Obama’s Economic Policy
I am frustrated with Obama for not addressing the questions about what he plans to do to turn around the economy. I am also frustrated with his anti-business, anti-globalization, and anti-free-trade rhetoric.
It has led me to ponder the question, what should US economic policy focus on to get some vitality back into the system?
And it has brought me back to a topic that I have addressed before, although not in very specific terms.
In this piece, I will.
The truth is, every economy needs a thriving small business eco-system to be able to get the virtuous cycle of job creation moving. So, instead of this anti-business nonsense, Obama really needs to turn his superlative oratory to a pro-small business / pro-business creation narrative.
And then, get into the specifics of how to re-engineer the venture capital industry, a dysfunctional business flushed with cash that is operating as a greed-infested scamville right now.
The National Venture Capital Association estimates that about $30.5 Billion was invested in 2007 by the industry, spread across 3,912 deals, at an average of $7.75 Million per deal. These numbers are pretty average, and representative of the industry over the last 5 years.
For businesses to start, the amount required is more in the $250k-$1 Million, an amount that falls below the threshold of venture funds’ investment sweet spot. This has created a funding gap in early stage venture capital, typically being filled by Angels, who are wealthy individuals and families. [Read: The Real VCs of Silicon Valley]
The reason this funding gap exists in the venture capital industry is that VC Firms are raising larger and larger funds to access larger and larger management fees. The industry operates with the structure of a 2% management fee per year and 20% carry, which is the industry term for profit sharing. [Read: Fund Envy]
While this structure works just fine if the industry returns very large profits, the problem is, business opportunities (VCs call them Deals) for creating “home run” ventures with 10x return on investment is scarce. Thus, a very small percentage of the deals that get funded by the industry actually returns serious profits. VC firms who invest in these deals lose money, but still are not required to give back their fat management fees which, in effect, they have not earned. And thus, a scam-cycle rolls on. [Read: Why The Venture Capital Model Is Broken by Dilip Rao]
If you look through the list of 3000-4000 deals per year over the last decade, a remarkably small percentage of them turn out to be home run plays.
So it is not efficient for an entire industry to be structured in a way that it depends on home runs alone, because new business creation needs to be encouraged even if they are not home run ventures. $5-$50 Million businesses – a large number of them – can create a thriving economy, and it is important that we restructure the venture creation part of the eco-system to support this goal.
Every $7 Million investment can support 7 $1 Million investments, and 28 $250k investments. But to manage 7 investments or 28 investments, venture firms need to hire more partners, and share the 2% management fee that is today being gobbled up by a remarkably small number of partners.
If the number of businesses created were to go up 7-folds to 28-folds, however, we move up from say, 4000 new businesses a year to 28,000 to 112,000 venture funded new companies a year.
I would argue, these deals, if they were pegged as interesting small businesses from the get-go, and not meant to be Billion dollar enterprises, would operate under a much healthier dynamic. Expectations, financing strategies, business strategies – everything would be better aligned with the proven reality that most ventures, indeed, turn out to be small businesses.
AND THERE IS NOTHING WRONG WITH SMALL BUSINESSES.
Here are some statistics about small businesses from the Small Business Administration (SBA):
Small businesses
* Represent 99.7 percent of all employer firms.
* Employ about half of all private sector employees.
* Pay more than 45 percent of total U.S. private payroll.
* Have generated 60 to 80 percent of net new jobs annually over the last decade.
* Create more than half of nonfarm private gross domestic product (GDP).
* Hire 40 percent of high tech workers (such as scientists, engineers, and computer workers).
* Made up 97 percent of all identified exporters and produced 28.6 percent of the known export value in FY 2004.
* Small innovative firms produce 13 times more patents per employee than large patenting firms, and their patents are twice as likely as large firm patents to be among the one
percent most cited.
So, while a small portion of the venture capital industry can go on chasing the Googles and Ciscos, most venture firms should realign to serve a different, yet to be fully figured out industry: venture capital for creating and sustaining small businesses.
