[Dave responds to my rebuttal, and so do I to his. See below.]
Well, many venture capitalists are ignorant and complacent, perhaps not lazy. Dave is known to shock his adversaries in the investment business in public, and I often smile reading his assessment of the consequential evidence of venture capital’s underperformance. But just because he too smells venture capital is not a system of success does not mean he knows or does what is right. Improvement of an undesired consequence does not by definition eliminate root-cause to cure-all. Like detecting cancer is not equal to healing it.
Dave McLure is in his own branch of deficiency, a further sub-priming and attempted downstream optimization (er! escapism) of venture capital that fails to yield tangible and renewable socioeconomic value to secure trust with the public. And without a better normalization of the evolution of humanity supported by innovation, the promise of innovation has just been reduced to a financial scam sold to a new chain of innocent fools. A fraud of popular proportion nevertheless, as many beliefs based on hope tends to be.
The probability of high-yield returns is unlikely to come from hedging on low-risk investments valued on the downside, supported by Dave’s model. Put differently, the avoidance of risk is highly unlikely to produce high-yield rewards the world even cares about. So while I enjoy Dave’s fodder and airtime on occasion, his alternative is not much better than venture capital’s.
Now on to venture capital.
Traditional venture capitalists, on the other hand, are spinning their wheels aimlessly as a BMW X5 stuck in the sand (I’ve been there). Meaning they use the wrong vehicle on the unsuitable terrain for their tires to get the desired grip. Let me explain.
The fundamental reason why today’s venture capital keeps choking on its exhaust is that it has bastardized the investment thesis from its original intent to support high-risk/high-yield risk profiles in pursuit of upstream innovation, to the support of an endless stream of downstream innovations with an increasingly commoditized risk/return profile. The majority of venture capital firms now deploy a uniform (yes, subprime) investment thesis and methodology, one fundamentally incompatible with finding outliers of upstream innovation.
Such incompatibility is the reason for a massive smoke-screen of false positives produced by downstream “innovators” trying to please the popular investment thesis du-jour and one that ignores the renewable evolutionary value the false negatives of upstream innovation could have produced.
Hence venture capital has mostly become a self-fulling and temporal financial prophecy, incapable of producing consistent high-yield returns that would otherwise lead limited partners (the investors in VC funds) to increase their trust and allocation in the asset class commensurate with the opportunity to innovate. The fantasy of unicorn valuations suspending the disbelief in that prophecy momentarily. Until yet another chain of greater-fool financiers are faced with the reality that outlier returns do not come from the bosom of uniform populism.
The point I am making is that most venture capitalists, by virtue of their uniformity and preeminent role as the arbiters of innovation, do not all understand the macro-economics, evolutionary impact and business of innovation. They remind me of referees in soccer who have never been informed about the rules of the game, cluelessness perhaps a better type-casting of their acumen and behavior. Nor are they held accountable by the principles of a meritocracy that would fix such behavior and output.
I close by having you make a note of the fact that the more recent successes in Silicon Valley (Tesla, Facebook, etc.) stem from founders tapping into or seeking alternative funding strategies from the start, and succeeding not because, but despite venture capital’s arbitrage. With venture capital scrambling as the desperate hangers-on in subsequent rounds.
Great companies are created by entrepreneurs who are driven from the start to change the world for the better and seek investment partners willing to bet on the same. The rest is merely evolutionary noise.
So, go big or go home.
Dave McClure responds:
clarification: 500 Startups strategy isn’t to limit downside risk; rather we aim to use large portfolio size (200–500+ companies per fund) to drive portfolio diversification, to have a statistically more predictable chance at finding outliers, and to achieve consistent returns from fund to fund. Given that our three main funds are all performing at between 17–20% net IRR, the strategy seems to be working reasonably well.
Yes Dave, I understand how you sell a hedging strategy of “innovation” to your limited partners as the “responsible” avoidance of risk, akin to the portfolio diversification they deploy across many asset-classes themselves. You’ve sold the dogs the dog food. Hats off.
Never mind such portfolio strategies being born out of the pursuit of 100-year old asset-classes with ever commoditizing downstream assets. Quite the inverse of the financial instrument needed to support outlier upstream technology innovation poised to change the world.
Successful financial instruments must be tailored to follow the nature of the investible asset, not the other way around. A confounding of consequence and cause so blatantly responsible for the depravity of reason in financial engineering. Meaning, contrary to how current portfolio strategies are built, an investible asset should dictate the financial structure by which it can and will succeed.
You are not significantly outperforming the performance of diversified portfolio strategies applied to commoditized assets mentioned above, you are not outperforming a “successful” stock-picker over the same holding period, and you are not performing commensurate with the wide-open opportunity to bring meaningful, diversified and renewable innovation to enhance the evolution of mankind. And any pursuit of innovation that does not enhance the renewable evolution of mankind and improves our equilibrium with nature is merely financial engineering that subtracts from it.