Update & flashback: The publication of this post led to a heated exchange with Dan over email, calling me a fraud when I called him the weather-man of venture capital, who ignores the signs of climate-change because it snowed today. If he really thought I was a fraud, why then did the publications at Fortune and Reuters, he both worked for, published so many of my articles there. Gotta love the press, spinning stories – aimlessly at times.
On with the original article:
With the wisdom only a reporter who has never worked a day in the business of innovation, Dan Primack at Fortune in his daily email declares venture capital fixed. Of course, I need to set him straight. What follows is my – slightly edited (for readability) – response to his declaration (posted at the bottom):
Instead, venture capital is sinking deeper into a morass of meaningless self-adulation, with the pundits desperately trying to extrapolate and juggle past indicators to produce tantalizing foresight and headlines to keep them at the “leaderboard” of page views — most ill-informed about the greater reality.
And can you personally honestly claim to know anything about business (cycles) because you write about it? Or know about finance and economics because you write about it? I suggest you consult with those outside of “the base” of economic dysfunction at times.
Listen, solely by innovation’s massive greenfield, venture capital should have outperformed, and still, should outperform any other asset class to date in terms of returns. It has not, and will certainly not through the continued sub priming of risk deployed by venture capital. The only outlier returns (save for socioeconomic value) are produced by those who can afford to circumvent the prevailing “rule of subprime law” in venture (Paypal mafia anyone?). So, the few innovations that succeed today, do so not because, but despite venture capital’s debilitating risk profile.
Venture capital will be fixed once its model is aligned with the same kind of rigor of merit entrepreneurs in the marketplace face. You just think it is fixed because the never-ending pull by innovation will always drag a few “lucky” firms out of their self-induced morass. But venture capital cannot be fixed when it continues to deploy greater-fool economics that allows VC firms and (on occasion) their LPs to reap the rewards before the public painfully finds out most of these technologies have no renewable value that improves their lives.
Frankly, your statement on venture capital is as foolish as George W. Bush declaring the Iraq attack “mission accomplished.” Both of you ignore the big picture all too comfortably. With the exception, you can absolve yourself at any time of responsibility for the impact of your declaration by simply declaring a new “cycle.” Ask Tim Draper, the inventor of the Draper Wave, how that is working out for him now.
I suggest you stop looking in the rearview mirror to declare the future of venture capital fixed, and realize that venture capital can only be declared fixed if the public (as a private investor, user and as an indirect contributor to many LP funds) believes it is an asset worth betting their future on.
Below is the full text of Dan’s email on the state of venture capital.
Venture capital is ‘fixed’
Here are two basic facts about business cycles:
1. They exist, and
2. People often dispute #1, particularly in the midst of a prolonged top or bottom.
So it has been for venture capital since the dotcom bubble burst more than a decade ago, with everyone from entrepreneurs to grizzled VCs adopting defeatist language about the industry’s “broken model.” The worst came in 2010 when median 10-year performance turned negative and a slew of longtime institutional investors (particularly endowments) began to abandon all but a small handful of VC firms. If venture capital had always been a cottage industry, it had become that cottage’s spare supply closet.
In 2013, however, the negative narrative flipped with ferocious speed: More IPOs, rising returns and broad-based success that included, but was not defined by, Bay Area Internet companies. The turnaround knocked nonbelievers upside the head with giant bags of money and will help enable the next great wave of innovation. Even if tech valuations sag or the stock markets sink, venture capitalists will have full wallets. By proving the cycle, 2013 has created something sustainable for 2014 and beyond.
Venture capital isn’t required to start a business, but precious few companies are able to scale successfully without it — something that even the most critical entrepreneurs seem to recognize. It’s the difference between building an app that Facebook buys after eight months and actually building the next Facebook.
For quite some time, though, widespread access to that money and advice appeared threatened. Fewer and fewer firms were able to raise new funds, and most of them looked remarkably similar to one another. That may have been okay for a small subset of well-networked entrepreneurs within the “right” geography and discipline, but many more would be left out.
That’s where 2013 came in. The headline was the high volume of IPOs, but the underlying story was the breadth of issuers and investors. For example, more than 40% of the year’s offerings came from life sciences companies (a practice area that many generalist VC firms had begun to either deemphasize or eliminate altogether). Commerce also rebounded, for both digital issuers like Zulily (a Seattle-based flash-sale site for moms) and physical ones like Potbelly (a Chicago-based sandwich-shop chain). Also note the geographic diversity, which was buttressed by more traditional plays like San Francisco-based Twitter.
And the more diversity of industry and geography, the greater number of VC firms are typically involved. This is reflected in performance data from Cambridge Associates, which showed massive improvement in median returns between June 30, 2013 and June 30, 2012. Not only for one-year internal rates of return (+48%), but also for five-year (+17%) and 10-year marks (+48%). That means more and more firms should be able to raise new funds, thus expanding the pool of funding sources for entrepreneurs.
Now it’s time for the big caveat: So far, institutional investors like university endowments and public pensions don’t seem to be playing along. A recent survey by Coller Capital shows that while these groups have become more optimistic about future performance – two-thirds expect annual returns for North American VC to top 11% — a majority still plans to decrease VC fund exposure over the next several years. A similar survey from Probitas Partners showed a record 43% of respondents saying that they no longer invest in venture capital funds at all.
Maybe I’m just a hopeless capitalist, but I honestly do expect the spigots to loosen. It took institutional investors a while to wean off of venture capital after the dotcom crash, and a similar lag may be occurring here (albeit in the other direction). All of these folks can read the data. Now what they need to do is realize that it signifies the existence of a VC cycle, rather than an uptick on the descent toward oblivion. Entrepreneurs are counting on this epiphany.
Termsheet by Fortune can be found here (oops, no more).