Venture firms can invest their expertise on building solid $5-$50 Million businesses, and perhaps not experiencing as many write-offs for making stupid business decisions by chasing returns that the nature of the businesses in question may not support.
There are huge opportunities today for creating wonderful, thriving small businesses. Yet, the most savvy set of investors are all focusing on a wild-goose chase that is an inherently impractical endeavor.
Barack Obama, if he really wants to make a dent into the US economic crisis, should spend serious intellectual horsepower understanding how to better utilize this $30 Billion per year available cash. He needs to work with the stakeholders, and help engineer a solution that can be a “real solution” than his stupid, populist business bashing.
I totally agree with your insightful article. Unfortunately Obama plans to do the opposite. Doubling the capital gains tax makes the risk return equation much less attractive which tends punish small company investments. Raising income taxes to 39.6% retards the growth of small companies that file under S Chapter provisions. Protectionist legislation hits high tech particularly hard, impairing both sales and supply chain. The policies he has announced are absolutely poison for Silicon Valley and the economy in general
Well, thanks for letting me know that I work for a greed-invested scamville. I hadn’t been aware of that.
I couldn’t disagree more with the tone, and message of the article.
On the comments about the VC business: it’s as diverse as any other. Tjere are good and bad people in it, just like any other business. It’s different from other financial services businesses in that we invest our own personal money alongside our LPs’, thus truly putting skin in the game. We share in the profits only AFTER returning all of the management fee to our investors. If we lose money, we don’t share the profits and, more important, our LPs won’t invest in us again. It’s a self-correcting market. LPs are mostly very sophisticated and not tolerant of losing their money. So the “scam cycle” that you describe doesn’t happen: LPs don’t invest in losing VCs. Do you think that a firm on its 7th, 8th, 9th, or even 3rd fund continues to raise money without having a successful track record?
On the Obama front: venture capital, like any other asset class, is at the discretion of the investors. Nobody is forced to invest in a VC fund, any more than they’re forced to invest in a winning, or losing, stock, or hedge fund, or anything. Having the government somehow direct the size and nature of a VC fund isn’t appropriate in a democratic, capitalist society. The government CAN, of course, allocate business development money to stimulating the growth of small businesses, and has done so in the past. It, like any LP, can choose to to invest in VCs or other assets classes and direct how the money can be invested. But it can’t, and shouldn’t, tell investors where to put their money.
Sramana, you seem to be sore at VCs, and that’s your prerogative. I worked at 6 venture-funded startups before joining Trinity. They collectively created over $200B of shareholder value, tens of billions of dollars of US exports and 50,000 or so jobs. I witnessed some aggressive and sharp-elbowed behavior by my investors, but nothing more than I’d expect if I was an LP. I never saw anyone behave illegally or even inappropriately. I saw a lot of VCs carefully balance their dual loyalties to their LPs and to the shareholders of the companies on whose Boards they served. I try hard to do the same. Your remarks are pretty offensive.
The stats on venture capital, as I’ve seen it, are, broadly: half the companies don’t return capital (returning something between 0 and 99%), 35% make a decent return (2-4 times) and 15% make great returns (5 times or more). You can’t build a VC firm by investing only in home runs, because they’re so very hard to predict. You invest with the hope of a 6x return, and a thesis for how it could be 10x.
Outside of venture capital, I don’t know how many small businesses fail, but I wouldn’t mind betting that it’s more than 50%. The VC filter DOES, I believe, tend to invest in better companies, and the help that we (try hard to) provide increases the chances of success.
I agree that the $250-500k funding gap is a problem. We try to do one or two of these a year, as do many others, but it’s not enough. The market is quite efficient, though. If the returns and rewards for this early-stage investing turn out to be attractive, you can bet that there will be more firms doing it, and quite quickly.
Sramana – Obama’s through with the primaries and can now tack to the center, as all successful US presidential candidates do once they no longer need to lock down their party’s ideological base. So expect him to tone down his protectionist rhetoric (excepting, of course, for the auto industry. Otherwise, Michigan is put in play, which it could be anyway if George Romney’s son is chosen as McCain’s VP).
