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Venture Company

• Redefining Capital Efficiency 7 May, 2010, 8:26 am
  By Georges van Hoegaerden[This article is a further expansion on the subject of Capital Efficiency of our article from one year ago, named "The trap of Capital Efficiency"]I cannot tell you how many times I still hear Venture Capitalists (VCs) mention how they look for and "create" capital efficient companies, and how masterfully they continue to sell that "strategy" to their Limited Partners (LPs) as a viable investment thesis. Those LPs subsequently must believe that they are now investing in a unique class of companies only they have access to (otherwise why is the mention of the specific denomination relevant), and instead of clambering to the old world of capital-inefficient companies, now have the opportunity to prance around in the formation of new, and sexy capital-efficient companies. Sounds good, doesn't it? Perhaps for those not seeing through the tactics of the spin-doctors.Let's dissect "capital efficiency" as deployed by most VCs:First, putting less money into companies, or selecting innovation that supposedly needs less money is a strategy deployed in the last 10 years that has proven not to work. 790 VC firm investors who make - say - two investments per year on average (low ball), produced no more than a handful of IPOs and no more than 10% IRR over the last ten years, is no testament that an attachment to the "capital efficiency" category carries any special value. With our economy now also in dire straits, the chances of capital efficiency bearing fruit has diminished even further. Second, with a fully loaded commitment from LPs the last ten years, VCs who look for capital efficient deals are dramatically fragmenting investment commitments by having to invest in more companies (to put the full capacity of the fund to work), and conversely increase the investment risk at a time when performance of the sector is already shaky. So the supposed capital efficiency of a startup, with uncalibrated VC fund sizing is actually capital inefficient to LPs. Third, the cost of acquiring a customer on the Internet has not dramatically changed over the years (if not increased), and so to lower the input into early stage technology companies disproportionate to the dynamics of their output does not only make no economical sense, it again increases the risk of success, opposite of what capital efficiency attempts to promise.Fourth, Internet technology companies deploy the same rudimentary economics to their customers as old-school companies, they are just using a low threshold (often immature) and a more immediate distribution channel (the Internet). But that immediacy combined with a little bit of money needed to enter into distribution significantly increases competition that in the end favors only those companies that provide relevant social economic value to its customers. And so not the lowest cost-to-entry defines the value of the company, but the quality of service it delivers to its customers. And quality of service is adversely affected by the improper implementation of capital efficiency and thus the reason why the current implementation of capital efficiency in venture capital is incompatible with building real value and public market trust (and therefor reliable IPOs). Fifth, capital efficiency as deployed by many VCs today, forces startup companies to build technology first. Yet the gating technology proposition offers no indication that the company will ever achieve macro-economic value that has the potential to outshine competition for the next seven years or more. For example, building winner-takes-all marketplaces (such as iTunes, eBay etc.) requires a minimal investment incompatible with the capital efficient VC model, and as such we have not seen any since the popularity of the flawed implementation of that model. Sixth, technology development is not the risk of a technology company, the application of the appropriate technology to a marketplace is. So, while it may have become slightly cheaper to develop a single line of code these days (I would argue that too), the amount of code needed to make a difference in a highly competitive market, forces companies to make more meaningful and robust products, which requires the deployment of a larger workforce with a cost that hasn't seen any significant reduction. So, just like in any production business, the people-cost is the most predominant factor of the success of the company, not the expense of technology it deploys. So, yes, capital efficiency the way it is deployed by the demi-cartel of VCs is a big fat lie, that has not and will not deliver. The ultimate subprime VC lieDon't get me wrong, capital efficiency is a prudent way to build any company. But the way most VCs confuse capital efficiency lies in the difference between inexpensive and cheap. The way most VCs implement capital efficiency is cheap and lowers a company's ability to grow up, and makes it more difficult for the company to move from the left side of the chasm (Geoffrey Moore) to the right side, where massive user adoption awaits. The currently popular deployment of capital efficiency spoon-feeds money to startups, which in most cases means the company cannot hire the much needed specialized expertise to turn it from a technology play into a real company early. Many startups can simply not hire a visionary CEO who protects their macro-economic agenda (and returns), and ensures the company remains owner-run (also favored by Warren Buffet) rather than investor-run. That means technology developers without sufficient business experience now run the asylum as inmates of the "investor prison", doomed to make the early mistakes that dilutes founding ownership and therefor - again - increases risk. So, capital efficiency deployed by subprime VCs is a foolish prophecy. Any VC who uses the phrase capital efficiency as a sector differentiation has no clue what he is talking about. For me, having seen all sides of the venture equation, capital efficiency is the ultimate VC bullshit detector; it communicates they understand nothing about economics, investment risk, innovation, the workings of the technology sector, and business in general.Capital efficiency today is implemented as downside protection by subprime VCs who look at venture investing as a commodity, and signals how they themselves therefor have become a commodity (and do not belong to operate in Venture Capital). Capital efficiency should drive upsideReal capital efficiency in venture capital is defined by the cost to produce upside, as opposed to the cost to protect downside. Most companies become extremely capital efficient once they establish beforehand what the operating plan of the business looks like in detail, and as such plausibly define how they need to be "lubed up" to run as efficiently as possible to achieve upside early. Contrary to popular Silicon Valley belief, technology does not create markets but has - at best - proven to support macro-economic and marketplace behavior that existed for many years. And real capital efficiency is easily achieved by identifying the behaviors that can be more efficiently supported or displaced with the help of technology as content and the internet as distribution. The selection of which marketplace (that is in timely need of efficiency) you pick as an investor determines how capital efficient an individual investment can be.Capital efficiency, therefor is not a sector strategy, but a way of picking individual companies that have the potential to create extreme and timely upside. So, from now on dear LP and entrepreneur, when you hear a VC mention capital efficiency, run the other way.
