For a group priding itself on identifying, nurturing and commercializing innovation, it’s ironic that the venture capital industry resides in the relative backcountry of financial innovation.
Considering all of modern finance’s experimentation and ingenuity (for better and worse), today’s basic VC model has remained untouched for over a quarter century. It’s as if 18th century traders swapping shares under a New York buttonwood tree agreed, “This is the future of finance.”
Why is it that the same investors obsessed with change and the next best thing haven’t applied their considerable talents to their own craft? For decades, this inefficiency was prized by a clubby VC industry as a competitive moat, keeping newcomers out and quietly maintaining a lucrative profession to fund vineyards and Gulfstream jets.
But I need not tell you that all isn’t well in venture capital. This isn’t another “VC model is broken” story. It is, however, an assertion that “We VCs need to reinvent the model.”
Journalists are only now scratching away at the VC veneer to reveal what industry insiders have privately lamented for some time—the asset class has not returned money to its limited partners in nearly a decade. Forbes’ recent skewering is just the start of a media BBQ.
Yes, there may be lots of turkeys in venture portfolios, but meager VC returns are the symptom of a systemic issue. Venture investors require alternate paths to interim liquidity for their 10-year fund structure to make rational sense.
The fact that great venture firms operating according to plan—partner with the best entrepreneurs, build great companies—are still finding themselves unable to realize value creation, exposes the critical flaw in the venture model.
The answer isn’t passively “waiting for the IPO window to re-open.” Rather than pine for the salad days of tech offerings led by Robbie Stephens, Montgomery, H&Q and Alex.Brown, it must be accepted that the world has changed. Surely the collective intellectual horsepower and sheer will of the venture capital industry can develop a systematic solution. Where to start?
VCs are always trying to catch the current—but they missed the wave. The wave of financial innovation over the last 25 years transformed nearly every facet of financial services, from exchanges to student loans. But it entirely bypassed the venture capital industry. It might seem like a peculiar time to extol any virtues of financial engineering. While the current market crisis reveals many of securitization’s downsides, it also exposes the detriment of not having a market capable of providing efficient and structural liquidity for its participants.
As an industry, we should work with large capital markets players (with great self-interest of their own) to build a more sophisticated system that addresses the needs of all participants–not just VCs, but entrepreneurs and LPs. A system that incentivizes and rewards early investors and shareholders for risks taken, allows for orderly interim exits and enables different types of investors to participate in the various stages of a company’s development.
Secondary funds like Coller, Lexington and W Capital are a valuable part of the ecosystem, but VCs should aim for a more comprehensive solution. Other innovative ideas like the Series FF shares developed by the Founder’s Fund, allowing for partial liquidation by early entrepreneurs, is the kind of creative approach that should be embraced. Goldman Sachs’ exchange-based effort to modernize private equity—the Goldman Sachs Tradable Unregistered Equity—seems the most intuitive answer, but appears to be more focused on traditional PE rather than VC.
We should not undermine what makes venture capital unique—but instead reimagine the method by which we finance early-stage companies and harvest investments. It’s time to put our collective fates back in our own hands, rather than remain at the whim of a fickle and ever-more elusive IPO market.