Georges van Hoegaerden: Are VCs Still Relevant?

The recent news about the reduced investment pace by venture capital in 2012 cannot come as a surprise to those who can separate the mindless cheerleading for a better future (we all want) from our own responsibility to clean-up its Neanderthal economics.

We should not stare blind at the quarterly reporting of how fast the arbiter of innovation spins its wheels and makes investments, but instead focus on the traction those investments should yield long-term. And how that traction builds social economic value, secures public investor returns post-IPO, builds enthusiasm with emerging groundbreaking entrepreneurs, and thus cements the renewable interest of institutional investors.

No emperor
Let’s face it, venture capital – on the whole – has lost its merit as the preeminent arbiter of innovation, incapable of serving an 80% greenfield of technology adoption that awaits. For way too long venture capital as the arbiter of innovation, has operated as the emperor without clothes.

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 $244B (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.

So much so that Joseph Dear, Chief Investment Officer for CalPERS (the largest U.S. pension fund and institutional investor in venture capital) was quoted in August of 2012 to call venture capital, ”the most disappointing asset class over the past 10 years as far as returns”.

Denial, denial, denial
Venture capitalists, unable to reinvent themselves with the chutzpah of great entrepreneurs, shake off calls for a true meritocracy with arrogant oligarchic denial and the purported cyclicality of venture capital to keep “the greater fool engaged.” With some greater fools clearly foolish enough to not realize that the only cyclicality in venture capital is the need for general partners to raise yet another fund in four years.

But what worries me more is not so much the downside-protection of institutional investors (who can compensate with returns from other asset classes), but the erosion of economic upside.

The aforementioned denial by venture capitalists plays dangerous games with the contribution of 20% of GDP mature innovation (with venture capital in its early fighting-form) can generate. Meaning, the economic incompatibility of venture capital to select and support groundbreaking innovation (for the last twenty years), has and will yield a direct erosion (at twice the speed) of 20% of GDP. A 20% we simply cannot afford to lose.

Yes, venture capital is contracting, but that contraction alone does not mean its participants know how to reverse its effectiveness in line with the greenfield of innovation adoption that awaits.

We estimate venture capital’s effective size now to be as small as 40 years ago, with only a handful of firms producing consistent monolithic venture-style returns for their investors (see our venture capital infographic). And a handful of venture firms will not be able to serve the 80% greenfield, nor build any meaningful contribution to GDP.

Causal effect
I first discovered the exact cause-and-effect of venture capital’s failings (and described in my preeminent video on The State of Venture Capital), and have been blowing the whistle for more than eight years.

Because of macro-economic illiteracy, venture capital has been allowed to turn subprime in the same way real-estate had turned subprime.

With Neanderthal economics that fail to establish a meritocracy as the guard rails for a free-market economy. Our economic ignorance is directly responsible for the uniform deployment of investment risk steeped in investor socialism. The stifling socialism that is guaranteed to be incompatible with finding outliers.

The only way to fix venture capital is to hold its participants to the same meritocracy as entrepreneurs. And so, until we fix the Neanderthal economics to which we hold investor feet to the fire, will we see a continuous flood of depressing quarterly statistics, disturbed perhaps only by more false positivity sold to greater fools, plot the ominous cyclicality of a winding down subprime spiral of venture capital – with devastating impact to our innovative culture that took 200 years to build.

So, yes. VCs are still relevant, but not in a good way. More like the drag from a ball-and-chain across the icy roads of our economic malaise. But I can fix VC, and beyond. I did not spend the last five years just complaining about it.

Stay tuned.

To see the original post, go here.

Georges van Hoegaerden is a managing director with The Venture Company. He blogs here and tweets here.

Photo courtesy of Shutterstock. 

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4 Comments

  • Some of my entrepreneur contacts would love to read this. Extreme frustration with raising capital from venture.

  • Whoa, Georges. Sounds like someone in venture spit in your coffee this morning.

    Three things we know to be true about venture:

    1) Smart guys still make money. Lots of it.
    2) All interesting new technology markets are created by venture-backed companies. 100% Corporates do great incremental research, but nothing breakthrough.
    3) The “greater fools” you talk about are the idiot LP’s who spend lavishly on firms they’ve heard of, not on individuals who make money. LP’s are, by and large, pretty dumb investors.

  • Frank,

    Thanks for your comments.

    Your remarks suggest this VC mediocrity is merely temporal, yet VC has been in a subprime state for 20-years (first in bull, then in bear state). As such it has systematically thrown out false negatives and instead attracted (some 99.4%) false positives with their subprime thesis. That erosion of innovative capacity and exploration is significant and quite more impactful than just a spit in my replaceable coffee.