• The first 48 hours, my iPad review 3 May, 2010, 12:53 pm
  By Georges van HoegaerdenI read a lot of iPad reviews before I found myself waiting in line to get a shiny new 3G iPad from the Apple Store last friday. Because WiFi is simply not pervasive (albeit more pervasive where I roam on the east coast than on the west coast, surprisingly I found even gas stations in North Carolina having free WiFi), the iPad without 3G is perhaps best suited for children who need a somewhat controlled access to the internet and for many of us who use their mobile device connected to the Internet primarily from home (according to a pre-iPad market study I recall). From the many other reviews (including Walt Mossberg's valuable assessment) you can read about the early experiences with this great new device. I agree with most of Walt's assessment but wanted to offer some complimentary considerations (from a demanding early stage entrepreneur, Venture Catalyst, Venture Capitalist and Venture Economist) I did not see. The iPad is a beautiful, easy to use computer that will serve the lifestyle, internet and computing needs of most people. You should get one at your earliest opportunity. If you travel frequently, the iPad 3G is so well equipped and easy to use, you can actually peacefully leave your main computer at home. Even novice users will suddenly have the world at their fingertips.Here are my remarks to make the iPad even better:StrategicallyThe requirement to tether the iPad for the first time to a regular computer and activate it through iTunes is beyond a lawsuit waiting to happen (it does not state such requirement on the box), not the right strategy for consumer adoption of the iPad. The iPad is a device that is likely to appeal to 5/6th of greenfield of the world's population that is not using a computer capable of running iTunes, and bound to find itself limited in market penetration by the tethered activation requirement. Apple should aggressively offer in-store and cloud based activation to combat this issue.PositioningNow, Apple is often referred to as a great marketing company, in my view because they don't do any positioning at all. Most of Apple's products are described by virtue of their beauty and their capabilities and just like with finding a woman with those attributes; you know instinctively when you want to be with her. Most other technology vendors still foolishly deploy expensive marketing departments to preempt who its buyers may be, and Apple merely states what the device does (in terms of benefits), the number one thing I find myself explaining to interested onlookers is that the iPad is a (lifestyle) computer, not just an iPhone Touch with a bigger screen. The iPad, also by virtue of which software capabilities are included (see below) suffers from a bit of public confusion and identity crisis, as witnessed by the complete lack of built-in printing capabilities.HardwareThe shape of the iPad is perfect for a handheld device, yet the 3G is big enough to make you want to rest it on your lap or elsewhere and tap around with both hands. My 5-year old daughter with smaller hands juggles with the weight and requirement to move the iPad around while playing games, yet not enough to keep her hands off my iPad.- The volume buttonThe volume button on the iPhone and iPad irritates me to no end, not where it is placed but which part of the rocker is volume up or down. Given that the iPad can be used in many orientations I would make the volume up and down switch sensitive to the context of the orientation. Meaning, no matter how you hold the iPad, the volume up and down coincides in direction with the visual clues on the display.- The home buttonThe home button is visually undetectable in the dark, and can be left, right, up or down depending on the orientation of use. This button needs a slight backlit to identify itself under low-lit and dark conditions.- Back curvatureOn a completely flat surface such as a desk or kitchen counter the iPad has a tendency to spin around easily, especially when typing hands-free. A slightly less curved back, with more surface area touching the underlying surface would improve resistance and offer more stable usage. - SpeakersThe current speaker position, (on one side only) leads to frequent muffling and diminished volume and clarity of sound when holding the iPad in landscape orientation when hands are prone to cover up the speaker slots. This needs a different implementation, perhaps dual mono sound asymmetric to the orientation of the device. - DisplayThe display, even though made from a special material smudges easily which when viewed from an angle and will make the owner look like a dirty animal. I am not an expert in display technologies to offer a solution, and these fingerprints are hardly noticeable to the user with a straight-on view of the device.- The BaseThe docking base for the iPad (sold separately) only supports a portrait display of the iPad while docked, not the most natural way to view widescreen videos nor the default orientation of the majority of photographs while charging.- TouchIt is probably a software modification, but I found the iPad sometimes responding to fingers not fully out of the way of the touchpad causing some unexpected behavior. Some of those fingers do not need to touch the iPad, I found out, to cause an in-adverted detection and operation. SoftwareApple is clearly ahead of the pack in delivering a compelling lifestyle computing device we can all use and therefor will catch most of the wind in addressing the imperfections of the software provided. That does not mean I suggest you should not buy the device, but it does mean Apple has room to improve with software updates that make the iPad better. I can tell (and know) that Apple is developing the software in corporate divisions with their own disparate decision making. As the first vendor to provide truly integrated desktop, mobile and cloud computing services Apple needs to reorganize itself amongst the development of IP (Intellectual Property) that spans those boundaries. No longer is the power of one capability on one platform important, but the lowest common denominator now defines the overall experience.- Portable capabilitiesWith much of development efforts at Apple focused on newer devices such as the iPhone and iPad, the lack of development efforts on its OS X companions are affecting the (synchronized) reliability of data on the new devices. With the release of Snow Leopard (OS X 10.6) Apple has really dropped the ball on the stability of the address book, iCal, e-mail and others that affect the use of all devices in concert. With the latest release Apple changed the way it deals with address book imports, how it deals with duplicate contacts, how it syncs address book images etc, to the extent that you need to verify and make frequent backups of every part of the process to prevent unexpected behavior.- MobileMeMobileMe is a necessity to synchronize over-the-air many of the e-mail interaction, contact, calendar and notes to keep your information up-to-date at all times, and you should therefor subscribe to it (a $99 / year charge). But it took me two months to figure out how to use MobileMe for my business without showing that the e-mails I sent were coming from MobileMe (a long story). Every business owner who wants to take maximum advantage of the iPad and iPhone capabilities is in the same predicament. The cloud services provided by Google's gmail finally came to the rescue. But it does worry me that to get and send e-mail using MobileMe a la BlackBerry demands the proper workings of no less than four e-mail servers. The same with calendar sharing where Google cloud services trump those of MobileMe, and for the first time my wife and I can now share a social calendar (using CalDAV) to which we both can add, edit and delete from the same calendar whenever we wish. These everyday capabilities should be supported by MobileMe monolithically by now, but are not. Also, MobileMe's iDisk and Gallery applications are not (yet) natively available on the iPad and users need to use the iPhone derivatives to continue to use those features. I am expecting a beautiful new Remote application from Apple soon, that allows me to control the Apple TV in wonderful glory.