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The VC-Entrepreneur Compensation Disbalance

Posted on Friday, Sep 28th 2007

We started discussing the leadership development problem in my previous post referring to Prof. Khurana’s new book about Business Schools losing sight of their mission of grooming leaders capable of building and running sustainable enterprises by following the money trail.

So, what’s happening in the Venture Capital / Private Equity world?

The compensation disbalance here is also quite stark. [Here’s a follow-on exhibit.]

VCs without much of an operating background constitute a trigger-happy lot, operating based on spreadsheets rather than experience or intuition. Of course there are exceptions, and VCs like Don Lucas, John Doerr and Mike Moritz have created enormous value, and have effectively helped build the ecosystem as we know it today. Nonetheless, the few rounds of Silicon Valley Gold Rushes have made it possible for opportunists who have also managed to flourish.

As for the compensations, General Partners at Venture Firms make anywhere between $1 Million to $3 Million a year without counting performance incentives. The carry is all upside. PE firms pay a lot more, and it is not unheard of that Partners at PE firms make $50-$100 Million a year. Then of course, there are the Hedge Fund Managers, who are also absurdly heavily compensated, who these days are getting into the late stage venture capital game.

In contrast, the poor entrepreneur bootstraps a startup, takes enormous risks, and if (s)he raises venture money, the first thing a VC does is to restrict his/her salary to a minimum.

It is a well-known fact that Silicon Valley startup CEOs are a dramatically under-paid bunch. For what it takes to do the job – the kind of stress, travel, opportunity cost, failure rates – many savvy entrepreneurs and executives have figured out that it isn’t worth it to be the CEO of a venture funded startup (if you have other options, that is). Being a VP is even worse. Only one out of 50 startups succeed (or may be one out of 100, I don’t know the exact ratio), so the equity component of the compensation package rarely pays off after the liquidation preferences, etc. are settled.

I would go so far as to submit, working for a VC-funded startup is more like having any other job, than true entrepreneurship where you actually are your own boss. Entrepreneurs / CEOs answer to a Board. There is a compensation committee that decides how much you make. You get fired and washed out of your equity stake based on the VC’s whims. This may be perfectly legitimate at times, since not all entrepreneurs scale to become good CEOs of larger companies. But often, these decisions are gut reactions, not legitimate, and entrepreneurs get slaughtered due to the VCs’ lack of experience or seasoned intuition.

Throughout history, it is the entrepreneurs who have built companies and shaped economies, not money managers. It is just plain wrong that we have created a system that compensates these builders at rates that are so much below the money managers.

It is incredibly important for us, as an industry, to solve this problem, and come up with a sustainable business model and incentive structure. Otherwise, talent will continue to be mis-channeled and applied to unworthy causes.

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I have found this to be a very interesting discussion.

I am a CEO for a VC-backed firm. I’ve been CEO of two other VC-backed firms and have done consulting work evaluating deals for other VCs.

I think that a lot of very good points have been made in the discussion but I have to argue to some extent with what I see as some of the basic assumptions.

Mostly, I feel that in this discussion we are greatly underestimating the value that VC’s bring to the business beyond money. It is true that VCs provide that vital financial blood, but it is also true that they generally contribute a lot to the development of businness plans and strategies. They also often bring a lot in terms of contacts and networks. My general advice to a CEO would be that if your VC is NOT bringing those things you need a new investor.

I also agree strongly that most people running start-up type companies are doing so in part to make money, but are also driven by other non-financial needs. I would say to a VC that if your CEO is driven by money alone you need a new CEO.

In terms of general fairness, I think that question is hard to answer. As has been noted in at least one other post here, both jobs are hard. And both involve very significant risks and a lot of work. As I’ve talked with many VC partners over many years I find they they find it very difficult to find the right deals and to work to make constructive input when they are covering such a broad spectrum and are dealing with things at a long arm’s length.

If you are not comfortable with extreme stress, dealing with unknown situations, and working insane hours don’t sign up for either job.

Dave.

Dave Rolston Tuesday, October 2, 2007 at 11:23 PM PT

No matter how you spin it, without VC or some sort of private/angel investment not many entrepreneurs would even get a chance. Where else are you going to get the money? Moreover, this is not all about the money that you make, but it’s about an opportunity and a chance to do what you really want to do (or good at).

Dmitry Grinberg Wednesday, October 3, 2007 at 4:24 PM PT

I think, in the last few posts, the theme that is emerging is the notion of serial entrepreneurship as a career path.