    On your points:
    1/ Yes, smart people can figure out how to continue to rob our economic bank and “make” money (99.4% of VC firms do not). I could do so too. But my values tell me that making money at the expense of turning innovation subprime and thus making it non-renewable is not an option. This money grabbing mentality under the cover of in-transparancy has got to stop if we want our economy to benefit in the same way its participants can.
    2/ Nonsense, corporate innovation is outpacing venture selected innovation by a long shot, especially innovation that bares any social economic value. Apple grew by 400% during the same period VC grew at -4.6% IRR. VC market excuses are therefore a lie. And innovation is only interesting or meaningful once its generates social economic value to the public (as a buyer and investor), not when you can simply sell it to an ever growing chain of greater fools.
    3/ I wouldn’t characterize LPs as dumb, they have an asset management focus (horizontally) and VCs have a sector focus (vertical). Both have made catastrophic miscalculations in the assessment of (embedded) risk, with VCs using “the voodoo” of innovation as their endless excuses why they could not outperform corporate, or organic adoption. But any financial system in violation of the rudimentary principles of a free-market will quickly gravitate to attracting similarly subprime participants (across the board).

    So yes, its not hard to ride the gravy train of false positivity in venture and do well for yourself short-term. But to do so without pragmatic economics that builds renewable social economic value is merely extracting money from our economy long-term, and erodes our leadership position in innovation, as well as erodes the much needed contribution to GDP.

    VC is serious business, and it requires grown-up economics to ensure not just its participants, but our economy flourishes from it pro-rata.

  • Glad you send out emails or I may have missed it this week. Originally I was going to quote a few parts of this post, but you have too many right points and It still surprises me how many people don’t notice. I recently made a slideshow. A simplification of course, but the funding of innovation is broken.

    Everything these days is marketed as innovation or disruptive. Many firms use the cliches on their websites “we invest in passionate entrepreneurs focused on innovating and disrupting big markets”. Not true in so many instances. As a friend and former GP returned to entrepreneurship said, most people using these words are doing none of them. Passion innovate disrupt..Yay! It is marketing to 1)bring in more entrepreneurs 2)keep and inflow of follow on LP investments 3)Looks good on the webpage

    Venture Capital is broken in a lot of ways and similar to corporate recruiting, VC recruiting follows some of the same methods. I’ll even apply this to USV (union square ventures). I enjoy reading the articles, but i’ll refer to the recruiting article from a year ago and another from a few years back. USV looked for candidates with social presences such as blogs, etc, which basically seemed to suggest they people are internet savvy. I googled those associates because I thought the article was interesting and made good points. To my surprise those associates selected had little or no social presence whatsoever. Stark contradiction to what was written…ahem, marketing.

    Whether you are from a top tier school or not, having a broader view and understanding of things is important. I’ve read quite a few articles on new VC recruits which seemed interesting, only to have short conversations with them to find out that some of them were pretty dense and only knew what’s on the surface of things like mobile and “tech”. No understanding of the technologies themselves or what is in the works with R&D. To me, that plays an important part in predicting trends as many try to do. It is also part of a long term approach. By looking at what is being worked on for the future, you can look at most things referred to as being innovative as…. well, not being innovative at all.
    …Clone wars, you can call it. Clone and iterate, call it innovate, say youre passionate…yadda yadda.

    Another part of this, many of the VC associates(partners too) in Tech only seem to have a very basic understanding of finance. The premise is that, you can learn what you need to learn in a few weeks or so. I’ve even seen this in a post by a Bessemer Partner. A basic understanding is sufficient to filling out forms, yes, but with anything… basic only takes you so far. Then it appears to be luck and “intuition” as they say. True intuition, is guided by variables such as learning and experiences which allows to make judgements. Otherwise, it is pure speculation.

    Not seeing the 80% Greenfield has to do with these reasons. They can’t see the Greenfield because they don’t understand it. I’ve had those emails too. “We understand x, not y, so we focus on x”. For an industry that talks so much about innovations, why is it rarely innovating itself and constantly learning from both mistakes and other readily available information such as R&D. Corporations do. Why are these 19-21 year olds seen as viable candidates to seek out investments, simply because of age in relation to new tech? So many things don’t add up or make sense. There is not a lack of innovative technologies, but in reality, there will always be a lack of people who understand them and can spot them. Historically, outside of this industry you can relate this to science itself…which is where tech comes from anyway. I once saw an ad on Tesla Motors which talked about Nikola Tesla…yet the description was completely incorrect and didn’t do the little known genius any justice. I wish i could remember the ad to give a link. I wrote them about it on twitter actually. Again, marketing of innovation and capitalizing on a word(in this case a name) rather than truly understanding innovation itself. Now i’m not saying that nothing Elon Musk is doing is innovative, but rather that these things are not the most innovative things going on at all as media stories would make them out to be. Hype..

    anyway, i have written too much ranting here early in the morning and I haven’t even touched on all of your points. I could go on about these subjects forever and yes, I am working towards solutions as well.. while I continue to learn throughout the spectrum of PE topics(oil&gas, RE, VC, IB, etc, etc) and study for securities exams. I don’t want to be one of the mediocre managers that I bitch about after all ;)

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