Venture capitalists rarely take their own advice when it comes to their own businesses.
There’s a common narrative that venture capital doesn’t scale. That narrative is so well accepted as truth that venture capitalists themselves don’t bother taking the advice that they generally dole out.
Here are some common truisms that are often passed down by VCs but aren’t applied in their own business:
Establish dominant market share and become the very best. VCs advise companies to find a niche and exploit it — and do not enter a super competitive space. But the venture capital industry is crazy competitive — often competing with 100 firms (that are usually staffed with super-smart people).
Have one CEO. VCs advise companies to have one core decision-maker. In the rare case, maybe there is a co-CEO. But many VC firms are run as a partnership with 3–8 equal partners (though some partners may be more equal than others). They’d never invest in a company run by committee.
Founders should demonstrate deep commitment to future value creation by taking low salaries. But VCs do not usually trade some of their short-term salaries for long-term upside. Most VCs pay themselves salaries out of their typical 2% management fees. If VCs took their own advice, they would be using most of that 2% fee to build systems and invest in the future. Or they would trade the bulk of the management fee for greater carry.
Companies should invest in growth and market dominance over profitability. But VCs themselves are extremely profitable. They do not hire aggressively, invest in technology, spend time on automation, or make any of the other investments in themselves that they would expect their portfolio companies to make.
Leverage existing advantages to expand into adjacent markets. VCs want companies to hire great people and continually level-up the management team. Yet the VCs grow their own businesses very slowly and do not take risks. VCs rarely move into adjacent markets, expand their brand, etc.
Keep expenses low — spend less on rent, fly economy, and generally be frugal. Yet most VCs do the opposite with their own expenses — often spending lavishly on rent, travel & entertainment, and more.
Companies should be long-term focused and should be doing things that outlast the founders. But many VCs set up their firms in a short-term oriented way. VCs often have much bigger key-man risks than the companies they invest in. And VCs, even successful VCs, rarely outlast their founders.
Governance structure in portfolio companies is a high priority. VCs think it is wise to have investors and independents on a company’s board. But VCs themselves often have much less oversight. Many thrive on potential conflicts of interest.
Companies should go public and being a public company is very good for the long-term. But venture capital firms themselves rarely go public.
Acquisitions can be accretive and strategic. The growth of a synergistic merger often can outweigh the dilution that comes from growing the firm. VCs rarely acquire other firms.
Venture Capitalists, as a class, are much less ambitious than one would expect.
Almost no venture capitalist would fund themselves. They are looking to fund people that are essentially the opposite of themselves. They are looking to fund outliers because their returns come in power laws. But for their own business, they are looking to play it safe and be conservative.
VCs generally do not want to rock the boat. They don’t want to do something different. They don’t want to change the industry. In fact, for many VCs, their biggest fear is that the industry will fundamentally change. They want to keep collecting their two and twenty.
That’s not to say there are not ambitious venture capitalists. There are. Many people are looking at changing the game. Naval Ravikant’s AngelList is a full frontal assault on venture capital. Tim Draper invented the venture capital franchise model. Masayoshi Son’s Softbank Vision Fund is changing everything in the late-stage venture capital (as did Yuri Milner’s DST before that). Sequoia’s amazing work ethic and competitiveness to be number one. Peter Thiel runs four large venture capital funds, a global marco hedge fund, and many other investing vehicles. Chamath Palihapitiya’s Social Capital is taking a long view on venture capital. Chris Farmer’s SignalFire, while yet unproven, is attempting to automate venture capital through data (like Renaissance Technologies and Two Sigma has done in the hedge fund world). Marc Andreessen and Ben Horowitz create a full-service firm which aims to have the best marketing, best recruiting, best conferences, etc. And the most ambitious people in Silicon Valley may well be Paul Graham, Jessica Livingston, and Sam Altman from Y Combinator.
Many readers may have an adverse reaction to some of the people above. They may think these people too bold or too reckless. And some of them may well be (time will tell). They will not all succeed with their grand ambitions. But their ambition is exciting. It is refreshing. And these individuals are acting more like the entrepreneurs they fund than the classic VCs that are the funders.
Most venture capital firms are surprisingly less ambitious than the entrepreneurs they fund. And they are also much less ambitious than their siblings who run private equity firms and their cousins who run hedge funds.
Private equity firms are run significantly differently from venture capital firms. As a recap:
- PE firms have 1 or 2 CEOs. VCs have 3-8 CEOs
- PE firms make large investments in back-office, consulting, and data science (Vista Equity has been so successful with this model). VCs usually don’t.
- PE firms create new products and become international fast (Blackrock spun out of Blackstone … and Blackstone also built up an incredibly successful real estate practice). VCs rarely create new huge products.
- PE firms focus on having succession plans. VCs have trouble making the transition.