- AppStoreThe Application Store (for the iPad) is supposed to support The Long Tail of applications plus the Torso yet it provides no intelligence (yet) to figure out what based on your interest is the best selection of apps available. That means you need to scroll tediously through thousands of apps icons only to have to start over once you installed one of them from that list (as the store does not remember your last position prior to install). That means you give up exploring the Long Tail of applications pretty fast, and the meritocracy the marketplace (and thus opportunity for app vendors) the AppStore intended to provide is severely diminished. And while iTunes bravely installs all previously installed compatible iPhone apps on the iPad, the AppStore makes no attempt to then upgrade the Apps (read upsell opportunity) to its iPad native companion. So, it takes hours perusing the AppStore to figure out which of your favorite App has a more capable iPad cousin. I found myself abandoning iPhone apps and instead bookmarking their respective webpages with an icon on the home-screen.It is also a bit of an embarrassment for AT&T not to have a iPad native iPhone account management app that also incorporates managing the 3G iPad subscription service. - DictionaryWhen entering text the iPad prefers to use capitalization in some weird places, insert spaces at other times (without "suggesting" it first) and in e-mail actually changed the from-address descriptor from "The Venture Company" to "The Company". It appears the dictionary used in the iPhone is more robust than the one used in the iPad.- iWorkAs a long-time iWork user (for most of my work) iWork on the iPad is a big disappointment. I was hoping to use my iPad as the device I could take to Limited Partners and present my now famous "2010: The State of Venture Capital", but I quickly found out that iWork on the iPad is not compatible (in many ways, it imports rather than opens OS X documents) with the version that runs on OS X. As stated before, parity of software capabilities between platforms should be of new importance to Apple as that will prevent people from re-evaluating other options. iWork (KeyNote, Pages and Numbers) are fantastically powerful apps on OS X, and in its infancy on the iPad. Novice users can still have fun with iWork on the iPad.- MailE-mail on the iPad looks and behaves stellar, yet with a few quirks. It appears impossible to change the reply-to address, notes are not synced over-the-air by default, regular IMAP e-mail is pull only and you cannot set a polling frequency. Some e-mails (such as private equity online) previewed incorrectly, the rendering engine must be different from on OS X, where it showed up correctly. Some Word documents could not be opened in Mail, not even with the version of Pages (and part of iWork on the iPad). I hate the horizontal scrolling while you reply to an e-mail, making it impossible to review what you wrote in place.- CalendarThe Calendar views are visually stunning and well laid out. But some of its functionality bothered me. One cannot change the calendar of an appointment after it has been created. I could not find an option to display the time in the week view (as on OS X), nor could I find a way to accept a Microsoft Outlook invite which it entered correctly in the Calendar. - BrowserA version of Safari runs well on the iPad, but I miss a few capabilities including a pinning of favorite pages (as available on OS X). Some documents, including v-cards (address book information from LinkedIn for example) do not load into the appropriate application (address book in this case). Some of the new social call-backs designed to integrate social capabilities by Facebook and Twitter do not work well on the iPad browser, thankfully a onetime process that can be handled on the desktop as well.- Long list navigationLong list navigation needs a new indexing approach, plowing through 4,500 contacts on the iPhone or iPad is not fun, nor is scrolling through 2,500 photos (a hobby) really practical. Some of the new indexing capabilities of iPhoto on OS X (face, date, folder, theme) would be welcome on the iPad. - Multi-user loginEven before purchase my daughter "claimed" certain usage rights to my iPad, which to keep things safe, really requires a multi-user login with separate menus. I am hoping that becomes part of the unannounced features pending for the iPhone4.0 release for the iPad slated for the fall. A new dawnI may discover more things that are not perfect on the iPad, but so far I have been inseparable from this nifty lifestyle device that manages to take on a much larger part of my business requirements as well. The continued development of the iPad will change the face of computing forever, and as a result people are no longer beholden to the lazy innovation and complacent attitude of Microsoft, joined by the mediocrity of cheap and ever commoditizing hardware partners. Apple has singlehandedly changed the computing agenda from business to lifestyle, and managed to serve its fast growing customer base with an experience that truly meets their every day needs.The iPad has become the third "woman" in my life (in the aforementioned analogy), who is bound to become more capable and more beautiful every day.
• VC roast; how to take Venture for a ride 20 April, 2010, 9:08 am
  By Georges van HoegaerdenIt is time for a Venture Capital (VC) roast, as I continue to see so many of its General Partners spread the rhetoric that Venture hasn’t performed all that miserably and that it will all rebound, ignoring that the opportunity-cost incurred by a systemic slide from Venture into micro-PE (or what we prefer to call subprime VC) is larger than not investing in Venture at all.The VC roastSo, let's have some fun and show you what to do when you are a Venture Capitalist and do not want anyone to get suspicious:- You graduated cum laude from one of the top Ivy League business schools in the U.S. that also invested in your firm as an LP, and discover that none of them have been able to make their endowments in Venture produce a decent return for the last ten years. Oh well, at least your parents loved you enough to give you a great start.- You copy the Private Placement Memorandum (the business plan of a VC) from a brand-name VC, enter new General Partners in the about section and voila, another VC star is born that Limited Partners (LPs) cannot possibly say no to.- You start raising new money, four years after your first, making it impossible for your LPs to establish the real merit of your initial investment thesis. You’ve just added another 12 years to your already comfortable existence and enjoy the stability of a more secure job than anyone else in government.- You are vague in the actual deployment of your investment strategy so you can balance early and later stage investments based on how the vintage of your fund should look on paper and what the marketability of your second fund is four years into your first.- You tell the world about how holistic your job really is, and how you as a member of the Venture sector are responsible for generating all these jobs, forgetting of course that you are mainly the matchmaker in the process (between the assets from LPs and Entrepreneurs) and it is not your money you put to work but the public’s money (dispersed through LPs to VCs). - You tell the world that you really need to exist because innovation is crucial to this country. Forgetting that anyone with real entrepreneurial experience and verifiable merit will gladly take your place the minute you get out of the communal hot-tub you refer to as a unique fund.- You become a member of the NVCA, whose protectionist agenda and lobbyist resources will provide you with plenty of ammunition to LPs and the government as to why your investments thesis, that is so similar to your peers in the industry should be protected at all cost for the sake of innovation.