way to rise groundbreaking innovation above the noise), treat VCs unfairly (which I think The Funded does), and treat LPs unfairly (for whom we built a permanent fix by virtue of a new market model). However, all participants should be held accountable to turn this sector around and produce outlier results consistently.

Why VC needs help

And while I have provided much rationale to clearing up the mysteries for the primary asset holders in Venture; LPs with money and Entrepreneurs with Ideas, my public support for VCs has been waning. Most probable because many VCs come across as arrogant, mislead entrepreneurs (sometimes without realizing it) and are the ultimate protectionists in the Venture ecosystem that leaves every participant unhappy except themselves, living a lush life and raking in astronomical management fees (from largely our public money) that at least secures their life for the next ten years to come.

But new General Partners in VC firms like some of my friends who are raising new funds, new GPs like Mark Suster from GRP Partners (a former entrepreneur who appears to agree with many of my observations, see the accolade) and even some we would classify as the older garde of the Venture ecosystem seem interested in a debate as to how their performance and the Venture business can become prime again.

The really "old" goats of the industry who survived the self-induced Venture malaise because of their early foray in the Venture business and hide behind their brand, PIPEs, annex, buyouts, secondaries and massive investment networks that allows them to smooth out (read: level fund returns so they all look optimal) performance, want nothing to do with any anything that could potentially cannibalize their cushy position. But who needs help if they can retreat to their own island and live happily ever after? I still spar with them at times.

So, let's give VCs who have not yet raised their crucial third fund and still need to demonstrate consistent returns to LPs, the benefit of the doubt. Without further ado.

Be aware of the sector's legacy

Limited Partners, as I explained in one of my previous blogs, have become extremely reserved when it comes to treating Venture as a viable asset class (or better, sector). The malaise in Venture is apparent and can no longer be simply explained away by the state of the economy (as Venture is resistant and out-of-cadence with it). Instead Venture by virtue of the growth in technology adoption (7%) should have simply grown rather than declined in performance as better custodians of innovation are able to prove.

Hence GPs raising funds need to come up with a much better story than the old tactic of copying the private placement memorandum from a "top-tier" VC that makes the resumes of the GP its biggest differentiation. Me-too funds are no longer funded and a whole new investment thesis must lie at the foundation of those who want to succeed.

Be aware of the pool you dive into

It is crucial to realize that while you may march to the beat of your own drum and with a unique investment thesis, the marketplace consisting of LPs with their asset - money -, and entrepreneurs with their asset - ideas - still has not yet substantially changed. Massive amounts of ideas without substantial Social Economic Value float around, and thus GPs need to be extra savvy to communicate their thesis clearly to prospective entrepreneurs.

Moreover the marketplace in which you act as the arbiter of Venture transactions (see our primer) is highly suboptimal. We repeat for clarity from a previous blog why even your stellar performance may do little for your LP. So, an LP that is diversified in many other VC funds may not recognize you as the outlier, because you participate in a marketplace that by definition mutes outlier results:

• A marketplace that marries the assets of supply and demand, with many arbiters not having - or earning - verifiable merit
• A marketplace that marries the assets of supply and demand, using a single commoditized investment thesis
• A marketplace that hides behind the performance of hybrid asset classes, sectors, segments and stages
• A marketplace that hides behind ten levels of diversification of risk
• A marketplace in which the arbiters do not compete (but syndicate)
• A marketplace which openly engages in price-setting and operates as an innovation demi-cartel
• An in-transparent marketplace that functions like a black-box to most marketplace participants
• A marketplace that appears extremely sensitive to economic aberrations
• A marketplace that has not produced healthy returns in twenty years

And that means that with a new fund you are probably better off raising money from a new LP, local or sovereign that understands how to distinguish between the scorn reputation of Venture and the massive greenfield opportunity that unwaveringly lies ahead and you become one of the few commitments in that fund.

Own and prove the validity of your unique thesis

But let's assume you as the GP realize all the above and have your ducks in a row and funds secured, how now do you build solid returns for your $100M plus fund.

Minimize syndication

If your investment thesis is indeed unique, you and only you are qualified to carry the risk for your favorite investment. Syndication is fragmentation of LP dollars and thus fragmentation of risk, which turns Venture Capital quickly into micro-PE. As long as the investment has large Social Economic Value, the right amount of focused risk will get it to fruition. Fewer deals at the right intersection of your unique investment thesis, with the appropriate support for upside will produce by definition much higher success rates than the sector average (otherwise your thesis is invalid). So don't be afraid to stand alone.

Invest in Social Economic Value

Many VCs have turned subprime, even some of the well know brands. Subprime is not defined solely by how much money is put in a startup but more importantly at which point. Most VCs defer risk to the entrepreneur and therefor create a highly fragile company from the start. The creation of Social Economic Value that can build trust for an IPO has a radically different planning and funding model associated with it.

Invest in market principles

For twenty years GPs have used technology as the starting point of making investment decisions. Yet, more crucial is the macro-economic impact of innovation in which technology is the enabler but not the deciding factor. Macro-economic impact can be achieved through multiple technology strategies and is likely to see a few different iterations in its lifetime. The starting incarnation of technology is the least of the investment risks and hardly ever proof that it subscribes to any macro-economic benefit.

Become an active investor

Most VCs wait somewhat passively until innovation walks into their door, the appropriate response for many GPs who do not have the experience, credentials and foresight of an entrepreneur. But many innovations, especially those founded upon macro-economic behavior can easily be predicted and thus also ignited by the investor. If you truly know your domain, you should be able to predict and reach out to great entrepreneurs and have them run with some of your vision at times.

Communicate your differentiated investment thesis clearly to entrepreneurs

I have heard the complaints from VCs overwhelmed with business plans which forces them to default to their old buddies network. Yet, if you communicate leadership as an investor those entrepreneurs that do not fit your thesis will stop knocking on your door. We experienced that ourselves as we were hesitant to turn commenting in our blog on, for fear of having to respond to the same messages all day, but a few clear answers made entrepreneurs understand what we stand for and diminished the interaction with subprime entrepreneurs significantly. A not so clearly differentiated investment thesis is the source of many wondering would-be-entrepreneurs knocking on every door they can find.

Be real and let your authentic merit define you

With the bottom falling out of VC performance, it is important for VCs to be as open and transparent as possible in setting a new tone. A tone that is not embedded in arrogance and ignorance nor a marketing tool to lure in unsuspecting entrepreneurs, but reflects a realization that you understand what the deplorable past of VC has done to innovation and how you intend to chart a much improved course.

Tags: VC, Fundraising, Funds