The VC Confidence Problem

“I don’t know what kind of a career I’m going to have in venture capital.”

That’s what I was recently told by a managing director at a well-regarded Silicon Valley venture firm. His comment had little to do with his own interest or ability in the VC business. In fact, he’s one of the more successful VCs out there, with at least one major several-hundred-million acquisition and a fistful of enviable portfolio companies. If anything, he should be one of the people who would keep his job in the coming VC shakeout.

His concern was that exits would become increasingly difficult to score, and limited partner money would dry up.

Even successful VCs think their careers are in trouble — a recent survey found that nearly 53% of VCs believe their business model is “broken — and that may be the biggest problem the VC industry faces.

So this is a problem. Would you bet on a baseball team where five of the nine players thought they were going to lose?

Finance is a confidence game, literally. One group entrusts its money to another with confidence it will produce returns.

VCs overdrew their confidence account during the dotcom boom and bounced bad companies on the public market. Limited partners were willing to roll with it, though. Confidence is sexy and boring pension fund managers still wanted a piece of the action.

So where did the confidence go?

At first, it was the “Venture Overhang.” You remember how all that capital that had been raised in during the dotcom era was all competing for too few deals?

Then there was the Chinese Wall that forced investment banking analysts to ignore newly-public companies. Bummer.

Then there was Sarbanes Oxley. Oh man, who wants to be on a public board with those onerous liabilities? You could go to jail if a company misstates earnings. Then there’s all the compliance costs that raised the revenue bar for would-be IPOs.

Then it was just that the “IPO Window” was shut. Or maybe it was the lack of boutique investment banks, as Dixon Doll recently suggested.

Now it’s the recession, the Denominator Problem and uncertainty about government stimulus.


There are three ways to restore confidence: project it, act on it and believe in it.

Projecting confidence can be easy. Just memorize a couple of key phrases and drop them into every conversation you have.

“We’re in the middle of the largest legal wealth creation the world has ever known.”

“Technology entrepreneurs have always led the way out of recession and into economic expansion.”

“Funds invested during a downturn have historically had some of the most impressive returns.”

“Innovation doesn’t wait for a macroeconomic turnaround.”

“We’re going to let other people wring their hands about the “model” being broken. It’s working fine for us.”

“Somebody’s going to build a dozen billion dollar companies this year and we want to be there when they do.”

Eventually these bluffs will beget reality as people start believing them. Would entrepreneurs come to Silicon Valley if they didn’t believe there was a chance to make more money than Midas?

Acting from a position of confidence is going to be a little strange at first.

Raise your carry and drop your management fee. Think of this as the Benchmark approach. Tell your LPs you’re so confident that you’ll make money, that you’re willing to forgo the management fee for a bigger piece of the carry.

Don’t offer founder’s stock, early liquidity, or even high valuations. Tell the founders you bring so value to the table in the form of “relationship capital.” Cultivate a take-it-or-leave it attitude.

Threaten to fire the CEO of any company that doesn’t accept a reasonable acquisition offer from a large, well-established buyer.

Believing that venture capital is going to make stupid money again may be the hardest part of this equation. Your hardest sell is going to be to yourself.

So get yourself a black and whitestriped tie like John Doerr’s (seriously, he has one tie), stand in front of the bathroom mirror and tell yourself that the next billion dollar deal is right around the corner. Plan out how you’re going to help your companies make sales, or make connections, or just make more money as your standing in the shower.

Change up your routine to break out of recidivistic thinking. Go read “The Hero with a Thousand Faces” and “The Art of Worldly Wisdom.” Drink six cups of coffee, listen to some heavy metal and go kick ass.

For more reading on the confidence problem, check out Gladwell’s latest.


  • I enjoyed this piece but of course the VC model is still broken and I’m not sure confidence will fix it. We need smaller funds keen to invest small amounts of money.

  • “Positive self-statements are widely believed to boost mood and self-esteem, yet their effectiveness has not been demonstrated. We examined the contrary prediction that positive self-statements can be ineffective or even harmful.”

    We can talk ourselves into believing whatever we want. How about something realistic?

  • Great piece, Dan! Why does it make me think of Al Franken in a SNL skit…?

  • The guys who are worried aren’t worried enough.