- Many PE firms are public. It is extremely rare for a VC to be public.
PE firms are generally much more ambitious than VCs. They are often 10-100 times larger in size (both in the number of people they employ and in the dollars under management). And they generally have much larger dreams.
The most successful PE titans are more wealthy than the most successful VCs. And while wealth does not equal ambition … it is correlated. There are an order of magnitude more PE billionaires than VC billionaires. And many of the most successful VCs made more money founding companies before they became VCs than they did as VCs.
Lack of ambition among VCs could be feature (not a bug).
Many entrepreneurs like the idea that venture capitalists are less ambitious. A founder might not want want someone on their board that is crazy ambitious … because that VC might not be able to make time for the new founder.
So there is definitely a possibility that perverse thing could happen: a less ambitious VC might actually be more successful because it might allow them to get into the best deals. (Yes, this is a weird theory and there is a 58% chance I will disavow it in the future … in fact, there is a 38% chance I will disavow this entire post in the future).
Of course, there is nothing wrong with only wanting to be worth $200 million and not $2 billion. That extra zero is not going to change their lifestyle much. So why rock the boat for that extra zero? Why get everyone to hate you to get that extra zero? Why take huge risks for an extra zero that is not going to change your life?
Venture capital can think bigger.
A few random thoughts that an ambitious venture firm might think more about:
- Instead of ruling by consensus, VC firms could have a designated CEO (or co-CEO). While many firms do have this in practice, making this more explicit would add clarity.
- Fund-by-fund equity really creates short-termism and creates lots of conflicting incentives. Imagine if Amazon gave out equity in each of product lines (AWS, Prime Video, e-commerce, Alexa, etc.). Ultimately an evergreen fund (like Berkshire Hathaway) will lead to greater ambition.
- Passing the baton to a new generation should not completely wipe out the equity of the older VCs that founded the firm. But the older VCs can’t keep running the firm while spending most of their time at their winery either. Being a good VC should be intense and take over 60+ hours a week. The older VCs could maintain equity in the evergreen company while issuing new equity to new employees (and new LPs).
- Run the firm with the aim to go public. That’s how you run a company. Think about how to get big.
- Look to acquire other firms. And yes VC is a services firm — but services firms can be run well at scale. Think of Accenture which has $41 billion in revenues and market cap of almost $100 billion at the time of this writing.
- Defer more cash payments to equity. While layering fees has been a great way to get rich in the last 15 years, it does seem like this model is very fragile.
- Look to dominate a niche (rather than competing with the smartest people in the world). Look to build a moat and some sort of network effect. That might mean significantly changing the game (like AngelList or Y Combinator).
Summation: Venture Capital firms rarely take their own advice when running their own firm. Private Equity firms (like Blackstone, KKR, Vista Equity Partners, etc.) are actually much more like venture portfolio companies than VCs are.
This is modified from a Feb 2018 Quora post. Special thank you to Tod Sacerdoti, Jeff Lu, Tim Draper, Will Quist, Joe Lonsdale, Bill Trenchard, Ian Sigalow, Villi Iltchev, and Alex Rosen for their insights, thoughts, and debates on this topic.
Good analysis! I think one of the challenges is that VC requires more subjective than objective decision making since there is less value that is observable in objective metrics in early stage companies. This means much of the value for the VC is in the investment individuals not the firm. This makes it harder to manage and scale. I think firms have a hard time identifying investments that can scale the performance of their star performers. I think this will continue until tech and new business models identify and provide capital on more objective metrics and with higher efficacy than we see today.
Some good points:
1. You are right about having a CEO. Or at least very specific functional ownership amongst partners and clear systems for adding / subtracting people.
2. not sure how much investment in data / systems is warranted. Some for sure, but there is a useful limit. Ryan Caldbeck has good threads on the challenges of data and tech venture capital.
3. Acquisitions of the most important assets, people, happen all the time. not sure of the value of platform / brand acquisitions – unless you need to do it to get the people.
4. I like the PE parallel, but I think you are cherry picking the ones on your radar (and likely a selection bias there). 99% of PE looks like venture – single product line, major profitability on mgmt fees, bad transition plans, etc etc.