- You decline to discuss publicly any rounds of funding into portfolio companies and its valuations, because at some point that may actually lead to the discovery of your real knowledge, vision and merit of decision making in Venture, or what a fool you really are. - You build out your investment firm to a wide global network, so you can have the unique ability to smooth out investment returns and strike up generous stacked management fees in all. - You tell the LPs that you are investing in “Capital Efficient” companies, omitting that capital efficiency is defined not by how much downside you protect, but how you enable upside. - You make the world believe that the best companies to invest in start with the discoveries from white males, under thirty, only a technology proposition, twenty miles from Sand Hill Road and built in a garage where you spoon-feed them $250K tranches, minimizing investor downside risk. Ignoring comfortably that the long-tail of viable ideas should just no longer be explored.- You tell on your blogs how entrepreneurs need to get better in building companies or how to navigate venture constructs, as opposed to spending all your time on finding groundbreaking innovation with enough upside that helps them hire the best.- You tell entrepreneurs nothing about your knowledge, performance and merit (and ability to invest or not) but expect to the entrepreneur to be fully transparent. - You demand from entrepreneurs that they realize you will bring more than money, while you will not talk to them directly and provide no substantial differentiation of your investment thesis on your website. It is maybe because you are not that special to begin with?- You sit in your office searching through piles of business plans, waiting until technology walks in the door that strikes your fancy. How come the visionary in you cannot proactively induce groundbreaking innovation?- You preach at the many technology “flea-markets” about what constitutes innovation and how to find the outliers, making no one wonder what you are doing at this “flea-market” to begin with.- For ten years you pushed valuations through the IPO funnel with little value and now, after you’ve squandered public trust, and struck by the impending retribution, you now defer all early risk to entrepreneurs and wait as long as you can to see if something miraculously pops up.- You add different investment vehicles to your firm, such as PIPEs, annex funds, buyouts so as to further hide your real merit in the demanding venture sector. - You give speeches to the world about free-markets from atop a comfortable perch of the most closed, dark, unregulated, in-transparent and proprietary market mechanism in the financial industry.- You write on your blog that Venture is all about relative performance and then compare Venture indices with those of 100-year old asset classes (with nominal greenfield and growth), so Venture still looks like a “star”.- You act confident that when the economy recovers all boats in Venture will rise again, delivering the evidence that you do not understand that groundbreaking innovation is resistant to economic aberrations, and your boats should be sailing the skies by now (as other custodians of innovation have proven).- You cry on stage (like a real man) about the nobel cause of improving our climate, after you realize technology investing does not make turkeys fly anymore and you are looking for greener pastures. Giving you the out to turn your venture firm even faster into a private equity firm (compatible with making greentech investments), a perfect slow paced Venture retirement strategy that makes everyone feel warm inside.- You tell the world that the Venture business is still "the envy of this world", forgetting that the financial system does not create the value, but the unwavering drive of the groundbreaking entrepreneurs you are choking. - You tell the government that regulation will kill innovation, forgetting that - at most - regulation will kill venture capitalists who cannot stand to have their merit exposed publicly.- You convince the senate that innovation is not at risk in our country, based purely on the size of its financial system being larger than that of all other economies combined, forgetting that a financial system eleven times the size of production is a very unstable foundation to begin with and how we’ve become a nation of gamblers rather than producers. Act surprised when other nations slowly start to eat our lunch.- You tell congress that there is no systemic risk in Venture, convincing congressmen that the sum of all investments in Venture (about $2 Trillion the last ten years) should really not have yielded more than 3% ($66B) in IPO value. - You tell the world that the malaise in Venture has everything to do with the economy, while venture funds have been fully loaded and startups (at best) produce discretionary revenue that is a minute portion of the overall market and thrives on the pressures of change in economies. - You tell your LPs how you invested responsibly by chopping up available funds into ten levels of bottom-level diversification and get them to nod favorably about the elimination of risk, rather to embrace the risk that separates Venture returns from Private Equity.- You tell your LPs afterwards that investing is cyclical and that they should have factored that in their equation, especially now that venture capital has turned into micro private equity. You do not need to tell them that Venture has become more risky because the risk you created as a member of the VC demi-cartel.- You tell others, shhhh..., how LPs are really not the brightest people on the planet and that they should take part responsibility for the demise of Venture. Because you are simply executing on the same “proven” strategy as your peers in the VC business. - You tell your LPs that your performance is top-quartile, allowing you to specify who you want to be compared with. What better job than to get away with with writing your own report card.- You say goodbye to Venture based on the lack of liquidity opportunities in Venture, dumping a sector from which you have extracted a “glorious reputation” and income but do not want to be bothered with the hard work of fixing it. Causal connectionAs with all roasts, the underlying message is a serious one. I can write and speak for days about the empirical improprieties in Venture I discovered as an entrepreneur, venture catalyst, CEO and venture capitalist in Silicon Valley. But rather than to debate each one it is more important to realize that they occur because of an incompatible financial system that allows so many people to take it for a ride."Mistrust of every kind of authority grew out of this experience, a skeptical attitude toward the convictions that were alive in any specific social environment — an attitude that has never again left me, even though, later on, it has been tempered by a better insight into the causal connections" -- Albert EinsteinWe need to fix, simplify and make our financial systems more accountable, in order to erase the behavior that stifles it. Our government needs to play a role in establishing marketplace transparency and instead of trying to curtail the symptoms, fix the disease that produced it in the first place. Limited Partners need to deploy more discipline with people who know the Venture Ecosystem inside-out and better yet, how it should work.Financial systems are a systemic threat to our economyThe behavior in Venture is very similar to the many improprieties of other financial markets, and simply less overt because of its complete lack of transparency to most marketplace participants. But improper behavior in Venture is like "child abuse" of our growing economy; it cuts off the spirit, zest, fortitude, and vision of young groundbreaking entrepreneurs who have the opportunity to become the new business leaders of our world. We will never be able to recover from the Venture malaise if it persists for too long, other nations are not sitting still. The real optimist in the face of the malaise in Venture is not the one who continues to milk the dysfunction or walks away in search of greener pastures, but the one who builds a systemic fix for the failure in Venture and helps groundbreaking entrepreneurs define a new compass of innovation. I have done both.
