Greater-Fool Paradise

Georges van Hoegaerden

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

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

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

Tell the truth

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

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

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

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

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

First, more danger looming

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

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

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

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

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

Only losers depend on socialism

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

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

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

A bridge too far

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

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

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

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

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

Shame on NVCA members

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

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

And you have to wonder about its current members:

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

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

Entrepreneurs beware

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

Yes, we can reinvent venture capital and the innovation it attracts. Not by deploying more subprime risk through a plethora of flash-in-the-pan alternative distributions (crowd-funding, incubators, etc.), nor to have government play the role of a venture capitalist to fill the void and mess venture capital left behind.

Instead, we must fix venture capital once-and-for-all by deploying grown-up and proven renewable economics of prime.

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