Also, McCain will almost certainly hit Obama hard on the likelihood of tax increases for middle-class households (that’s where the really big revenues are), so Obama will have to tone down the populism if he’s to win the non-unionized, libertarian-leaning states that will be to this election what Ohio was to the 2004 election and Florida to 2000: Colorado, Nevada, New Mexico.
Re the venture capital industry, Obama’s fans don’t like to admit it, but he’s the darling of the hedge hogs and VCs and has taken more money from them than from almost any other industry. If he wants to burnish his populist credentials, he should, IMHO,
a) give the money back. He’s rolling in money from online donations and doesn’t need the hedge funders’ $. He can raise millions overnight fromt the Facebook crowd alone.
b) show some guts and leadership, and immediately propose a change in the tax code to tax carried interest as income rather than as capital gains. To hell with Chuck Schumer.
c) propose that the tens of billions in tax revenues raised thereby be spent on greentech/cleantech vocational training programs for non-college bound US high school graduates and students
d) propose a tax holiday on management fees– not carried interest– for funds that make smaller, early-stage investments a la Sramana’s suggestions.
e) put forth a package of intelligent, targeted interventions on behalf of working families with small children (huge increase in per-child deductions, credits for preschool and medical care, etc).
f) embrace universal health care as the intelligent PRO-BUSINESS solution, and out this plan directly to the Rush Limbaugh crowd of small businessmen, contractors and entrepreneurs. End this insane linkage between employment and health insurance that exists only in the US and that is an absurd relic of 1950s-era negotiations in the US auto industry.
Tom,
Management fees aren’t taxed right now, as they’re spent on running a fund. A big chunk of management fee goes to paying for that; we don’t just divvy it up amongst ourlseves! If you’re suggesting that the portion of management fees that is paid to VCs as their salaries not be taxed, I don’t see it. Sure, that’s my paycheck that you’re talking about, and I’d certainly enjoy not paying federal taxes on it. But it doesn’t seem right. However, I think that you’re on an interesting track: providing some incentives to the COMPANIES, not the VCs, for early-stage invesments (e.g. no payroll taxes). If you remove management fee taxes, I can immediately think of several ways to game the system, and smarter people than I will think of (and implement) even more.
Thanks, Alex, very constructive insights – I appreciate the dialogue. I agree that payroll tax holidays for startups makes a lot of sense. There seems to be increasing momentum for overhauling our Rube Goldberg tax code.
Alex,
If you read my article carefully, I said that a small number of venture firms should continue to do the wild-goose chasing that is at the heart of building the franchise companies like Google and Cisco. And for that part of the eco-system, the structure in place is fine. I don’t at all contest the point that a portion of the asset allocation needs to be focused on wildly speculative bets.
But it is not the right structure for the rest of the ecosystem, and that’s where I see the problems.
And also, if you read carefully, I am suggesting that venture capitalists get involved in more ventures, not less. But re-engineer the system so that it happens intelligently, as opposed to the way things are happening now. “Outside of venture capital, I don’t know how many small businesses fail, but I wouldn’t mind betting that it’s more than 50%. The VC filter DOES, I believe, tend to invest in better companies, and the help that we (try hard to) provide increases the chances of success.†I agree. Almost 85-90% of the businesses outside venture capital fail.
I am a huge fan of old-school venture capital, which once upon a time used to be “mentor capital.†But with the fund size inflation, this industry best practice of mentor capital seems to indicate that it will be going away. This is of huge concern to me, and to many others who are less willing to open their mouth in public than I am. This industry phenomenon is what I label “greed invested scamville.â€
As for your point about venture capital being a self-correcting business, I beg to differ. It’s a very long cycle / feedback loop. Fund lifecycle is 7-10 years. So, for that duration, partners are making serious (too serious) compensation, and even if they don’t raise another fund, they are already quite wealthy. This, I call a scam. And it’s something that the structure of the industry does NOT self-correct. That is precisely what I have an issue with.
