“We can’t solve problems by using the same kind of thinking we used when we created them.” Albert Einstein
With the second venture bubble bursting, it is time the venture model evolved. And none too soon.
The question is how?
A Model Ready for Change
It’s ironic that the industry that purports to fund innovation has innovated very little itself.
Tom Nicholas, the William J. Abernathy Professor of Business Administration at Harvard’s Business School, wrote of this very fact in his recent book — that may be the consummate work on venture capital — ‘VC-An American History’;
The fact that partners’ talent matters most is an important finding, and is consistent with the fact that the VC industry has been remarkably devoid of organizational innovation since Draper Gaither and Anderson was founded as a limited partnership in 1959. pg 311
The very concentration of activity in so few communities speaks to the absence of innovation in the structure and scalability of venture funding. Most vcs invest in their ‘back door’, still relying on personal connections, ‘analog’ due diligence, and largely social signals to define their decision making process.
Wall St. Can Be Instructional For Solutions
There is some new research confirming how to fix the historical venture model, and the research points to solutions that look a lot like what happened on Wall St. following the Crash of ’29 and the Great Depression:
Require transparency: the ’33 Act required it following the bubble & fraud from the 1920’s.
Diversify: the ‘40 Act formalized the formation and management of properly diversified investment pools; mutual funds, ETFs, UITs, etc.
- Research confirms (HERE & HERE) that properly diversified portfolios can deliver appropriate risk-adjusted returns.
Don’t time ‘the market’: indexing and dollar cost averaging to manage the security selection bias and timing risk is ‘de rigeuer’ for the public markets.
- Research confirms (HERE) that informed follow on funding optimizes total return of total capital deployed in venture funds.
Why Is This Not The Current Model?
Few investors, startups, mentors, advisors, or even long-time financial journalists realize the venture industry may be the last financial services industry that has NO PROFESSIONAL STANDARDS required of the participants.
Anybody can be a venture capitalist.
Let that sink in…..
There is no formal body of knowledge/best practices that vcs are expected to know before launching their fund.
There is no formal training, licensing, accreditation, oversight, Code of Ethics, censure procedures, etc.
Many venture capital funds are already violating their fiduciary responsibilities to capture and report the tax implications of transactions within their portfolios, causing their taxable LP investors to pay more taxes than they need to.
It’s Time VC Became a Proper Profession
With the second venture bubble unfolding, coinciding with a decline in expected forward returns in the public markets, $Ts are looking for a better place to capture better risk adjusted returns.
The current venture model is not equipped to allocate this level of capital with institutional scale and rigor.
A good first step would be to bring some professional standards, training, basic risk and portfolio management training to those entrusted in investing other peoples’ money in this asset class.
This would assure the good research already available could be implemented in new venture fund models and accelerate the evolution of a process that is over 60 years old.