    Venture capital has lost money if you take out the (relative) handful of deals that have created big public brands.

    Customers will embrace new brands only when they value innovation more than reliability; once they value reliability more, the brands in that industry are built, and will be the ones distributing future innovations.

    Quick poll re: energy — reliability vs innovation? Right. Those brands are built.

    Venture is in structurally deep (and deepening) grease.

  • “Don’t offer founder’s stock, early liquidity, or even high valuations. Tell the founders you bring so value to the table in the form of “relationship capital.” Cultivate a take-it-or-leave it attitude.”

    Right, and the firms that tend to do this have lower grade entrepreneurs and investments. Look at the successful recent hits in the valley and they had entrepreneur friendly valuations – Google, Facebook, LinkedIn, etc. Great companies almost always generate multiple termsheets.

    I agree with the first post the model is broken for most firms.

  • @westside: Good point on valuations. That’s how John Doerr got Netscape—he offered Jim Clark a valuation that NEA wasn’t willing to go for.

    @Dustin: Disagree that people don’t want innovation. Would you have asked for the Internet in 1988? The point you raise is still valid, though: We know VCs can make money during a technological revolution (such as the Internet), but can they make money during a period of evolution? It’s a good question that I’m going to have to think more about.

    @Jeff: Scary that you think Dan wrote this.

    @Michael: I’d hate to tear a page out of Hamlet, but maybe VCs should consider his advice: “It is neither good nor bad, but thinking makes it so.” Of course thinking you can fly won’t cause you to sprout wings.

    @IanDSmith: You’re right. The line between positive thinking and self-delusion is pretty thin. I’m not sure the model is broken as much as VCs just aren’t investing in good companies or doing the right things to help them grow.

    What if you hired someone to cut your grass while you’re at St. Bart’s and came home to find your grass armpit-high. You’d be pissed. You’d call the grass cutter and ask him what happened. First he’d tell you that he came one day, but it rained. Then he’d say he wanted to get it done, but his mower ran out of gas and his cousin couldn’t drive him to the gas station. Still pissed? Well then he says that the blades on his mower needed sharpening and were too dull to cut with.

    At what point do you stop listening to excuses? Confidence may not fix the VC problem, but excuses for poor performance and general malaise aren’t helping either.

  • Of course the reality is VC industry needs adjustment, but never take out the big deals when you count the return from VC. It is like checkout Microsoft but take out Windows revenue. Isn’t that the beautify of VC: out of 10 deals, 5 failed, 3-4 normal return and 1-2 blockbuster. It is for sure that 7-8/10 fail and 2-3/10 normal return structure does not work.

    VC firms will figure out a ways to adjust and make it work. The economy and overall market need VC to play an important role, a role that is different from five years ago.

  • I see the VC world as at an important inflection point right now. You have the big, old firms with large funds who are looking to make large investments. Most of those firms are suffering from the current “VC Problem” with a few obvious exceptions (Sequoia).

    Many of these old-line firms, realizing that the early stage technology businesses that made their name and early fortunes no longer require the massive piles of money they’ve raised to successfully build, have turned their attention toward larger enterprises which DO require gobs of money — even if it’s often just project finance (alternative energy). This has more to do with supporting the income “needs” of the top few managing partners via the 2% than any real belief in the returns potential of the portfolio to generate the 20%. So that’s one end of the spectrum, and that end is very large. It’s most venture firms actually.

    The other end of the spectrum are the guys who remain truly interested in venture capital investing and have made peace with the fact that most technology businesses aren’t as capital intensive to start as they once were (open source, offshoring, mature tools, savvier customers/buyers). And as a result, they’ve geared their funds around the opportunities, instead of the reverse. These are funds with a tiny handful of people, say 3-5 partners with a fund size on the order of $50-$150 million, looking to fund tech companies who get the present reality and are lean, mean, cheap, etc. These are guys like First Round, Maples, Silverton…

    I firmly believe that the second group will earn great returns for their investors while the first languish. The net result is that the VC business will continue to dramatically shrink and provide sub-par returns, as a whole, for at least another 5-10 years. But while that is happening, there is a renaissance happening on a smaller scale.

  • […] 2, 2009 by Amit Agarwal Funny article in peHUB which states that the VC model is broken and the partners need to boost confidence of all […]

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