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The VC Model is Broken: Ideas, Anyone?

TheFunded.com Open Letter

Posted by The Founding Member on 2008-11-12

PUBLIC:

The following presentation was delivered to key faculty at the Harvard Business School to start a dialog about the future of venture capital. The presentation was shared by a Member in attendance. Members, please add your ideas on how to improve the model by posting feedback below. Enjoy!

TheFunded - Canarie
View SlideShare presentation or Upload your own. (tags: investing vc)

Posted by dude on 2008-11-13 10:07:50

Great work, Adeo! Let's hope they take heed.

(but is canary being both dead and misspelled two things worng?)

Posted by anonymous on 2008-11-13 10:21:13

I both agree and disagree. I agree that the VC model is broken, in that it is too, well, incestuous. It focuses on funding companies within its own network, thus avoiding all the great value opportunities elsewhere. It is also deeply subject to a herd mentality, everyone chasing the few hot ideas, rather than a more rigorous analysis and diversity of investment (which is the first rule of investing).

I disagree in that the VC model isn't for everyone. The VC model is focused on big hits... but the overwhelming majority of companies that need funding are not looking to be (or shouldn't be looking to be) big hits. They are companies that can generate $5MM, $10MM, maybe $20MM in annual revenues in many years, and are thus good, solid businesses.... that would be destroyed by the "get big fast" pressure of VCs. What these firms need is: (a) an understanding of what the VC model is, so they can avoid it; and (b) opportunities to approach other investors.

Posted by Anonymous on 2008-11-13 10:29:23

Excellent job Adeo. Socialize the message please.

For the amount of smart people investing it is amazing that they havent processed the data and found these patterns.

Clearly we need a VC approach to recognize that companies like Google, Ebay, Amazon, Facebook can be incredibly huge and also to bet big on them.

The problem is then why the other companies that they invest in, dont amount to anything. Is it a problem of judgement where they can only get one out of 10 (or less) right. Or is it because the VCs are inept at actually helping these other companies succeed and it is really a matter of founder ability, luck, timing, etc for the one success they do get.

Posted by Sharing is good on 2008-11-13 10:48:02

It does feel broken, in many of the big ways you cite. From a personal standpoint, the smaller recommendations at the end about standardized term sheets and getting early stage investments to cost less than $10k feels so right and so critical.

Last year, my startup spent 10% of its money on legal fees -- to close a round of financing and work on the terms of use contract, and that was after big "discounts" from my law firm. And sure, $25-$70k closing fees aren't a big percentage of $1-$5m dollars, but it does feel preposterous in real terms. There are so many better ways to spend that money.

The me-too investments drive me crazy. I've watched competitors that are so lagging and faulty get funded and I think, who did the diligence? And I also see new ideas not get funded because there is no benchmark to guage their market or technical viability. I don't have an easy answer for how to solve that.

Posted by Anonymous on 2008-11-13 12:20:33

A friend of mine just left a very prestigious and high-paying job at a big VC firm to run a startup company. He said that getting good returns is damn difficult, even at his blue chip fund.

Posted by anonymous on 2008-11-13 15:31:13

I probably have a unique perspective, having run a firm for 12 years that did damn good due diligence for startups. I participated in a lot of VC pitches, sitting on the entrepreneur's side of the table. Here's a tale:

We spent several months talking to potential customers for a semiconductor startup's product. We got strong interest and developed business and co-funded development opportunities in two market segments.

We did a partners meeting at KPCB. Five full partners were in the room, including one whose name is on the door. We presented facts, business and investment terms offered by industrial partners, and more than most startups could ever wish to have at a pitch meeting.

The comments from the partners were unbelievable. "We did this at XXX and it failed," said one, not mentioning that he did it radically different, and it was 28 years ago. "Intel is the best performing semiconductor company, and their returns aren't good enough for us," said another, with not a small amount of arrogance. Not one question about the publicly-traded companies who had offered to co fund development, or about the other business opportunities we developed.

After the meeting, one partner (who had 20+ years of operational experience) pulled me aside and said he wanted to learn more. While the rest disappeared to the catered seafood buffet that they enjoy every day, he asked intelligent questions about the markets, potential partners, and sales opportunities. It was clear that he did not feel comfortable addressing these issues in front of the group, although he is a full partner, and is personally on the list of wealthiest people in the world (His sister had a run in with the SLA a while back). This one guy, although he came from a vastly different industry, had more business sense than the rest of the room combined.

I used to think that this was an extreme case. Now when I read the posts here in TheFunded, I realize that much of the VC industry is in the same boat, and has the same unrealistic expectations. Although the So if you ask me if the VC model is broken, I'll say, yea, and the reason isn't what the presentation above describes. The reason is the way that VC's have come to view themselves and their position in the world. Just count the number of times the word "arrogant" comes up on this site. The VC industry won't be fixed until that changes.

Posted by mrblack on 2008-11-17 01:05:04
Posted by pnkearns on 2008-11-24 16:24:41

It seems that the VC model is structured more as a club than a business.

Posted by Anonymous on 2008-11-24 17:45:32

Evergreen funds are a good idea.

Posted by anon on 2008-11-30 21:55:29

The presentation points out lots of flaws with the VC biz model
The solutions don't make too much sense, if returns are low, how does funding more companies increase returns?
The shakeout that should have happened in 2001 will happen in 2009 - 2010 because ten year returns (which are what the LPs evaluate asset classes on) are now officially terrible. Hopefully this will help improve VC quality. Our entire capital economy was affected by cronyism the last two decades and VC was no exception, but certainly wasn't exceptional. The survivors of the two market crashes will by definition be solid and hopefully the next generation of VCs will be better.

Posted by beaner on 2008-11-30 21:58:23

the interesting observation is that ebay accounted for a huge % of the returns of the entire industry. If you add a few more companies; skype, google, you tube, paypal to this list you see that most of the returns are generated by a small handful of companies.

Another idea is small money in + modest exit = good % return