As Populist as it May Feel, 98% of VCs Aren’t Dumb

By now you will likely have read Andy Dunn’s scathing post about Venture Capitalists in which he decries the industry’s masses.

I read Andy’s post with a knowing smile on my face. After all, I am no stranger to the publicly expressing the frustrations of dealing with the downside of this industry as I wrote about in 2006 when I was an entrepreneur.

But VC is like congress. It’s easy to hate it en masse yet many people love their local congressman.

Why?

Because they know him or her. They see how hard she does her job. They know her personally and know she cares about her constituencies even if she has to make tough trade-offs from time-to-time.

In the original version of his post, Andy writes

“This essay is dedicated to the great VC’s on my board who I am lucky to work with: Sameer Gandhi from Accel, Jeremy Liew from Lightspeed, and Kirsten Green from Forerunner.

I rest my case. “Hate the industry, Love my local guy.”

But many of the assertions in his post – while populist – aren’t exactly how things are in reality. So I thought I’d have my hand at a friendly counter point.

After all, I understand’s Andy’s frustrations with the industry.

And yours as well. I have felt them myself.

I wrote Andy first to be sure he wouldn’t be offended if I did. Luckily Andy is good natured

So let’s look at the main assertions

1. The industry is dying, except for the top 2%

“I don’t know the exact math, but I hear it again and again: the top 2% of firms generate 98% of the returns in venture capital.”

Unfortunately the first part of that statement is true. The second is not.

The top 2% do not drive 98% of the returns.

I have seen many slices of the data. The quickest I could find was from PitchBook. As you can see from the chart their data suggests there are about $25 billion of VC distributions per year in the US.

According to FLAG Capital there are 100 active VCs (as defined by making at least $1 million in VC per quarter for 4 consecutive quarters).

Their data looks at tech VCs. So for argument’s sake let’s triple the number of active VCs and call it 300.

 That would mean 6 firms drive $24.5 billion in returns.

Not even close to the case.

Most top tier VCs return about 3x invested capital and outlier funds (the best of a vintage) might return 6-8x. It’s true this was much bigger in the dot com era but I’ve studied the data and know that over the past decade these numbers are right.

So if you take 6 very strong performing firms of $250 million and assume they do 5x each that is $1.25 billion each, $7.5 billion in total or 30% of the industry returns.

But Mark, many of the great firms are $500 million and up! If you double your number that would mean 60% of industry returns. Not too shabby!

Yeah, true. But the larger funds usually have lower returns because they are often investing bigger dollars at later stages with less risk and therefore lower returns.

As you can see in this Cambridge Associates data, early-stage investing beat later stage investing in returns in 70% of the past 30 years.

It is true that every few years a fund exits that delivers smashing results because it has Facebook, Google or Twitter in it. But as an LP you can’t count on that any more than VCs can. You invest across many funds just as VCs invest across many companies.

The better way to think about VC returns is, do the firms consistently beat alternative asset clases on an IRR basis to adjust for the increased risk and lack of liquidity?

Here the data is not always kind to VCs.

But the top 25% do consistently beat the alternatives. The problem is the illiquidity because investors are often locked in for 7-10 years. The goal of an LP is to get into the top decile. But picking today’s top 10 does not pick the next year’s 10.

Take for example Accel. When it went to raise its fund 10 years ago the rumor was that many LPs were disappointed with recent returns and did not re-up. Yet their next fund had Facebook in it. Doh.

And I believe that Accel has consistently shown its ability to be in the top decile in the last decade.

But the funds that every LP wishes they were in – USV & First Round Capital – not to mention Foundry Group, Spark Capital, Floodgate, True Ventures and others either didn’t exist 10 years ago or were just sprouting. Neither did Andreessen Horowitz.

So the reality is that yesterday’s winners are no guarantee of tomorrow’s success and today’s emerging managers might just be tomorrow’s best investors.

The industry isn’t dying. It is changing. And reinventing itself. And some firms will go under. And others will emerge. That’s normal. It’s  a market, after all.

In 2000 our industry had more than $100 billion in LP money. By 2009 had reduced to around $15 billion in capital from LPs. In 2013 it is expected to be around $35 billion.

Not. Dying.

Why?

Compare the state of play in 2013 versus 15 years ago. 33% of the world is on the Internet on average of 3.1 hours / day. There are 138 million smart phones in the US alone and … wait … 99 million tablets. Insane.

2008 App ecosystem on iOS = $0. 2013 = $25 billion of which Apples stage is more than $8 billion at > 90% gross margin. Credit cards = less friction = more purchases = cha ching.