• Setting a new goal in Venture 14 April, 2010, 9:19 am
  By Georges van HoegaerdenThe Venture business has got the world upside-down, is what I wrote in a recent comment to a VC and I meant it. Just as upside-down as many people who buy a house and get a mortgage confuse a liability with an asset. A great example I heard Robert Kiyosaki (from Rich Dad, Poor Dad) refer to in an infomercial in the background while I was doing work on a quiet sunday. Venture should perform much betterFrom many discussions, publications, public statements and strategies discussed in new Venture videos it is clear how a large part of the Venture community struggles and puts up relative performance metrics (such as meaningless top-quartile definitions), and pad themselves on the back that Venture is still outperforming public markets. All while technology Venture performance should have blown other asset classes and public markets away, by virtue of its massive greenfield (5/6 of the worlds consumers) and continued growth in technology adoption (even through the worst of our recent economic downturn). But Venture is looking at the wrong metric of success.Focus on upsideThe real issue in Venture is that the innovations Venture Capitalists select, barely have any Social Economic Value (SEV) and therefor by definition have severely limited upside potential. On a scale from Technology to Market, to Execution, to M&A, to IPO, to SEV (as depicted in the enclosed chart), most venture investors today look for technologies and apply their risk thesis to the lefthand-side, or downside of the scale, hoping and praying to ever reach the righthand-side.Frankly, most investors have upside and downside confused, which is the source of their deplorable performance. Technology development is not a testament to ever reaching Social Economic Value. And to demand from entrepreneurs that they build technology is a sign of how they further defer the majority of even downside investment risk to entrepreneurs ("show me what you have built") as a prerequisite to investing (as we explained in the reference to Vinod Khosla's perspective in 2010: The State of Venture Capital). What we have lost over many years of irrational exuberance in Venture is our ability to spot and target large Social Economic Value. Social Economic Value defined by the trust of the public as a customer, not to be confused with an IPO, which is defined by trust of the public as an investor (preempted by an investment bank). In the 90s venture investors pushed valuations without value through the IPO funnel, which led to a loss of faith and a retraction of IPOs post 9/11. The way to regain trust with the public is not to sell them another lie, that is based on nothing but the hope and rise of the economy that is supposed to float all boats again, but to have the public use the product as a customer, and let them make up their own mind about its value as an investor. Hence the definition of upside in Venture defined as the creation of Social Economic Value as opposed to an IPO. IPOs will flourish once that public trust from consumers is achieved.Reverse engineering upsideA fundamental difference in the investment thesis is that as a Venture Investor, instead of looking at the gating technology proposition, you assess an innovation based on the merit of its ability to change the world (where it is likely that no prior implementation exists). But you as the investor can align with the entrepreneur based on a shared vision, compass and the likelihood that the support of that Social Economic Value will feasibly occur within the next five years. And that means that both the entrepreneur and investor share the predictions of the trajectory that builds Social Economic Value, a much better equilibrium between entrepreneur and investor. One in which according to Warren Buffet, the “owner oriented attitude far outweighs the periodic downside". No longer are entrepreneurs pestered with demotivating rounds of ownership dilution based on unpredictable microeconomic aberrations and, no longer do investors waste time worrying about the minutiae that do not affect the Social Economic outcome. Rather than forward planning from a technology starting point, Social Economic Value is created by back-planning or reverse engineering upside. Meaning, in order to create large SEV a certain IPO range needs to be achieved, which can be swayed by M&A interest, which is created by great execution, which stems from understanding the behavior of marketplaces, which can be served by technology. Technology is the derivative, not the goal.The distinction between prime and subprime innovation is simple. Prime innovation is attached to existing macro-economic behavior (and usually the absence of technology previously) and relatively easy to predict (I would be happy to share examples), while subprime innovation is attached to a technology wave with a short expiration date and little macro-economic value (a main reason why many acquisitions perform so poorly) that has a minute chance of ever producing viable returns. Investing different leads to different entrepreneursUpside investing applies the proper risk to an early stage Venture, it applies it to the assessment of anything else but technology. Because, as technologists the creation of technology is the least of our risks. But it requires a VC fund that can carry most of the $25M runway needed to create the success of any disruptive Venture today (yes, "capital efficiency" is a lie). The small funds can continue to deploy their subprime risks, while the larger funds have the opportunity to separate themselves macro-economically, by spawning real innovation. The minute you as an investor set a different compass and focus on the creation of Social Economic Value, different entrepreneurs come out of the woodworks that subscribe to that investment thesis. Suddenly you will meet the entrepreneurs that through years of experiencing macro-economic deficiencies, have a vision of how to change the world for the better and as a result generate the large outlier fund returns Limited Partners need to see to stay confident. Change is inevitableWe may see a slight upswing in IPOs this year, as the economy recovers, micro-PE deals are the best game in town, and those with money to play regain some confidence. But if we as investors do not change our investor tactics and produce real Social Economic Value, it is inevitable that Venture will descent even further to micro-PE than it already has, and continues to suck the risk and returns out of performance. And that would be the kiss of death to Venture and to the wide-open opportunities in innovation that still lie ahead.
• My advice to VCs 11 April, 2010, 8:57 am
  By Georges van HoegaerdenI am perhaps the most well known (so they say), open and prolific contrarian of the complacent attitude, role and performance of Silicon Valley's most notorious Venture Capitalists (VCs), and frequently I get the question from entrepreneurs suggesting that those VCs must just hate me with a vengeance. My consistent answer to that question is;Very short: "I don't care, the truth needs to be told", Longer: "I don't care what the many subprime VCs who underperform think of me",Even longer: "I would not raise, nor suggest other entrepreneurs to raise money from VCs who cannot be challenged on their merit, methods and madness",Longest: "If they hate me so much, why are many then in conversation with me - my arguments are apparently crisp and tantalizing enough to engage in the debate for a better future"Tough and fair, yet balancedThe reason why many VCs continue to talk with me is that I've known many for a long time (as a former part-time Venture Partner trolling, eating and networking with them on Sandhill Road) and that my observations are tough but fair and stem from an authentic desire and urge to fix Venture. Honestly, I like many General Partners personally, I just despise the institution they have created - in the same way many of us like their congressmen but hate congress. But smart people can be wrong (and use their smarts to protect their self interests), and many VCs are seriously wrong.The Venture ecosystem (the way it works top-down) is structurally flawed to which blame could and should be directed to Limited Partners who do not deploy sufficient investment discipline to such a specialized sector, to VCs who have taken the liberty to take the system for a personally prosperous ride, and also to massive volumes of would-be-entrepreneurs, who attracted by the predominantly subprime investment thesis made it significantly harder