You take some money from Angel(s) on your first venture, learn some, build a bit of credibility and reputation.

You succeed or fail.

Do another.

Build some more credibility, experience, reputation.

So forth and so on.

I can tell you, I know a lot about this path, and it takes a humongous amount of energy to carry on in this mode. You have to really have a level of fire in your belly that keeps you going.

That said, it is an exponential growth learning curve, and I have personally enjoyed the journey.

Also, it helps to start early, since if you are starting on a serial entrepreneurship path at 40, by the time you have gone through your learnings, 10 years have gone by, and perhaps you don’t have the appetite for this kind of risk-taking anymore.

Or, you have made enough money to prefer being an Angel investor yourself.

I don’t know. I will tell you when I am 50 🙂

Sramana

Sramana Mitra Wednesday, October 3, 2007 at 4:38 PM PT

It’s a lifestyle, a passion. Not a career path (there are no promotions :-)) and not something you can do just to make money. It requires a passion that cannot be derived from “greed” only.
But what a blast it is! I get to create a business from scratch! And I get to see if my ideas are any good. And I get to work with great people. And I am challenged to the edge of sanity every single day.
I can’t imagine ever again having a “regular” job. I feel so fortunate, and that’s what keeps me going on the days when nothing seems to work, making the pilgrimages to Sand Hill, juggling 6 balls at once…

Umberto Milletti Saturday, October 6, 2007 at 12:14 PM PT

This is true. It’s a way of life, rather than a career path. And it makes “fitting in” inside large organizations, playing the politics, waiting for promotions … seem rather unpalatable.

Sramana Mitra Saturday, October 6, 2007 at 6:37 PM PT

Of all the comments there were 2 discussions regarding the timing..when to get a VC funding. Is there a formula?
Is there a valuation at stages like…
1. Idea formation
2. Idea modelled
3. POC of Product
4. Beta Product
5. Beta Customers
6. Paying customers
7. Regular Cashflow (Resellers).
I am an entrepenuer in India, with a Infrastructure product, and am between step 5 and 6 (i.e)the beta customers agree to pay, subject to some additional features to the product.
I am sorry if there is a slight diversion but I would like to have your knowledge on the following:

  1. I need only 0.5 million dollars, all the VC’s are not interested because the requirement is less.
  2. All the angel investors are thinking because of the following: a. The market is saturated/overcrowded(then they ask for market size!) b. You are not in internet space (we fund only internet start ups) c. You have a good team but are first time enterprenuers. d. you dont have US presence (if you have gulf presence they say there is no focus!)

Entrepenuers (these are my views only)…..
1. Any product can be improved upon and no market is saturated.
2. Market size determined by analysts eg Gartner report, IDC report etc are very specific, Actual Market size is more a gut fell if you are in that field for few years….
3. For 0.5 million dollars I dont want to part with lot of equity…

Look forward to your advise

Ramaha Tuesday, October 23, 2007 at 4:29 AM PT

Hi Sramana,

I need to know about venture funding for an idea. Pl let me know to whom I need to contact for this.

Thanks,

Chandra Mouli

mouli Sunday, December 23, 2007 at 7:17 AM PT

[…] SM: What you are bringing up is an issue many entrepreneurs have experienced. A total disrespect and arrogance on the part of the VCs. They forget, that the sole basis of their existence is to “serve” entrepreneurs, and not the other way round. I don’t know if you’ve read it– I wrote a highly controversial piece last year called The VC-Entrepreneur Compensation Disbalance. […]

Lars Dalgaard and his Success Factors (Part 6) - Sramana Mitra on Strategy Tuesday, March 11, 2008 at 8:47 AM PT

Entrepreneur Home Business | Entrepreneur Home Business…

……

Entrepreneur Home Business | Entrepreneur Home Business Monday, February 16, 2009 at 4:11 AM PT

Is there no concern these days where cash is king and the VC’s with the cash are abusing this power to squeeze the entrepreneurs are in no position to negotiate. I have also heard some VCs colluding amongst themselves in a syndicate before the lead term sheet is signed. What can we do?

Jeff Thursday, April 23, 2009 at 2:44 PM PT

I agree with the notion that the VCs are vital to many ventures, but in return, the entrepreneurial pursuits are the lifeblood of those VCs. I would caution the VCs from ‘biting the hand’ too hard.

They generate resentment, distrust and perhaps under this administration, more careful ‘viewing’ of recent deals and syndicates.

Dave Friday, April 24, 2009 at 9:56 AM PT