2. The best VCs don’t try to help entrepreneurs

I’ll admit that I do know one VC firm who’s strategy is not to call their entrepreneurs and not to be involved in operations. But I seriously only know one. They believe that stock picking is the most important function they can play. They are also less than 10 years old.

But the people whom I consider best in this industry are quite helpful indeed.

Let’s look at some great companies.

Facebook. Is it right that VCs had no involvement in persuading Sheryl Sandberg to join the fledgling company? Not according to my sources.

Google. If you read Ken Auletta’s piece it makes it clear there was active VCs involvement in the early days. It led to hiring Eric Schmidt. And Coach Campbell. And to finally admitting that ads weren’t evil so that Google could copy the model of the fast growing Overture.

Twitter. There have been a lot of management shuffles at Twitter. But in my mind there is no doubt that placing Dick Costolo at Twitter was the most positive thing Twitter has done to become a long-term success. Hard to imagine that Dick joined “organically” or that his becoming CEO also was organic. My guess is both had heavy VC involvement.

Amazon. I’ve heard directly from top executives that Jeff Bezos (in my opinion the most talented person in the tech industry) has received his fair share of VC coaching in the early years

Tumblr. Nothing was more heart warming than the photo of David Karp hugging Bijan Sabet after the sale to Yahoo! And hard for me to imagine the Fred Wilson and Albert Wenger weren’t instrumental mentors to David.

After all, many people love their VCs but hate the industry.

According to Andy

Dear Dumb VC, it’s so painful to sit in meetings with you and hear your vision for what the company should do and what’s going to happen in the industry. Just so you know, Dumb VC, the top 2% never do this. They’re too busy using their superb judgment getting into great deals and bowing out graciously from the ones they don’t want to back.

Not in my experience, Andy.

The best VCs I know take 11pm conference calls. Meet with their teams on weekends. Broker critical introductions since entrepreneurs are often younger & newer to industry whereas the best VCs often have great contacts across decades and many deals.

In my mind, the best VCs actually deliver outsized returns by “leaning on the scale” not by “deal sourcing.”

I had dinner last week with somebody you would consider one of the best known names in our industry. I asked him what he’s learned as a VC. He said,

“I prefer to do Enterprise A rounds and Consumer B rounds. On the enterprise side, I know every buyer of technology in this industry. So I can make a huge difference in the company’s trajectory. And I’ll know in 18 months whether we have product / market fit. But we can have a huge impact on that. With consumer deals you can’t manufacture consumption. So I prefer to watch what works first and pay a higher price to get in when it’s proven.”

This rang true with me. Great VCs create the fabric of their success by backing the best entrepreneurs they have access to and then helping them to lean on the scales.

This happens at acquisition time, too. The best VCs know the buyers and can help guide and manage the process.

3. VCs Spend Too Much Time Deciding

Yes. This one is probably true. And for a good reason. Even though I know this sucks when you’re an entrepreneur and just want the money deposited tomorrow so you can get back to running your businesses.

Many entrepreneurs come by with great pitches and say, “I’m hoping to have term sheets in the next 30 days.”

If this happens to you as a VC – you’re too late to the deal. Shame on you. Get to the entrepreneurs earlier next time.

If you don’t really know the entrepreneur through many meetings, debates and encounters – it’s really a crap shoot the fund them.

That’s why I wrote this.

Per Andy,

“I should be building the company, you should be deciding quickly whether to invest or not.”

If anything a “Dumb VC” would decide quickly without knowing the entrepreneur. In my opinion Dumb VCs are too worried about being in “hot” deals so they chase the hottest new trend, the fanciest, best known entrepreneur or the party round that has so many other great names attached to it that they feel they can’t miss this one.

The unfortunate reality is the most partners at VCs firms see hundres of deals every year and invest in 1-2 of them. After 6-7 years they therefore have 7-10 board seats, which is about all most VCs can effectively manage.

A priori many deals look attractive.

Post hoc it’s obvious who the winners were.

Ask any VC who’s been in the industry 10-20 years and they’ll tell you that often those that looked the best when they wrote the check didn’t turn out to be the best. And vice versa.

So caveat emptor to those that feel rushed into deals.

Some of the most bizarre sounding deals end up being huge winners. Some of the most obvious companies and talented entrepreneurs end up not working or burning through too much capital.

VCs are wise to go slowly.

Even though that may not be what entrepreneurs want.