for VCs to separate subprime from prime innovation.My observations are also balanced in the sense that I do not subscribe to new mechanisms that treat entrepreneurs unfairly (we just launched a new way to rise groundbreaking innovation above the noise), treat VCs unfairly (which I think The Funded does), and treat LPs unfairly (for whom we built a permanent fix by virtue of a new market model). However, all participants should be held accountable to turn this sector around and produce outlier results consistently.Why VC needs helpAnd while I have provided much rationale to clearing up the mysteries for the primary asset holders in Venture; LPs with money and Entrepreneurs with Ideas, my public support for VCs has been waning. Most probable because many VCs come across as arrogant, mislead entrepreneurs (sometimes without realizing it) and are the ultimate protectionists in the Venture ecosystem that leaves every participant unhappy except themselves, living a lush life and raking in astronomical management fees (from largely our public money) that at least secures their life for the next ten years to come. But new General Partners in VC firms like some of my friends who are raising new funds, new GPs like Mark Suster from GRP Partners (a former entrepreneur who appears to agree with many of my observations, see the accolade) and even some we would classify as the older garde of the Venture ecosystem seem interested in a debate as to how their performance and the Venture business can become prime again.The really "old" goats of the industry who survived the self-induced Venture malaise because of their early foray in the Venture business and hide behind their brand, PIPEs, annex, buyouts, secondaries and massive investment networks that allows them to smooth out (read: level fund returns so they all look optimal) performance, want nothing to do with any anything that could potentially cannibalize their cushy position. But who needs help if they can retreat to their own island and live happily ever after? I still spar with them at times.So, let's give VCs who have not yet raised their crucial third fund and still need to demonstrate consistent returns to LPs, the benefit of the doubt. Without further ado.Be aware of the sector's legacyLimited Partners, as I explained in one of my previous blogs, have become extremely reserved when it comes to treating Venture as a viable asset class (or better, sector). The malaise in Venture is apparent and can no longer be simply explained away by the state of the economy (as Venture is resistant and out-of-cadence with it). Instead Venture by virtue of the growth in technology adoption (7%) should have simply grown rather than declined in performance as better custodians of innovation are able to prove. Hence GPs raising funds need to come up with a much better story than the old tactic of copying the private placement memorandum from a "top-tier" VC that makes the resumes of the GP its biggest differentiation. Me-too funds are no longer funded and a whole new investment thesis must lie at the foundation of those who want to succeed.Be aware of the pool you dive intoIt is crucial to realize that while you may march to the beat of your own drum and with a unique investment thesis, the marketplace consisting of LPs with their asset - money -, and entrepreneurs with their asset - ideas - still has not yet substantially changed. Massive amounts of ideas without substantial Social Economic Value float around, and thus GPs need to be extra savvy to communicate their thesis clearly to prospective entrepreneurs. Moreover the marketplace in which you act as the arbiter of Venture transactions (see our primer) is highly suboptimal. We repeat for clarity from a previous blog why even your stellar performance may do little for your LP. So, an LP that is diversified in many other VC funds may not recognize you as the outlier, because you participate in a marketplace that by definition mutes outlier results:A marketplace that marries the assets of supply and demand, with many arbiters not having - or earning - verifiable meritA marketplace that marries the assets of supply and demand, using a single commoditized investment thesisA marketplace that hides behind the performance of hybrid asset classes, sectors, segments and stagesA marketplace that hides behind ten levels of diversification of riskA marketplace in which the arbiters do not compete (but syndicate)A marketplace which openly engages in price-setting and operates as an innovation demi-cartelAn in-transparent marketplace that functions like a black-box to most marketplace participantsA marketplace that appears extremely sensitive to economic aberrationsA marketplace that has not produced healthy returns in twenty yearsAnd that means that with a new fund you are probably better off raising money from a new LP, local or sovereign that understands how to distinguish between the scorn reputation of Venture and the massive greenfield opportunity that unwaveringly lies ahead and you become one of the few commitments in that fund.Own and prove the validity of your unique thesisBut let's assume you as the GP realize all the above and have your ducks in a row and funds secured, how now do you build solid returns for your $100M plus fund. Minimize syndicationIf your investment thesis is indeed unique, you and only you are qualified to carry the risk for your favorite investment. Syndication is fragmentation of LP dollars and thus fragmentation of risk, which turns Venture Capital quickly into micro-PE. As long as the investment has large Social Economic Value, the right amount of focused risk will get it to fruition. Fewer deals at the right intersection of your unique investment thesis, with the appropriate support for upside will produce by definition much higher success rates than the sector average (otherwise your thesis is invalid). So don't be afraid to stand alone.Invest in Social Economic ValueMany VCs have turned subprime, even some of the well know brands. Subprime is not defined solely by how much money is put in a startup but more importantly at which point. Most VCs defer risk to the entrepreneur and therefor create a highly fragile company from the start. The creation of Social Economic Value that can build trust for an IPO has a radically different planning and funding model associated with it. Invest in market principlesFor twenty years GPs have used technology as the starting point of making investment decisions. Yet, more crucial is the macro-economic impact of innovation in which technology is the enabler but not the deciding making factor. Macro-economic impact can be achieved through multiple technology strategies and is likely to see a few different iterations in its lifetime. The starting incarnation of technology is the least of the investment risks and hardly ever proof that it subscribes to any macro-economic benefit. Become an active investorMost VCs wait somewhat passively until innovation walks into their door, the appropriate response for many GPs who do not have the experience, credentials and foresight of an entrepreneur. But many innovations, especially those founded upon macro-economic behavior can easily be predicted and thus also ignited by the investor. If you truly know your domain, you should be able to predict and reach out to great entrepreneurs and have them run with some of your vision at times. Communicate your differentiated investment thesis clearly to entrepreneursI have heard the complaints from VCs overwhelmed with business plans which forces them to default to their old buddies network. Yet, if you communicate leadership as an investor those entrepreneurs that do not fit your thesis will stop knocking on your door. We experienced that ourselves as we were hesitant to turn commenting in our blog on, for fear of having to respond to the same messages all day, but a few clear answers made entrepreneurs understand what we stand for and diminished the interaction with subprime entrepreneurs significantly. A not so clearly differentiated investment thesis is the source of many wondering would-be-entrepreneurs knocking on every door they can find.Be real and let your authentic merit define youWith the bottom falling out of VC performance, it is important for VCs to be as open and transparent as possible in setting a new tone. A tone that is not embedded in arrogance and ignorance nor a marketing tool to lure in unsuspecting entrepreneurs, but reflects a realization that you understand what the deplorable past of VC has done to innovation and how you intend to chart a much improved course.