Also, I really have no problems with the venture capital industry as such, and as you know, I have worked closely with many of your colleagues in it over close to 15 years. And I qualify this by saying that about the portion of the industry that “works.†Your fund, I would say, by and large, “works†and so far, you have not fallen prey to the seduction of raising $ 800 Million funds in the quest for easy money. And I respect that.
As for the tone of the article, let me tell you this, that I find a lot of VCs and their attitudes obnoxious and arrogant. You said once on this blog that you recognize that venture capital is a service industry, and you exist to “serve” the entrepreneurs.
Well, tell that to your colleagues who don’t seem to get it. I keep hearing from entrepreneurs how they were badly treated by VCs. It’s not right, and you know it.
I’ll address the policy issues (the more interesting part of the discussion) separately.
Tom,
I like the idea of Tax incentives (may not be Tax holidays) for early stage investors, and I like Tax Holiday on Payroll Taxes for the small businesses as well. The early-stage tax incentives need to be carefully thought through as Alex rightly points out.
Alex,
At the end of the day, Government’s intervention can (should) only be through policy changes, not necessarily intervention. Policies require incentives and taxes. So I think both you and Tom are brainstorming about the right issues.
And, I would encourage you and others to think about what I have said in this article about trying to funnel more venture capital into the early-stage game, without being defensive about your industry.
You know me enough to know that I don’t say things off-the-cuff. There is thought behind it.
All,
One possible constructive mechanism for Obama to consider would be to incent corporations to participate in early stage venture capital [$250k-$1M bracket] by offering them specific tax breaks for doing so. If every Fortune 500 company started doing hundreds of such investments, and staffed their investment arms with seasoned executives who are capable of playing the role of “mentor capitalists,” that would certainly be one way to stimulate small businesses.
If every seasoned executive with the skill-set could “mentor” 5-10 businesses and help build them up to $5-$50 Million businesses … imagine the economic impact of that large scale effort?
Instead of bashing corporations, Obama should start thinking along these lines, I feel.
On the Venture Capital industry side, another possibility is to impose a “tiered management fee tax” similar to payroll taxes on funds that are doling out exorbitant management fees. I have no issues with VCs making exorbitant fees as long as they make it from carry. It is the “management fee” component of VC compensations that is screwed up, and needs to be ironed out. [I'd like to see some numbers on the management fee component of the venture capital industry, but I have not been able to find anything at all. The industry operates in secret, and doesn't have to report anything. Something seems fishy and awkward about it. If you go to the Hedge Fund bracket, well, that is totally our-of-control.]
Sramana – Thanks for tackling this subject again. I missed the last round of commenting because I am in the throes of launching a new bio-energy company. Today…I have a few minutes to dive in.
Last weekend I was at my HBS 20th reunion (yes, I can’t believe it either) and met with one of the Finance profs to discuss a new VC model that I have been “inventing” for quite a while. The new model is intended to address the very concerns you have expressed. As an entrepreneur who has raised a lot of money (as well as failed at it too from time to time) and seen a long list of other people’s great business ideas not get funded, I looked into why this has been the case. The key stumbling block is the VC firm structure and the overall investment thesis.
First of all, VC firms generally have a limited number of partners. This is done because of a believe in the phenomenon I call the “Renaissance Investor” and a realization that it is difficult to get to agreement and stay coordinated if there are too many partners that have to all be involved (at least to some degree) in the investment “green light” decisions. The belief is that VC partners are exceptionally capable (comapred to the average mortal) of being able to be deeply knowledgable about an industry, be able to analyze business models, identify breakthrough ideas from a wide range of technologies, have financial “whiz kid” status, be an unusual judge of character in terms of whether a team is capable of business success and provide uique operational oversight and management assistance. Personally, I think it is not possible for this to be the case generally and I have met few (if any) investors that can perform at that level. Nevertheless, the industry is based on this view of partners. The key bottleneck comes as a result of the fact that partners sit on the boards of their investments and can realistically only sit on 5-7 boards. Given a partnership of 5 a firm has a simultaneous investment pool of 25-35 companies. Now, given your point that firms have large pools of capital to deploy, they are forced to put larger amounts into each deal (given the limited number of simultaneoous investments they can support) and so are forced to seek only companies that need large sums and can become the next Google. The solution is not to add more supposed “Renaissance Investors”in the form of partners, its to change the very structure and investment thesis. There may very well continue to be room for the existing cabal to exist, but I am not entirely sure.