5. I think the reason good private equity firms look more like companies is that they have aggressively become multi product, which forces you to become like a company. The leverage in the the products being together comes largely from fundraising, data / deal sharing internally, and back office – all of which demand centralization / mgmt.
it’s very provocative – i *love* the initial premise but then you trash it by:
1. adding a disclaimer to all the top venture investors and a few not so top investors
2. how familiar are you with private equity and the firms you discuss? i like provocative but making a double provocative argument is like speaking to a group of silicon valley folks and telling them trump is amazing and social networking is an overall good for the world. you divide your supporters into an even smaller venn diagram (those that will agree with your venture capital premise and those that will agree with your private equity premise)
I completely agree. Other service firms (accenture, goldman, Cognizant) as well as financial firms (blackrock, KKR, etc) have all found ways to do this. From what I hear, Sequoia may be close to this with a variety of funds under one house
Auren, usually I am a fan of your writing, but in my opinion I feel you may have missed an extremely important point in the early stage venture capital business: it is not a scalable business. Instead it is a craft practiced by individuals that learn that craft over many years. Each individual can only manage up to 10 boards at a time (if they expect to be a good board member and participate actively). It is incredibly hard to hire new partners, and despite having full time in-house recruiters focused, and tremendous amounts of partner time spent on hiring, most firms are lucky if they can find one new partner to add to the firm every year. If you add too many partners, you damage the whole decision making process which requires the partners collaborate to make great investment decisions.
So talking about “dominant market share”, “investing in growth and market dominance over profitability”, “going public”, and doing acquisitions, make no sense in this business context. For those to make sense, you have to have a scalable business model.
What matters in this business is returns. The moment firms try to expand, by managing more capital, and adding too many partners, they typically generate lower returns. (There might be one or two exceptions to this that prove the rule.)
Yes, but partnerships are by definition and structure different animals. You’re conflating businesses designed to deliver earnings (funds) with companies designed to scale and dominate categories. In PE (and really only large PE btw – KKR, Blackstone, Carlyle, etc), they are multi-line businesses trying to scale. Hence, CEOs, public offerings, etc.
In VC, only a couple have ever gone public, and it’s never gone well for long (mismatch of long-term assets in short-term cycles). So VC’s aren’t trying to scale. They sometimes raise bigger funds, and hire a few more ppl, but that’s just usually more work for incrementally diminishing returns. Same for Law firms, architectural firms — pretty much most earnings/oriented partnerships.
Depends on your definition of success my man. If money is the only driver then PE guys are much less ambitious than the hedge fund guys. I like to play a team sport, deliver crazy good returns to my LPs, work with entrepreneurs on fulfilling their potential which is a mentorship art not a transaction, and prefer not to manage a lot of people. If those are the goals, bigger is not better.
On the private equity side, I think you have made a bunch of generalizations with a 50,000 foot glance at a small subset of firms. Those generalizations are generally incorrect when applied to the industry as a whole.
I also feel like you are also using the wrong term, and maybe that’s where I am struggling… I am not sure that “ambition” is created by an evergreen structure, a 2%/20% structure, or a holding company structure, and some of these choices are actually contrary to other points you are making… Getting large seems to be a sign of ambition for you, but size actually leads to more fee income, and getting rich on fees is probably not a great thing for ambition….
You say: “PE firms have 1 or 2 CEOs. VCs have 3-8 CEOs”
Not true for 25 years. Has begun to happen and only at a small subset of firms. Most of them remain structured and managed as partnerships. “N” is too small in your sample
You say: “PE firms make large investments in back-office, consulting, and data science (Vista Equity has been so successful with this model). VCs usually don’t.”
The bulk of private equity firms are in the middle market, and don’t do this. Not because they don’t WANT to but because they don’t have the fees to do it. Vista did not do this when they were on their first $800MM fund. Massive AUM has afforded them the ability to do this – not many venture (or private equity) firms have $1BN of annual management fees. Probably the wrong case to use as your example, and if you are going to do that, then your VC example should be the equivalent (Sequoia, A16Z, etc..)
You say: “PE firms create new products and become international fast (Blackrock spun out of Blackstone … and Blackstone also built up an incredibly successful real estate practice). VCs rarely create new huge products.”
Don’t confuse creating new products with gathering assets to drive AUM. Blackstone has added products, rather than creating them. The input is AUM and the output is fees. Blackstone is more comparable to Vanguard than it is to a VC firm. The AUM game does not work for VC.
You say: “PE firms focus on having succession plans. VCs have trouble making the transition.”
Nope – they are just as bad at this as VC firms. The ones that do this well are the exception not the rule. I’d put a lot of money on my being able to give you significantly more PE firms that have blown up over succession than you can give me that have successfully navigated succession.
You say: “Many PE firms are public. It is extremely rare for a VC to be public.”
Not MANY. Again – a very small subset. And the ones that have traded well have NOT been pure play private equity firms. The characteristics of neither Private Equity nor Venture Firms lend themselves to being good for the public markets. Furthermore, being public is a means to an end – not an end in itself, and I don’t know that there are a lot of VCs who would currently say that being public is a necessity or either a sign of or a determinant of long term success.
You say: “Instead of ruling by consensus, VC firms could have a designated CEO (or co-CEO).:
Why do you believe that this is a good thing and what do you think this achieves?? If you are looking at investment decision making, I think 30 years of research will show partnerships outperforming sole operators (hence the massive bias of fund LPs)
Re: the CEO comment.