• Getting Venture un-stuck from its subprime maelstrom 8 April, 2010, 5:37 am
  By Georges van HoegaerdenI keep hammering on the systemic dysfunction of our financial system in Venture that sits atop the massive entrepreneurial capacity of this country, that is crushing it slowly to death (having done so for some 20 years already). And frankly, I start getting a little tired of having to repeat myself, over and over again, spawned by misleading articles from VC bloggers and their cohorts and being surrounded by a halo of negativity (albeit deserved). I prefer to spend my time on fixing and building things.Fix 1 of 3: a top-down fix for Limited Partners. Check!To combat that dysfunction I took action, analyzed the Venture ecosystem from the outside-in and covered in my presentation "2010: The State of Venture Capital" how Limited Partners (LPs) with $1B in assets under management dedicated to Venture can instantly correct its malaise from here-on out. Intrigued, many of the LPs in Venture I spoke with now need to go back to their management and essentially confess how inadvertently they allowed Venture Capitalists so much slack in "playing" with the money they committed, that caused the descent to a predominantly subprime sector in the first place. Some big-boat LPs will find it hard to make the turn and simply leave the sector. In light of the massive opportunity in technology venture that will prove to be a very foolish choice, because unlike in any other committed asset class or sector, ahead in technology venture lies a massive greenfield ready for the taking. Many entrepreneurs will keep pressing forward no matter what financial system they encounter and their need to make lemonade out of lemons will force them to submit to subprime terms and conditions that are so prevalent in Silicon Valley today.Fix 2 of 3: a fix for groundbreaking entrepreneurs. Check!Yet I run into entrepreneurs all the time (or rather, they run into my philosophies on my website), who have laid the foundation of some groundbreaking innovation that does not fit the mold of subprime investors and are poised to die a sudden death if not helped along. After all, not the false positives are the biggest source of failure in Venture, but the inability to attract real outliers who refuse to be the pimp's ho.If I only had the time to dedicate more time to them:One of those companies was a company with great technology, a much better immersive gaming experience than the Nintendo Wii (available before the Wii), that would dramatically broaden the bell curve of adoption of gaming and, because of the subprime nature of Venture, is now relegated to a less optimal strategy of becoming a technology services company and a PE deal at best. Another company tapped into a lack of free-market principles in digital photography in which supply and demand transact in artificially arbitrated manners, much like music before iTunes where the Internet could provide instant disruptive value to assets sold today. That is if investors would understand that macro-economic value supersedes pure technology plays. Another company had developed a small part of a new way to find things on the internet that had the ability, with some significant elevation of its macro-economic benefit, to become a much more intelligent operating system than what is currently available on the iPhone or the iPad. Again and again, the stale investment thesis of many investors in Silicon Valley fails to recognize the potential of big ideas that has proven to yield big returns.Examples abound. But investors with a dumbed down investment thesis and limited scope will never get to see or hear from these innovations:"Whether you can observe a thing or not depends on the theory which you use. It is the theory which decides what can be observed". - Albert EinsteinSo, what I decided on is to take action again and capture, nurture and proliferate the creation of groundbreaking innovation by having entrepreneurs not foolishly follow the investor compass, but follow their own - with a little help from us - in identifying large social economic value, and help deliver that proposition to prime investors all while making Limited Partners aware of the vast opportunities that still lie ahead. It is time we treat Venture like the real marketplace we defined it in our Venture primer.Welcome to The Venture Company Network. The Venture Company Network ("The Network") will operate not under the structure we proposed in a fix for LPs just yet, but will follow the free-market principles that ignite the natural evolution of competition and meritocracy of all participants in the Venture ecosystem. That means that entrepreneurs (and subsequently investors) regardless of their descent, location or brand, and only defined by their unique and verifiable merit will be given premium attention into making investment marriages happen.We focus only on ideas that can lead to sizable returns for LPs by producing social economic value that can generate the public trust needed to re-ignite IPOs and therefor big ideas need to gravitate towards the following: • $1B single-trigger revenue opportunity • Macro-economic relevance and impact • ~$25M venture risk • $300M+ venture exit in 7 yearsRemember, capital efficiency is a loanshark's trap, especially when you consider what that popular phrase has produced in the last 10 years. The Venture Company network is like TED for technology innovation, but for Ideas worth Building. Its current incarnation is just a start where we begin to "separate the boys from the men". We completely ignore the way subprime VC works today and focus solely on the creation of large social economic value, regardless of cost (as cost is somewhat irrelevant to the size of upside). Entrepreneurs can get more information about The Network here, where they can review its terms and conditions and join. Your involvement and contribution as a groundbreaking entrepreneur will help get the best innovation in front of prime investors, improve your chances of succeeding and get the sector back on its feet. I am committed to making that happen if you are.Let's raise the bar together and provide proof to show that under a heavy (and incompatible) financial system remains a vibrant entrepreneurial capacity and inventory.
• Why entrepreneurs should not follow an investor compass 8 April, 2010, 5:37 am
  By Georges van HoegaerdenI think it is quite hilarious to see so many Venture Capitalists (VCs) tell entrepreneurs everyday how to build a successful business, given that they have no political leg to stand on to offer such advice. The advice offered ranges from how-to-build a company (many have never) to how-to-talk to an investor (to submit to subprime?), to how-to-deal with their downside protection. The merit of the VC compassThe reality is that in the marriage between the assets of the Limited Partner (money) and the assets of the entrepreneur (idea), VC has proven to be a miserable match-maker by virtue of its empirical and statistical performance (see here). So in essence it is the VC who needs help in finding more disruptive innovation, not the entrepreneur providing it. We covered at length how few VCs actually have had the relevant personal experience of guiding an early stage company as CEO from the left side of the chasm to the right side (where massive adoption awaits) and why few of them actually have the merit to judge innovation to begin with. But even if some GPs did have the personal experience, the model by which many deployed risk is simply incompatible with finding the outliers of innovation to which none of their innovation "scripts" applies. With an overall success rate in the last 10 years by VCs of less than 3%, simply raising a first round from any investor has statistically become the entrepreneur's highway to hell. And VCs openly and proudly admit to their demi-cartel (confusing a strength with a weakness). Here is some evidence I picked up from the Twitter hemisphere recently that describes that abuse of power, the lack of investor competition and the dysfunction of the Venture market model so well:If U (that is "you" in text-speak) say to investor A that investor B wants to invest, expect A to immediately ping B. And if B says no, kiss goodbye to A. Now I have spoken with the investor in the past who said this, and know some of the portfolio companies from his first-time lower-teens "play" fund, and can imagine how he depends on the consensus from his peers to make investment decisions. He cannot invest using a truly unique thesis, as he simply cannot support the runway of any of his companies monolithically with such a tiny fund and I feel sorry for the stance he has to take. But the commoditized investment thesis (alluded to in the Tweet), stuffed with syndication makes for a cess pool of subprime deals that is so indicative and prevalent in Silicon Valley.So entrepreneurs