What VCs think about the venture capital business

June 14, 2010

– Charley Polachi is the co-founder of Boston-based executive recruitment firm Polachi, Inc. The views expressed are his own. –

We surveyed more than 1,000 venture capitalists last summer with one simple question: “Is the venture capital business broken? Yes or no?”. After 53 percent said “yes,” it got me thinking about what exactly is going on here. I reached out to 50 general partners of venture funds across the country from Silicon Valley to New York and Boston to gauge the state of the venture business.

I started the conversation by asking: “How does the venture business look on January 1, 2010, when the industry can no longer drag around the 1999 returns in a trailing 10-year average?”

The following is a compilation of the responses I received:

1. Building great companies versus building products that can be sold. Interestingly, venture capitalists on the West Coast talk more about building great companies and venture capitalists on the East Coast talked about the realities of having to manage their portfolio and build products.

2. M&A over IPO. It is very difficult after the economic meltdown for a pension fund, a fund-of-funds or an endowment to make a commitment to the “asset class” of venture capital. With less money going into the system and because it takes longer to get money out of the system, the overwhelming majority of venture capitalists I spoke to felt that M&A would be the inevitable outcome rather than an IPO.

3. Resistance to innovation. Innovation capital is vital to our economy. Startups create more jobs in America than anything else and we need the innovation machine that the venture capital industry represents. One of the partners shared with me an ironic observation – he works in an industry that preaches innovation, creating new businesses and investing in new ideas, but the venture industry itself doesn’t want to change. It’s almost institutional in its view of itself as it relates to structure, fees, compensation, succession planning, etc.

4. Size of funds will decrease. No surprise, but I was surprised at how small. VCs felt the ideal size fund to invest in early stage technology ventures was probably less than $150 million with only three or four really good investing partners and limited or no leverage. The days of 12-plus guys around the table trying to put $1 billion into the system won’t work.

5. Industry in need of a major reset. Another hot topic: If there were 800 firms two years ago doing early stage tech investing it would be no surprise if there are only 400 firms in two years.

6. Trend toward pay-for-performance. Surprisingly, a lot of the venture capitalists felt that compensation needed to be aligned more with results, as it was too much relative to the amount of work they actually do.

7. Return to apprenticeship model. Bring in bright, young talented people, marry them up to a senior person and inculcate them with values and hands-on experience that results in a good investor in seven years, versus the direct entry hiring we saw at the top of the bubble, when the money had to be moved and put to work faster.

8. Increasing fund raising internationally. Several mentioned “there is always new money out there and American venture capital is viewed as a status symbol by the newly wealthy in other parts of the world.” Fund raising will likely move to other parts of the world where new family money is created.

9. Concern over strength of syndicates. I heard a healthy degree of concern about the strength of syndicates and venture guys are being very careful about who they invest with. They prefer the safety of “familiarity” over working with new people while also looking at which partner has longevity.

10. Age gap. The guys in their 50s want it how it was 10 years ago and the guys in their 30s want change – albeit well paid – and they are disappointed the promise of success and wealth has not developed.

11. Pockets of optimism. Many believe that the right-sizing of the industry is good and innovation and investing will continue to create businesses and jobs, especially in health-care technology, environmental improvements in conservation, renewable, efficiency, tech-enabled services, consumer, mobility, and gaming.

Although 53 percent felt the industry was broken, it had a lot to do with the timing of the survey in mid Q2 2009. I will continue to be optimistic about the future of venture capital as a profession and more importantly about the benefits of investing in innovation: job creation, problem solving, wealth creation for founders and investors and maintaining our competitive position in the increasingly smaller global economy.

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It’s inadvertently revealing that not one question addressed the morality and responsibility of the Venture Capital industry.

Years of flipping IPOs of money losing firms, fueled by under-the-table spinning, pushing the off-shoring of U.S. high-tech jobs, and taking capital gains on carried interest make VCs look like a bunch of Bernie Madoffs.

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