I believe that the venture industry is at an inflection point much the same way that the mortgage industry was 25 years ago. Remember the time before mortgage backed securities? The home loan industry had a similar bottleneck phenomenon that the VC world has today. Once that model was changed, the old way went away and the market opportunity increased by at least an order of magnitude. The change was not driven by the insiders and that will not likely happen here either (unless a pioneering VC has read “The Innovator’s Dilemma”).
The new model is designed to take advantage of the enormous number of great ideas that will make 2-5x returns on invested capital that ranges from $250K (initially) to $5M (or possibly even more). A much larger pool of capital will be deployed, likely 10x of what is now invested by limiteds in the entire VC market. The expectations are that a large number of investments will fail but because of the law of large numbers, the average return will still beat the S&P 500 and the beta will be appropriate for the risk taken and it will be more predictable than current VC investment models. This approach requires a disaggregation of the various roles that the current renaissance investor embodies. It also leverages technology to more closely monitor from afar the activities, expenditures and success/failures of the investments.
For the past 2-3 years I have been writing on the subject with an eye toward tightening up the concept. My meeting at HBS was intended to recruit a heavy weight academic to the team and it looks like I have succeeded. The main reason is based on your insight that one of the best outcomes of this new approach will be a vibrant economy for the territory receiving the investment capital. I would like to invite others to engage with me on this topic. Its a big opportunity and I believe important, even critical, that this transformation take place. Hence, I’ll take all the help I can get.
Jack
Jack,
I agree with you that the “innovations” will not come from within the existing venture industry as we know it. It will need to come from outside.
I think, an extremely viable place where this innovation can take place is within corporations.
Sramana
Sramana – I think you are onto something there. When we look at how GE makes internal investment decisions, they choose pretty much every opportunity that meets their internal cost of capital plus some margin that justifies the investment. Somehow I think GE (and the like) would love to have an investment vehicle that allowed them to put $1B to work on deals that could get 3-4x returns.
I think it is well beyond 3-4x returns. Just tax savings on profits would give them enough case for doing investments if the policies are crafted right.
Think about eBay and Amazon, and their “seller” eco-systems. They could very well also fund “sellers” or “power sellers.”
Similarly, Google could fund “publishers” who use their AdSense for Content and help build a large network of small publishers. This would cause them to also take another look at their AdSense business model, for example, and make it a fairer structure.
SunPower can fund entrepreneurs building solar power plants.
There are lots of opportunities for creating strategic “franchises” and use policy / taxes to stimulate the economy through such entrepreneurial efforts.
All -
While what you write is factual it misses a key point, I think. Small businesses are more often service businesses and at the low end of even that sector. Because of the globalized world and the fact that we get so many goods from other countries, we need businesses that create “hard goods” or services that are used by other countries.
Small businesses are more like barber shops. Very helpful and we need them but they only help circulate money in a local economy. They more generally do not bring in money from the outside.
And since we spend so much of our “hard dollars” on imports like oil, natural gas and even consumer electronics and consumer staples, we need businesses that can help balance that out.
And competing on a global scale takes serious cash generally.
This does not address Obama or any of the campaign rhetoric up to now. But as another writer stated each candidate has nailed down their base voters and now will move to the center and make the real promises that will hopefully move us forward.
And I certainly believe that Barak Obama will do this better than John McCain.
Frank,
I am not sure I agree with the fact that service industries is a problem. Look at India. India’s IT/ITES industry was a $30 Billion+ industry last year, and generated 4 Million+ jobs.
If the US can find niches in which “services” are defensible and don’t get outsourced, I don’t see a problem with services. In fact, a lot of system integration work that requires physical presence, including solar systems, or alternative energy power plants, or water desalination plants – for example, may all be acceptable small businesses.
