The vast majority of venture capital firms fail to produce consistent venture-style returns to their limited partners. A renowned money-manager representing prominent limited partners as the investor in venture capital firms adamantly proclaims that number to be less than 35. From knowledge about those 35 firms, the majority of which reside in Silicon Valley, we estimate the number of successful venture capital firms with venture as the monolithic thesis (in non-diversified undiluted technology investments) no more than a handful.
The silent death of entrepreneurialism
Meaning, entrepreneurs with innovations that promise authentic socio-economic value that can produce outlier venture-style returns have no more than five investors with some verifiable investment merit to choose from or suffer the devastating consequence of uniform arbitrage that turns outlier entrepreneurial ideas inevitably subprime.
Quite deplorable considering that the greenfield of technology adoption worldwide remains at more than 80% (ITU/UNESCO data). Which begs the question, why is the performance of innovation arbitrage regressive while the opportunity for market penetration is wide open and should yield progression? The misalignment between opportunity and performance suggests innovation and its arbitrage are entirely incompatible.
Venture as an asset class has failed
Venture capital, as an asset class, has utterly failed. Some suggest more than 1/3 of 790 venture investors have turned into living dead or given up and closed shop, unable to garner interest from their investors. My many conversations with those investors (limited partners) who feed venture capital firms reveal that venture has become the dirty word of asset management. Few have answers to how it can recover.
The venture capital lobbying organization (the NVCA) feverishly attempts to dampen the demise of venture capital’s reputation by quoting nebulous IRR (Internal Rate of Return) statistics. Hiding that absolute performance comes from a few firms and different firms each vintage suggests that luck may be the driver of their cyclical stature rather than the proclaimed “best practices” that its venture capital lobbyists quoted.
The leeches are hanging on
Some of the aforementioned “successful” venture capital firms tempt fate by deploying their financial war-chest to a handful of innovations that succeed despite, not because of the role of venture capital (hello Facebook) as one of the few remaining investors with enough cash in parallel and stacked funds able to comply with entrepreneurial success. Venture capital “success” is achieved again not by a unique alignment of foresight it is supposed to deploy but just by association. But who is counting?
To challenge my criticism of venture capital and the fix I have in mind, I periodically throw myself into the lion’s den of venture capital and relish talking to its founding fathers to find out what I might be missing. I am full of respect for the founding fathers of venture capital, who did not have access to the excessive diversification of risk so omnipresent today and had to singlehandedly prove their merit to institutional investors before technology investing was even considered an asset class.
Not a single introspective argument to the surface, yet quite a bit of interest in the disruption I have in mind for venture capital. But each time I do so, I am stunned to learn venture capital’s problems are comfortably explained away as the cost of doing business in venture capital will economically correct itself by attrition or is merely the cyclical nature of the asset class soon to rebound. The cases for change are in favor of reality, and rebuttals are losing steam.
Venture capital is incompatible with innovation
In its current form and deployment, venture capital steeped in investor socialism is by economic principle incompatible with finding the outliers of innovation because the macroeconomics of outlier innovation and stifling socialism are.
Russian roulette with public trust
As venture capital has turned subprime, so have supplemental funding methodologies meant to feed them. Access to capital is not the problem of start-ups, and neither is access to private investors to start-ups they fancy. The real problem is the implicit deployment of subprime investment risk (and damaged public trust from -30% 2-year trailing post IPO values), which by economic principle will never yield prime returns that can keep asset managers coming back for more.
Improving financial support for startups (by government interference or crowd-funding) will not make any positive, sustainable impact. An economic marketplace that trades subprime or uniform investment risk more aggressively will be responsible for even faster attrition of the asset class (meant to support outliers that can produce $1B companies and its many jobs) than we have witnessed.
No increase or decline in money to the venture asset class can make up for the ill-conceived deployment of excessive embedded and self-induced subprime risk. More subprime risk deployed to innovation will only produce more distrust in its future.
Return to prime
The only solution that can rescue venture capital is an economic mechanism that forces it to invest prime to apply significant risk to the innovations that deserve it, in a way not dissimilar to how venture capital achieved its footing some 50 years ago.
And the quicker we implement such fundamental innovation to the business of venture capital, which forces every investor to invest prime (or get out), the sooner we will recover (and surpass) the 20% of GDP groundbreaking innovation has proven to generate.
Our obligation to the future
For purely selfish macroeconomic reasons, we need venture capital to perform, not because of a purported deep dark desire to punish its general partners.
Let’s all focus on the future. Because if we want to continue to lead the world in bringing groundbreaking innovation to market, we need to do better than deploy Neanderthal economics to its arbitrage and instead induce change to venture capital that can set a new standard for discovering innovation the world can genuinely aspire to.
We gave birth to venture capital in this country. Our fiduciary duty is to make venture capital grow to become a prosperous economic adult and perform in line with the most significant opportunity for innovation that still lies ahead.