1. The best VC’s to work with from an angel perspective are the “dictatorship-in-denial.” Founders Fund (Peter), Greylock (Reid), Khosla (Vinod) precisely because they have CEO’s so that have coherent strategies and selection criteria. Aka – intellectually brilliant eccentric founders = Founders Fund. Killer hunger founders = Khosla.
2. These dictatorship funds avoid the mimetic problem of the what pitch sounds good from partner-to-partner (not from entrepreneur-to-partner). With most VC’s the best guide to whether they will fund a company is whether the elevator pitch is easy from one partner to their peers. This leads to massive over funding of simple ideas to explain (Self-driving car, food delivery) and underfunding of abstract ideas (Middleware, API call businesses etc)
You combined 2, I would argue very different, points into one post:
1. VCs don’t act like companies in which they invest
2. VCs are less ambitious than PE firms
I think both points are true. However, most PE firms are nothing like companies in which they invest, either. Most don’t have a niche (Vista as an exception. Blackstone, KKR, etc. have no specialty). Most have senior partners who don’t do deals, keep huge chunk of the economics, and do poor job of generational transition (Kravis and Roberts are still running their firm). Most PE firms have lavish offices, fly first class, and have significant current comp. And so on.
So a topic, perhaps for another post, is whether investment firms, fundamentally, SHOULD look differently than operating firms, because they do.
* Many VC’s don’t do a good job of specializing and doing one thing well. Many do, especially in the enterprise space. I find those that do can generate better returns more consistently. Frameworks help. But there are lots and lots of exceptions.
* VC firms in general are not run very operationally. True.
* The better firms are very operationally. Lightspeed for instance has achieved such success by running the firm like a sales machine – metrics, check-ins at every step, post mortems. So there are exceptions. I think firms like Signal Fire are much more metric driven and quantitative as well.
* But in general, coaching, feedback, post mortem’s are not done well. It’s very much a mercenary approach.
* Decisions processes are often unclear – often it is decision by committee with different partners having different authorities. There are some firms with one CEO. But VC’s are also partnerships. That is sort of the nature of a partnership. You’re hiring a bunch of alphas, who were executives / CEOs, so they don’t really want to work for someone else.
* Growth vs. profitability is hard – funds can only scale so big, otherwise you get into running large complex organizations with lots of management. In many ways the more disciplined firms stay smaller and focus what they are good at, have few partners so they can make quick decisions and focus on deals vs. managing a large overhead of people.
* Public vs. private – There is a lot of variability in performance from fund to fund, and earlier stage firms are rewarded for taking big swings. That level of variability might be harder to stomach with public investors. The best deals look stupid at first, but so do the worst deals. PE on the other hand can go public, bec/ their returns are more consistent. 2x – 5x, w/ much less downside. Also, there are long periods of illiquidity in VC firms, which makes it a more difficult asset class. I’m also guessing private companies would not want the level of disclosure you would need as a public company.
* Acquisitions to grow – you’re essentially buying people. That often doesn’t scale well. I’ve seen this a lot with services businesses, which is what VC is. Again, its harder for VC firms to drive the same returns as they scale.
* Investing in people and operations – This is challenging. I don’t think you get much value out of this unless you go all in. Most of the VC’s that try this don’t get much leverage from it. VC’s also don’t have enough budget to cover this effectively. You have to go all out if you want to do this. Even A16Z does a mediocre job at this, and they have a massive staff. You also have an issue that if you underpay those people in operations you don’t get great people, but if you give them shared economics as a partner the economics don’t wor. PE Firms it does work. You can operationalize a lot of things. You an get your portfolio companies all on the same tech stack, train the reps teh same way . . . . That doesn’t work as well for early stage companies. Also, PE firms have HUGE mgmt fees, and they can pay those operating partners really really well, and they can get really good operating partners.
Thanks for sharing this. I love it.
the biggest thing is that lack of systems thinking in most VCs. Almost all VCs are extremely transaction-focused: how do I win this deal? how do I optimise this structure? Very little thought about the second order effects that that behaviour drives – and so little attempt to build moats, network effects, etc.
I think you see this most clearly in pricing. Most VCs would run a mile from a company that said it was in a low barriers-to-entry industry and would have to compete on price almost all the time. But that’s 99% of VCs… The genius of YC is long term, apparently sustainable premium pricing. Yes, they’ve improved their deal over time, but to nothing like “market price”. It amazes me how little attention that aspect of their model gets; it’s the key to the whole thing.