4. VCs shouldn’t call their entrepreneurs once they invest

“Dear Dumb VC, now that you’ve invested, leave me alone! Did you know that the 2% never call their entrepreneurs?”

I’ll just leave it to entrepreneurs to decide on their own on this one.

I call often. So I must be dumb, I guess.

My view … it is my job to be a sparring partner. I want to challenge the founders view.

Why?

Because being an entrepreneur is a lonely job. You have to make tough decisions with few inputs and little history from which to base your decisions. CEOs can rarely express their uncertainty and doubt to others.

So the VC’s job is to challenge. Cajole. Debate. Offer contrasting views. Play Devil’s Advocate.

And then step back.

And let the entrepreneur decide the course of action. Even if it is different than what you would have decided.

Fred Wilson talks about this in his post about Tumblr.

I seriously know exactly one VC whose policy is not to call their entrepreneurs. One.

5. VCs often don’t use the products of the companies in which they invest

Agree whole heartedly. I never understood investing in companies in which you didn’t really understand their products.

I blog. I create videos. I use analytics. I use social media. I IM and DM and SMS. I Instagram, Cinemagram and Path. I Quora. I Trello and Salesforce and DropBox and 500px.

I try to live a “day in the life of” the users.

It’s hard for me to imagine investing in companies in which you don’t use and understand the products and markets.

6. VCs should never be late

Hard to argue with this. Nobody should really ever be late to meetings because it’s disrespectful of other people’s times.

But I’d be lying if I didn’t say I wasn’t habitually late. But I have been since I was a kid. No excuse, but it turns out to be one of the most common traits of people with ADD as I found out when I read Delivered from Distraction.

I wish I were better. I struggle. I try to make it up with humor, kindness, apologies and by giving more time at the end of the meeting.

Many VCs are in fact late. Many entrepreneurs are, too. So are corporate executives.

I have found that being on time versus being late is a personality trait more than a power play.

What I hate more than anything is when people are late and then cut meetings off early. If an entrepreneur was told they have 45 minutes they should get 45 minutes.

In a perfect world everybody would be on time. In reality, that is seldom the case.

The best entrepreneurs don’t get too worked up about this. They understand that it just is. It’s hard for me to imagine that an entrepreneur who was waiting to see the CEO of their largest potential customer would leave if that customer were 20 minutes late. You might be bummed, but you’d bite your lip.

So what I’m really hearing is, “VCs piss me off. So when they’re late the piss me off even more.”

Fair enough.

I pitch a lot of LPs. I have to raise money, too. Many are late. Many don’t return my emails on time. Many don’t commit when I want them to.

I have walked a mile in their shoes so I’m a lot more tolerant about it these days than I used to be.

7. You suck if you don’t have 2+ $1 billion exits.

Ergo I suck.

I work with partners who have seen 15 such exits. My partner Yves will have 3 in our last fund alone and possibly 4.

Me?

Zero.

But I became a VC in 2007 and wrote my first check in 2009 – 4.5 years ago.

So $1 billion exit is unrealistic for me.

And as John Doerr has noted, “your lemons ripen early” so I like to say that if I had a ton of exits it would be because I haven’t done my job as well as I would have liked.

Most great companies start to really shine in years 7-10.

I believe I have some great investments. And some that are proving more challenging. And if you call any founder I’ve backed – good and bad – they’ll tell you I don’t quit easily. I’m on their side good times and bad.

I am seeing some companies like Maker Studios and DataSift where the growth has been faster and more impressive than any companies I ran. And while all companies have challenges – I am inspired by their progress to date.

In Summary

I was an entrepreneur previously. I know the frustrations.

I am now a VC. Not yet for as long as I was an entrepreneur.

I spend significant amounts of time with VCs now that I have gone to the Dark Side. I have more empathy than I once did.

I see the hours and hard work put in by my peers. I see how much time they spend on the road away from their families. I see them on conf calls at any hour – even from vacation.

It’s hard being an entrepreneur and making money.

It’s hard being a VC and making money.

In reality neither side is evil.

It always reminds me of my time as a CEO. Everybody always thinks they can do your job because they’re doing the hard work while you get to fly off to conference, speak with the press, go to fancy board meetings & dinners. They think it’s easy – until they have to do it.

VC is a bit like that, too.

From one of you. Now on the other side of the table.

BTW,

I think a more humorous attack our industry’s behavior was done by this hilarious video done by my friend Dorrian on YouTube recently

 

Dunce photo by PaperDoll Dreams on DeviantArt