State of the VC Industry
It’s the golden age of the entrepreneur, but the people who fund them aren’t happy about it. At yesterday’s Kauffman Foundation Fellowssummit in New York, a trio of veteran limited partners who invest in venture capital firms spent an hour taking questions from a crowd of 125 budding VCs and entrepreneurs, tossing out buckets of cold water along with their encouragement. What they want for Christmas: fewer VC firms, smaller funds, and saner valuations.
During the past 15 years, LPs put $20 billion each year into VC, about four times the $500 million committed to venture in total during the decade 1985-1995. If venture is going to return to the cottage industry it once was, the LPs will have to scale back their investments. This year may go down as the year LPs finally blew the whistle on the venture capital model. Pretty much every one will say publicly or under their breath that the model is broken.
To recap: Over the last ten years only 20 firms, or 3% of the universe of VC firms, generate 95% of the industry’s returns, and the composition of that sliver doesn’t change all that much over time, according to Cambridge Associates. The Kauffman Foundation blew the whistle hardest of them all with its May 2012 self-flagellating report, now required reading in VC-land. In its experience over two decades, Kauffman had only 4 out of 10 venture funds exceed public market returns. After paying the firms’ stiff fees of 2% of assets and 20% of the profits, and often waiting 10, 12, 16 years to get all their money back, Kauffman found that almost 80% failed to deliver the 2x net of fee “venture” return expected. Kauffman now plans to move more of its VC allocation into public equities, invest directly in start-ups to avoid paying fees, and invest in fewer, smaller VC funds where the venture partners put up at least 5% of the equity, instead of the 1% it was seeing for years.
At the Kauffman Fellows Summit, Mel Williams, the general partner of fund-of-funds TrueBridge Capital Partners (and Forbes’ partner on the annual Midas List of tech’s top investors), had some encouragement, calling venture “still one of the most exciting industries to work in,” where you get to help realize tomorrow’s great growth companies. Just don’t expect him to give you money unless he knows you well (my words, not his). Mel’s $700m+ plus fund (and he plans to raise another soon) is earmarked for VC firms with mileage on them. Case in point Bessemer, a big position for TrueBridge, is 101 years old. Rick Slocum, the chief investment officer of the the Johnson Company family office, says he occasional invests in “farm team” of young funds, but they’re usually in buyout and usually done for other, strategic reasons. He doesn’t like to have a lot of VC investments chasing the same deals and bidding up valuations, because then the loser is him. Based on his remarks, he has more enthusiasm for other asset classes such as buyout, where the bigger funds have adopted more LP-friendly fee structures as the sizes of funds go up. Doug Coyle, who runs private equity for the $3.5 billion Rockefeller Foundation, will continue to thin the ranks of VC firms he works with from around a dozen to below five. And those will be the elite firms everyone wants to get into: Accel, Benchmark, Sequoia, NEA, all of which are already in the porfolio. The hard part, jokes Coyle, is getting money out of all the ones he’s put money into already. “There are funds from 1988 that I still haven’t gotten all my investment back.”
Venture deals and dollars committed have been fallen this year compared to last, but what Paul Kedrosky said two years ago is still true. The number of funds needs to shrink by 50%. The art of picking start-ups is not built to accommodate the kind of money that’s being thrown at it. You know it’s true when you hear VCs like Benchmark’s Bill Gurley complain that LPs are blowing it by inflating the sizes of elite funds. There probably should only be about 200 firms instead of the 500 actively investing today, which down from 1,000 during dotcom days but roughly flat over the last 10 years (with plenty of zombies in there). Time to get back to the “cottage industry” venture once was.
http://www.forbes.com/sites/bruceupbin/2012/10/25/investors-in-venture-capital-plea-for-sanity-restraint-in-2013/
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