And, of course, I believe there’s even more opportunity to do that at the individual level than at the company level… and even more opportunity to build a network effects business. So I guess on net I’m pretty happy the industry has such a dearth of true ambition
Thanks Auren. It’s a provocative post.
the venture capital industry is fundamentally different than emerging tech industries in its competitive dynamics and maturity – so the lessons VCs give to companies may very well not apply to the VC industry itself (that fact it doesn’t align doesn’t bother me). You wouldn’t expect large LPs (foundations, family offices, etc.) to structure themselves the same as VCs just because they are investors – or long only mutual funds to set up their firms the same way as the companies they back.
While I disagree with some of your suggestions like:
* Single CEO – It’s hard to get the best VCs to work for one CEO
* Going public – Privacy of investments and how they are doing is an advantage to the private companies (3i is public and that hurt when it tried to win deals)
* Acquiring other firms – again, the people/incentive problem results in the best people wanting to work for/by themselves – there also seems to be a natural limit to firm size at the early stage at least (Softbank may prove me wrong for larger companies)
I agree with some of them too:
* More equity/lower cash. LPs would and do love this – better alignment. Only problem is the best VCs get both higher equity and high cash.
* Dominate a niche or try innovative things – great firms are doing this and then expanding (Y-combinator, Emergence, etc.). I also think Softbank, A16Z, Thiel have done great here.
I also think that while VC changes slowly, it does evolve. Firms are becoming more proactive, using more data, raising larger funds and investing more dollars in fewer companies – there’s also more competition between firms (less friendly industry than 10 years ago) and different players/strategies than ever before (which hopefully is a good thing). It’s a fun/but certainly not perfect industry. Key for me is always having respect/empathy for entrepreneurs and realizing that what you are asking them to do may be different than what you ask of yourself.
the other side to this article, are the LPs who are even further behind in thinking of what we do as a business not a craft or activity.
Super interesting premise. My experience in working closely with PE guys recently has been that they have an almost total disregard for anything but a combination of growth and EBITA, and a laser focus on making a dollar on a dollar, no matter the sector or whether the company has a prospect for innovative, breakthrough platform or product. The big guys do seem to have huge market control ambitions recently though, (softbank and ride-sharing,etc.). Reminds me of the Hunt brothers and the silver market.
Predicting the future is hard, and it is really interesting to take a step back and follow the money. If you look at the big fund-of-funds that have lots of history (like Adams Street, Horsley Bridge, Flag, Common fund, etc.) most back both VC and private equity. They typically make long term commitments to investors across multiple funds because while they back great managers, they believe that luck plays a much larger role in getting big outcomes than certainly the VC would believe. Even the best investors are not immune from confirmation bias. Good VC’s and VC firms are not run by entrepreneurs or visionary’s. It is even less so for PE. Even Vista literally has a “playbook” that their portfolio company CEO’s are handed when they take over, and I understand they are expected to follow it or be replaced.
I am not sure that entrepreneurial vision (or tactics) are rewarded in Venture or PE. I think creating a company from an idea, and driving it to a successful outcome is a totally different mindset, personality, risk profile, etc than managing a portfolio of assets to maximize returns across funds. I am not sure one translates easily into the other, consistently. I came from an operating role into VC, and that is not necessarily an easy or logical path. VC and PE are also very, very different businesses and people, and not really just niches in a risk spectrum as they might appear on the surface.
I think it’s not really a question of ambition, it’s that most PE guys are in the money business, VC are in the money and ego business, and most entrepreneurs are scratching an itch that is driven by something entirely different.
Not sure I agree, completely. Because there are a lot of terrible PE firms. I came from that industry originally.
a) venture capital is typically pre-product market fit and primordial stages of something that may be working
b) PE firms: most are looking at cashflow and future revenue (growth may not always be the thing they care about). they are much more operationally intensive and the alignment is almost never w/ employees and existing shareholders.
c) agree Vista and a couple of other firms have gone down a better path, but that’s because they are investing in post product market, mid-tier enterprises. (that’s where they started)
d) venture capital at a high level has issues scaling the primordial stage. once you get into growth / later stage deals, one of the issues does become scale of capital.
– Market share. You can add that no VC firm manages their business looking at market share. Perhaps with the exception of Sequoia, none of them look at the top of the funnel and track what percentage of opportunities they are seeing at the early stage. Decision making (picking) is important, but certainly a lot harder to manage and optimize than your at bat %. And yet, VC firms don’t pay attention to it to see if their reach is expanding.
– CEO – You are right. VCs would never invest in a partnership. I would suggest in venture there are only two models that work. True equal partnerships, which don’t scale, but work well. And true dictatorships with clear hierarchy (Sequoia). Everything in between is not sustainable and will gravitate over time to one of those extremes. The problem is that most VC firms are in between – not really equal and also leaderless as the same time.
– Salaries – Applies to older venture firms. Starting a new venture firm is not very lucrative until fund 3.
