Kauffman report : Broken VC, Guilty LPs, and the way forward

 The Kauffman Foundation seeks to put the final nail in the coffin of the VC malaise, with a thoughtful and evidence based recap of what we already know: “VC is Broken” and driving the point home to Limited Partners: “we have seen the enemy and it’s us”.  

The notion is that insufficient focus on alignment of interest and sloppy performance measurement has led the majority of LP’s down the garden path when it comes to actual performance.  You can go read the report if you want all the gory details and I wrote a rant about this in February of last year.

I am going to focus on the way forward for LP’s.

How do you diligence a VC ?

Pretty much every VC firm does a similar song and dance when raising funds.  If I was an LP I would spend most of my time doing two things:

Entrepreneur referencing.  Referencing VC’s through other VC’s is an OK proxy but it’s really entrepreneur who can give you solid evidence of what it’s like to work with an investor.  Entrepreneurs also talk a lot amongst themselves about which VC’s they like to work or rate.  A goldmine of unbiased information if you can get it.

Digging into the VC’s culture, compensation and methods.  A few years back, before we decided to be an equal partnership, we had serious compensation misalignment issues.  This (and other factors) led us to lose one of our key contributors, Sonali de Rycker, who left for Accel.  Yet hardly any prospective investors asked about compensation when meeting.  Nor did they ask about the mechanics of decision making, or seek evidence of our culture, of how well we nurtured out own talent.  You want to find out if a firm is stable and a good place for its emerging stars to shine ?  Follow compensation and decision making and dig hard.

What kind of VC should you back ?

Im my mind, there are two core strategies that I find attractive and then a ton of variation on the theme that I have more trouble placing.  

On the one hand is seed and early stage company building, where you try to build and understand projects on low capital invested and demonstrate enough value to the entrepreneur that he wants you in his next round (let’s call it the “Union Square Ventures” strategy).  

On the other hand is the “let’s catch the company on the escape velocity curve” strategy (let’s call it it the “DST” strategy).  People get upset about this one because they don’t understand how you can pay so much for early companies and scream “bubble”, but that’s because they think linearly and don’t appreciate how fractal outcomes are, really.  Stacey at GigaOm talks of “a hit driven strategy being a sign of too much money” and I think she may have gotten that part wrong in an otherwise great article.   This is the world of the “Haves” (Accel, Greylock and a few others).

Some rare firms like Sequoia and A16Z achieve the barbell (pursuing both) but these are rare animals.

Whichever VC you back, that VC needs to stand for something and do it well and better than anyone else in their category.  Benchmark Capital is a shining example of a focused investment strategy, so is First Round Capital for a different flavour.

VC’s who don’t embrace the VC Disruption are in trouble

We’ve looking at the most significant upheaval ever in our funding environment, both because of the giant sucking sound of liquidity leaving the market but also because of the advent of awesome funding platforms like Angellist and Kickstarter.

We live in the Age of Markets, and transparency is upon us.  

There is an excellent post by Semil Shah on this topic on good ol’ Techcrunch and Stacey nails it over at Business Week.    I can try and simplify the argument for you: our world has been rocked by the cloud disruption (in terms of how companies are built, launched and scaled), by the advent of increasingly liquid funding markets with standard products (Angellist, Kickstarter, SecondMarkets, Series Seed documentation) and some “data transparency” products (TheFunded, Angellist).  

Fred Wilson (the person, not the meme :-)) has a pretty hilarious take on this (again courtesy of GigaOM). 

Whatever you think of Angellist (haters gonna hate) and whether or not you supported the JOBS Act, we live in the Age of Markets and it’s finally impacting the world of venture and, yes, Limited Partners (see Bison).  And that changes many things.

Fractal (Fractured) Future

I don’t think the past is a particularly good guide to the future of our industry, but I know this:

  • embrace market change
  • know what you stand for
  • live by the strategy that you profess
  • oh, put points on the board

Otherwise, it’s going to be a long road to get a fund raised.  The age of dithering is long gone.  And  I could not be more excited :-) 

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