Sramana,
You propose a tiered management fee tax. Isn’t all income in the US taxed at progressively higher levels already? Are the LPs forced to invest in funds that pay salaries to the partners that they don’t like? Nope. Why not simply propose higher tax brackets for everyone who gets paid more than you decide is correct?
Also, you can figure some of the numbers out for yourself. Take an average mid-size venture firm, and look at how many partners and employees there are for every $100M of fund size. Guess that management fee is 2% and ignore that it declines as the fund reaches maturity. Say, for example, that a firm has two partners and 2-3 other employees per $100M of fund (I can think of several). Say that the management fee is $2M/year, to pay four people, travel, consultants, office space, research, conferences, utilities, comms, etc. You’d probably come up with a number somewhere between $300k and $500k per partner. Is this handsome compensation? Sure. But is it out of whack with US compensation for senior, experienced people in corporations? Nope.
Yeah, you can probably find someone who pays him or herself $10M/year out of management fee, but there are always exceptions. Sportspeople, entertainers and others have similarly wide compensation distributions.
I’m surprised that, in a market that’s completely governed by its customers’ desires, you’d propose to single out venture capital for special tax treatment on compensation. LPs can do the math on number of partners, employees, and results, and the requested management fee.
Alex,
As I said above, I have absolutely no problem with:
(a) reasonably small fund sizes that preserve the VC’s ability to do early stage venture capital, and
(b) I have no problem if VCs (like entrepreneurs) make boatloads of money when they “perform”.
I do have serious problem with “free” money, because it creates bad dynamics. And I have problems with the fact that really heavy free money that VCs at north of $500 Million + multiple parallel funds are making as management fees.
You do the math. I did it very publicly in my “Fund Envy” article on Forbes. Have a look at it. It is cited above.
And as long as the base management fee remains in the $300k-$500k bracket, I have no problems whatsoever with the economics of the fund. That is commensurate with senior management compensation anywhere, and that is perfectly in line with where management fee should be.
But my beef is that this is no longer the case.
If the venture capital industry pays north of $500k as base management fee, that is where the beginning of trouble is. Where is the incentive to perform?
And if you do some research, you will see exactly what I am talking about. Like you, I can cite examples of funds where our friends work who are going for this dynamic.
Alex, I am astounded that you are defending a phenomenon which many in your industry openly admit to, although they won’t want to be quoted on it. You, of all people, are not unaware of this dynamic in your industry, are you?
Btw, on tiered income tax, I am actually very much in favor of going low on taxes on carry or capital gains, which are, roughly speaking “performance driven” versus management fee, or base salary which are flat.
[...] discussion on Obama’s Economic Policy somehow got side-tracked to a discussion on venture capital compensation, which is not what I had [...]
Yeah, fair enough, Sramana: VC pay spans a wide range, as does all pay. I’m a strong, maybe naive, believer in market forces. If I were an LP, I’d want to invest in VCs with proven skills and track records, and I’d be happy to pay up for the better ones. So you bave to ask yourself (I do) if, or why, an LP would invest in a huge fund where the math shows that the partners are paying themselves $2M+ in base salary per year and yet they don’t have strong track records and/or don’t perform. Why do people invest in hedge funds where the principal takes out $100M a year? Nobody compells them to do so. It’s one of the quirks of capitalism.
I know CEOs who make $150k, and others who make $10M. There is no obvious correlation between compensation (base or bonus) and actual results or even apparent competence. This is another inefficiency in the capitalist system but I still believe that it’s the least bad system that we have.
I’m not defending the phenomenon of mega-funds with mega-fees, but I also don’t feel any need to regulate or control them. Clearly, greater minds than I feel ok with investing in such funds and paying the fees. It’s a transfer of money between consenting adults completely within the law and tax code. Would I pay some dude who hits a ball with a piece of wood $30M per year? Hell, no. But I’ll defend the right of someone else who thinks that’s a good idea to go spend their money that way.