– Adjacent markets – VC have tried, but it has never worked. Think all the firms that build HC practices. Most failed and only a few still do both. But their inability or unwillingness to get into the PE game is noteworthy.
– Outlasting founders – You are right, the partners have little incentive to worry about the firm beyond their retirement.
– Examples of innovation, I do not think Social Capital or SignalFire are good examples. Keep AngelList, but I would take out SC and SF because you would lose credibility in the argument.
– PE vs VC ambition. I think PE is just a much larger asset class. VC is tiny, tiny, tiny. The volatility of returns in VC is very high, which also makes them attractive to only very long-term focused investors. PE is much more correlated to the S&P500
Great article. In general I agree, VC firms are run as small businesses, and generally poorly run ones at that. They don’t have a lot of staff and are largely centered around one or two people. Decision making is haphazard, so is the process to hire new partners. Generational transitions are often firm ending events due to the lack of long term thinking and ego/identity tied up in the firm from early partners (name on the door?). It’s somewhat shocking the hypocrisy you mention continue to be the case in the industry.
While I don’t have all the answers, I think two reasons for this are 1) the size of the overall VC market and 2) the tremendous ‘stickiness’ of brands in the market. VentureCapital is a very small part of the financial world, deploying $71B in 2017. Compare that to PE which is 10x larger, deploying $594B in 2017. With a much smaller market, you can generally cover it with a small staff and operate as a small business.
The persistence of brand in this small market is pretty stunning. The names and faces of the “best” firms that founders want introductions to don’t change from year to year. As a result, the data has shown that almost all the returns in the business go to the top quartile of funds, which are often small firms and see no need to change the way they operate.
We push ourselves to think differently about how to operate and we are quite inspired by Vista and others in the PE market.
First off, I like this an intellectual argument because it is something we spend a lot of time thinking about.
Our business is not a winner-take-all business. It is not even a winner-take-most business. It is more like a law firm or an investment bank than a technology business. And the reason is because it is so people dependent. Entrepreneurs typically want Person XYZ to be on their board and if that person moved to another VC fund they would still want Person XYZ on their board. So you rent a brand for a period of time like you borrow a car.
Can you imagine saying “I was going to by salesforce for my CRM system but this really great sales rep just moved over to PipeDrive so I am picking them”? No.
You can try to make your VC firm into an Iron Man suit that anyone can step inside and become a great VC. That doesn’t work really well. It takes a decade of training.
There are ways we can become more ambitious and I am working on those. The greatest thing this industry has ever done is not AngelList. It is YC. And YC is responsible for a huge percentage of Sequoia’s big outcomes.
The other issue is that if you want multiple superstar dealmakers in the same firm you are going to end up with mgmt. by committee. The reason is that most of these people are rich enough to do their own thing and don’t want to work for someone else. Take for instance Benchmark where every partner except for Sarah Tavel is a billionaire. The partners don’t even live in the same city (and not clear if they like each other), but they still win great deals.
The firms who have invested a lot into platform like First Round Capital (FRC) and A16Z are very interesting to me, but I think if you take Josh Kopelman out of FRC that investment goes to $0.
To be honest, I don’t find your argument convincing, straw man or not. Yes, the “venture capitalist” may not heed the advice his gives others. However, its seems to me that the VC is in an inherently different business than the ones in whom he might typically invest or dispense advice. It is a professional discipline, with its own scale limitations, operating structure, required expertise, judgments, etc. Is it really practical to capture market share? Isn’t that a prescription for disaster in venture capital? Where would the “savings” of low cost structure be invested – is there really a need for such systems investment that is currently starved or is this inherently a business of human judgment and manual labor? Thus, the same wisdom/bromides that might apply to an operating enterprise (one CEO, low salary, capture market share, etc) simply do not generally apply by my observation to the VC environment. This can be true even if the VC has a certain parochial interest in preserving the status quo – if he is doing well.
I’d love to see more strategy innovation from VCs. To be fair, there are way more very specialized VC firms than ever before. Sector-focused funds (e.g. supply chain, robotics, retail, etc.) didn’t exist 10 years ago, and non-generalists were rare. That said, you’d expect even more specialization. I think large LPs support conservatism as they gravitate toward strategies where they’ve made money, which are those in use 10+ years ago. Another reason why capital has been slow to diffuse out of Silicon Valley as well, IMO.
On having one CEO:
this is an interesting point. Small funds often do have one de facto decision maker who owns the majority of the mgmt. co. / votes for the majority of the managing membership, but it’s the minority case. So why partnerships? I think because, first, VC funds are much more singularly focused on one activity: investing in the right companies. This function is just stronger with multiple people—if one person had the final call there’d be no real diversity of thought or ability to challenge a decision. I believe a group keeps the decision making process honest, rigorous, and better-informed. Second, there are fewer critical day to day operational calls in running a VC fund. Yes, hiring is just as important, and there’s fund admin, capital strategy, marketing, portfolio support, etc. But often either these are decided upfront, outsourced, or executives are hired to oversee those functions. Third, and finally, to the extent funds take them, the GPs themselves sit on boards—there are only so many boards one GP can handle. Between the last two points, there wouldn’t be much difference in terms of work, responsibility, or required skills between a “CEO” GP and another GP.
On deferred compensation:
Overall, you’re right in that mature funds get more of their aggregate comp in fees than they’d generally advertise. Especially with large-AUM funds, the model can look more like asset mgmt. than anything else. That said, emerging managers usually do spend a lot of those fees on operations. In our first fund, we took relatively low salaries because we needed that cash for travel, an associate, events, legal, etc. (though admittedly not as low as a very early stage startup founder). Fund stacking is what changes the game—a firm that raises a $50m fund I then a $50m fund II after 3 years will generally be making $1-1.25m in Y1-3, but then $2-2.5m in Y4-5. Probably more board seats but still 2x the cash for the same investment pace. On one hand, I do think you need strong salaries for strong talent—venture returns are highly volatile even amongst great firms, venture fund lifetimes are long, and strong young talent needs a certain level of income consistency to be incentivized. On the other hand, like everyone else, GPs will take what the market gives them, and demand for alternatives (VC especially) is historically high.
On market dominance:
Couldn’t agree with you more here. With the rise in portfolio support / platform (a la A16Z, OpenView) and data strategies (a la Correlation, Signal Fire) in VC, I feel this is one area that innovation and competitiveness has actually forced the industry to evolve and give up on margin a bit, to the benefit of founders (and ostensibly LPs). But the built-in resistance to truly disruptive operational spending due to the fee structure is blatant. To be fair, ROI on some of this stuff isn’t obvious. But at the very least, I’d expect to see more creative new investment theses / strategies by now.
On lavish spending:
The budget dollars a CEO doesn’t spend go back into the business as retained earnings. The fee dollars a GP doesn’t spend go into his / her pocket. Those fee streams are owned by them (the management co owners anyway) and LPs don’t even generally see the operating vs. take-home breakout. So lavish spending doesn’t really benefit GPs per se. If there’s a gripe here it should probably be with the fee structure.
Long-term focus:
Agree 100%. Effective succession is rare in VC and turnover of which firms are “best” is really high. There’s little incentive for an old, semi-active fund founder to give up carry, even if it means the funds performance atrophies—if fund dies with them, that’s no skin off their backs. Especially in small funds, key man risk is insane, though the prevalence of partnerships helps. It’s astounding to me how little LPs seem to care about this stuff.
On governance:
I agree. LPs do have a strong effective say in what younger firms do / don’t do because they need that capital for future funds. But investing, VC included, still very much operates on the “great man theory,” for better or worse. There are benefits, but on the “worse” side, I think the number of scandals, lack of diversity, prevalence of toxic personalities, employment lawsuits, etc. that occur in the industry speak to that.
On going public:
I think it’s fair to say the main reason companies go public is to provide liquidity to its investors / shareholders. Investment funds don’t need that to create liquidity. I’m also not sure the financial profile of the vast majority of funds would be palatable to the public markets. Public investment funds like Apollo, KKR or Blackstone, are generally 10-50x the size of the largest VC funds, and much more diversified. Who knows though—down the road, if the Vision Fund model takes hold, that could change.
On acquisitions:
I think it’s fair to say the main reason companies go public is to provide liquidity to its investors / shareholders. Investment funds don’t need that to create liquidity. I’m also not sure the financial profile of the vast majority of funds would be palatable to the public markets. Public investment funds like Apollo, KKR or Blackstone, are generally 10-50x the size of the largest VC funds, and much more diversified. Who knows though—down the road, if the Vision Fund model takes hold, that could change.
Haha. I like it. If we ever see a VC firm seeking venture capital itself, we’ll know that there’s no-one left who gets the joke.
I read the article. It’s definitely provocative and a question I have asked often. The answers are much more nuanced. VC is not a scalable business and is probably not a great business relative to PE. And so I don’t see if as a question of ambition and more structural.
This is a good article. When we move to establish dominant market share, rather than treat it as a conquer everything challenge (like perhaps a16z did), we go really deep in a few more narrow areas and get to know them and have better connections to the leaders in them than other funds / build personal relationships with all the key ppl. I hesitate to write about it too much other than to discuss with my LPs since it works very well for us – although maybe we should do a little more noise on places where we are doing very well.
We agree on the one CEO, lower salary / high upside, investing in market dominance w advisors we take on and expenses for all our industry-specific conferences etc.