So I guess my concern comes down to your desire to stop consenting adults from spending their own money in ways that you disagree with. If the mega-funds end up not working out and losing money, those consenting adults will presumably spend their cash somewhere else. Or they may decide that they’re happy, for some unfathomable reason, to plow vast amounts of money into losing teams who pay themselves huge salaries. It’s their money.
Trying to control this is a slippery slope. For example, I personally think that buying a timeshare is a moronic thing to do. But I don’t have any desire to stop others from doing this because (a) it may be me that’s the moron, because I don’t understand something about timeshares and (b) it’s their money.
One final point: there IS a negative consequence to mega-funds that I can see: they drive up valuations for later-stage investments. As you know, raising money at too high of a valuation can be just as bad as raising it at too low of a valuation. In some sectors, I’m seeing valuations that just plain boggle my mind: they’re 4 or more times higher than I’d pay. Some large funds drive these higher valuations. As always, they obviously see something that I don’t, and it’ll take time to see who’s right. If this high valuation trend turns out to be wrong, then LPs will notice and the market for mega-funds will correct. Yeah, it’ll take a long time, so it’s not very efficient. The upside of mega-funds is that they can’t and won’t look at small investments. That creates a market vacuum and, boy, markets abhor a vacuum. If it turns out the the best returns come to folks who invest in seed and early-A rounds, then, great. It’ll either be the angels or the VCs who focus on that who win. Again, this takes time, and is inefficient, but it does work in the long run.
Oh, and by the way, on the topic that you originally raised: I firmly support the idea of government policies that stimulate and encourage the creation of small businesses. The simplest and most direct form for that is to provide tax incentives and, indeed, to provide incentive for investors to help such companies. Then it’s down to venture capitalists and all other types of investors interested in this space to figure out how best to leverage those incentives. I love carrots. I don’t like sticks. If VCs choose to ignore that opportunity, it’s their choice. Personally, I’d favor incentives aimed primarily at the companies (which, in turn, can benefit their investors) but leaving the companies with myriad choices on how to get funded. There’s nothing like having competing suppliers. I see it right now in the VC business, and it means that entrepreneurs are getting better terms than, say, a couple of years ago. Competition is good for everyone in the end.
“If I were an LP, I’d want to invest in VCs with proven skills and track records, and I’d be happy to pay up for the better ones. So you have to ask yourself (I do) if, or why, an LP would invest in a huge fund where the math shows that the partners are paying themselves $2M+ in base salary per year and yet they don’t have strong track records and/or don’t perform.”
I think some of what is going on is people WITH some trackrecord, in their mid-forties-mid-fifties are not thinking about “another fund,” but rather deciding upon a 7-10 year compensation optimization. Let’s just take out $20-$40 Million each among 7 partners, and then who the hell cares what happens to the fund? We’re out of the market at that point, retired.
The LPs are, indeed, investing in “track-record.” But they’re getting scammed in the process.
If you leave this up to market forces, then it will take 7-10 years to correct.
Btw, one of the market forces in a free-market is “information.” One of the reasons I decided to do journalism was to take on issues where traditional media doesn’t have the experience or incisiveness to get to the deeper issues.
So, I think, the LPs need to be “educated.” And contrary to your faith in the LPs’ complete understanding of the issues, I think they are actually behaving like sitting ducks in these cases. It is a matter of bewilderment for me.
As for the economic policy discussion, I am looking for ways in which incentives can be created to stimulate larger scale entrepreneurship. See this piece for a synthesis of some of the nuggets based on this thread: http://sramanamitra.com/2008/06/06/obamas-economic-policy-2/.
I would appreciate your thoughts on this. My observation, also, is that only the top of the venture capital pyramid can play the high-risk, speculative venture game. The lower end should focus on lower risk, but solid ventures, if they want to make 2x-3x returns, instead of losing their shirts.
How do you achieve that stratification / segmentation? I am not sure. But I am thinking about it. Ideas are more than welcome.
“I love carrots. I don’t like sticks.”
Alex, are you running for office?
The carrots-and-ponies party has my vote.