I haven’t thought about going public – for PE and others I have not seen it help the culture and for now I think it would be a distraction. And while we have been expansive about who to bring on, I haven’t done any acquisitions – for some of my companies they can be strategic but for others they don’t make sense. For us, I’m not sure an acquisition would make any sense except perhaps to branch into a whole new area at some point maybe, but not for now.
I also think you’re right as you note in here that showing too much big ambition isn’t ideal – you want to have time for ppl and to be careful what you are signaling to founders as it needs to be more about them. Which also changes how one discusses these things.
The model is clearly changing, but will take another recession to filter out the wheat from the chaff.
The two contra observations, from the summary points, that jump out :
1 I would not put private equity into the category of taking low salaries. Arguably the highest current comp for any profession on the planet
2 I ( and many other VCs) certainly have never argued that being public is a very good thing for the long-term. I actually think that being private for the long-term is better. But as an investor, I do want to liquidity in one form or another !
For many of the successful firms, e.g. Benchmark, Sequoia, Accel, etc. I believe the reason is that they are successful in their mission which is to deliver great returns to their LPs, which is the ultimate goal of a VC, and that they don’t believe they can do that as well with a different model. That is certainly the case with us where we have debated all the new models that have emerged. I haven’t seen YC’s returns, but in their absence, it’s not clear to me that the scalable investment models (e.g. YC) can deliver the kinds of returns that a smaller non-scalable fund can deliver.
i agree almost all of your points that VC would be a more equitable and potentially more successful industry if it were run more like VC-backed companies.
I would say that having one (or two) CEO’s can sometimes be good and can sometimes be quite bad. When too much power/carry/control is concentrated in 1 or 2 partners – this can limit the independence of the other non-CEO partners when choosing deals. I think the Benchmark model of all equal partners may be better for objective and unbiased decision-making. Government works best when there are multiple branches with checks and balances on each other, and truly benevolent dictators are hard to find. the saying “power corrupts” is a truism that applies to VC too. for VC funds/firms there is no board of directors as there is in companies to provide that check and LP advisory boards and LPs (the erstwhile shareholders) have no power unless someone commits a felony or the key person provision is triggered by departures. VCs may be more like management consultancies or law firm partnerships – which are set up to pay out profits at the end of the year, rather than build out product lines and equity in a company – except that VCs don’t pay out profits at the end of the year, they pay it out at the end of a 10-15 year fund. And layer-in the management fees from several dovetailed funds, the long tail of these management fees (often still large fees in years 8-13) is kind of obscene.
Great observation. A few additional observations I’ve had, for what it’s worth:
* VC’s look at making an investment as a success. They spend the lion’s share of their time sourcing deals so naturally feel a sense of accomplishment on making an investment. At a PE firm, there’s far less emphasis put on the investment as a celebratory milestone. PE firms are more firmly focused on a path to exit, which includes detailed planning and understanding contingencies. In short, the work has only just begun when PE firms invests.
* PE teams live in the trenches with their management teams. PE teams are an extension of the management team helping to make connections to potential customers, identify acquisitions, hire talent, etc… While I’m sure this is also true of some VCs, in my experience VCs are more likely to take a hands off approach.
* VC and PE firms will both say they focus on management talent as a key to investing success. However, PE firms are much better at building networks of executive talent to populate key positions within their investments. And, the PE firms will move much quicker to change management when an investment is under performing. VCs don’t have the same flexibility being in a minority position on the cap table, but I think VC firms could benefit from more formal management development process and management bench management.
Interesting piece. Not sure the comparison makes a ton of sense though – PE is usually pretty different in lots of respects (VCs don’t tend to do company buyouts and PE funds don’t tend to lead Series A deals as far as I know as an example). There are some interesting folks that have successfully done both – Insight Venture Partners comes to mind.
In terms of the difference between investing and operating (as that’s also in essence part of your comparison), I’d point out that investors are more similar to coaches and operators or entrepreneurs are similar to players. You need both players and coaches to be successful in most sports and most companies. They just play fundamentally different functions. For what it’s worh, in my experience people tend to gravitate to being a player or a coach. You either want the ball and to make the play yourself or you want to put the right people on the field or court to be successful and that’s where you get excited. It may be why the most successful investors (and coaches) tend not to be players and the most successful entrepreneurs (and players) tend not to be as good at coaching (or investing).
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Most VC firms are focused on short term gains rather than everlasting market dominance. It is for this reason that some of the best VC firms from the 2000s are no longer around today. There are very few VC funds that have been able to reinvent themselves and expand their reach as the tech industry shifts. Traditional VC is primed for being disrupted. Network Effects models, such as Y Combinator and Entrepreneur first, are much more ambitious than traditional firms.
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It is a good blog with full information about venture capitalization. I read your full blog and yes, venture capital has to ask for investment so it is kind of less ambitious. Anyways thanks for the blog. It will help many people who are searching for venture capital.
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