should not get derailed by the general VC compass, as it:Generated no more than 3% public value over the last 10 years (below 1% if you take the Google IPO out of the mix)Lost about $1.7 Trillion in fundsEroded public market trust with short term gainsFor twenty years real entrepreneurs have been abused by a financial system that first threw money at anything moving and ten years later retrenched and still imposes the fear stemming from the minute social economic value those opportunities created. The entrepreneur's conundrumBut that leaves entrepreneurs with an interesting conundrum, of who to listen to. If the compass of the VC that may give the entrepreneurs their first money to start building their company cannot be trusted, where else do they go to get their idea funded? VCs exploit this problem by basking in the glory of no real deal competition (they prefer to syndicate) and no other financial instrument that can compete in providing full runway support for early stage innovation. Meanwhile entrepreneurs get more desperate and bow down to the will-power of the VC cartel, and submit to its terms.That deadlock caused the smart entrepreneurs to leave the "dating scene" altogether (and find better custodians for their intellectual brainpower) and leaves a maelstrom of subprime VCs actively telling hopeless entrepreneurs how to build greater returns using subprime deployment of risk and terms. And we still have 10-years of past subprime deals clogging up the pipes of venture firms to look out for and ready to pop soon. The answer, my friendsInstead of listening to the opinion from many VCs (whose merit is impossible to assess, but based on average sector performance generally deplorable) drawn out in the blogosphere, entrepreneurs should simply follow the compass of success. So I hear: define success. Success in early stage technology innovation is highly dependent on the creation of authentic social economic value and public trust (and attachment to existing macro-economic behavior), that creates valuable IPOs, that can be courted by M&A, that is supported by high-growth venture investments, that is spawned by the proper deployment of investment risk.Venture investors need to step up to combat the lack of trust our public market has in technology companies. Since many venture investors pissed away public trust in the 90s with their choices of new public companies that suggested massive valuations but proved to contain only nominal value, investors now need to be extra diligent in producing authentic value the public market can trust again. But entrepreneurs need to learn that the real value of the idea is not described by populist investor buy-in, but is defined by how unique and how well the company can build that social economic value. And that means instead of forward planning from a first round of funding, entrepreneurs need to set their compass to point to a social economic endpoint, get agreement with investors on the objective and then back-plan to what steps and investments are needed to achieve that public trust. Social economic value is not proven by first building technology (the least of our venture risks) and will not evaporate anytime soon, so entrepreneurs should not leave their jobs just yet, before they are adequately able to sell the viability of reaching the end-point to a prime investor. Groundbreaking entrepreneurs follow their own compassThe definition of the compass, the pin-pointing of social economic value can best be established by the entrepreneur (not investor) with the unique vision for a better world. By the groundbreaking entrepreneur who by definition does not subscribe to the populist view, who has the vision and ability to enable change, and an unwavering passion to improve the way the world works (as Craig Furgeson says "reminds you of anyone?").All Venture investors need to do is assess whether the vision and ability to execute of the company, started by the entrepreneur is plausible in generating the large social economic value that was promised. Cost is highly relevant only to those investors who have nothing to hang on to but downside protection. The opportunity for creating large social economic upside in technology remains priceless. When life gives you lemonsRaising money is just like dating, those who pretend to be someone they are not will find themselves inevitably failing, and unhappy with what they submitted to. So, they key to raising money is to keep looking for an investor who has the merit and money, and can subscribe to what the entrepreneur is selling (by virtue of its goal). If none do, and one has clearly defined the path to large social economic value, stay firm and keep at it. Only groundbreaking entrepreneurs make orange juice when life gave them lemons.
• Re-investing in Venture unchanged, is the definition of insanity 23 March, 2010, 10:48 am
  By Georges van HoegaerdenI have the utmost respect for groundbreaking entrepreneurs, or better yet all the people who produce great products (or unique services). I love technology and believe we have not even scratched the surface of its macro-economic impact. And it is those entrepreneurs, with the simple power of their dreams and perseverance, who collectively and unwaveringly hold up the massive weight of an outdated and incompatible financial system eleven times the size of production that keeps this country afloat. It is for them that I fight to make our financial system more modern and nimble to withstand the test of time. The writing is on the wallUnless you have been living under a rock, you should by now be aware that the performance in Venture for the last twenty years has been deplorable. After a fantastic start by people like Bill Draper, and point successes from next generation icons like Vinod Khosla in the nineties, Venture quickly became the stomping ground for anybody with money, not necessarily combined with merit. Growing numbers of Venture Capital (VC) firms arguably over-invested in their interpretation of innovation that had the majority of even the 90s funds (with vintages in the 2000s) generating no more than 10% IRR on average. Just the last 10 years VCs have generated no more than 3% public value out of all investments made, or specifically lost about $1.7 Trillion in, mostly public, money from their Limited Partners (LPs). And the performance of the current funds does not look much brighter as witnessed by incoming reports from early 2000 funds and the discontent of many LPs I speak with. And on the mirrorBut even if you are not a fan of numbers, which often become the subject of endless debate and can be excused away since they are lagging, not leading indicators, Venture has produced only a handful of viable companies that ultimately created some sustainable value public markets have faith in. Seven-hundred-and-ninety (790) VC firms in the U.S. chomping at the bit producing no more than a handful successes is the billowing smoke that indicates a raging fire. More specifically it indicates "the system" or "the compass" by which Venture is deployed does not work, its systemic approach is broken and only a few outliers in Venture produce the returns that make the headlines for all. When doing you best just isn't good enoughVCs now hold on for dear life, blaming their lack of performance on esoteric macro "windows" of opportunity (irrelevant to startups), and they feverishly add up portfolio revenues to claim they are still producing value and are doing "their best", all while big corporations frequently beat them to the punch with real innovation that outpaces the market. VCs attempt to hang on to comparing Venture to 100-year old asset-classes, sectors or segment indices, padding themselves on the back with a relativity theory that is as flawed as comparing apples and oranges. Unlike these old indices that have become somewhat stale because of their age, Venture continues to ride on the information technology platform that continues to grow aggressively (despite the economy) and still leaves a massive greenfield (5/6 of the world's population) underserved. VCs have not succeeded in tapping into that upswing and their best is clearly not good enough to make us proud. Venture Capital morphed into Micro-PEVenture Capital, after the irrational exuberance of the early 90s, has quickly and predominantly turned subprime - or - into micro-Private Equity, with most risks deflated and/or deferred to the entrepreneurs. LPs who thought they invested in Venture Capital, by virtue of how they deployed money, instead invested in a more risk averse Private Equity segment, a different thesis with different risk/rewards associated with it. But we ended up getting what we invested in; micro-PE returns. Nothing Ventured, nothing gained.Looking good spending moneyNow, I see some LPs "blindly" renewing their commitment to Venture, which for LPs that have access to prime VC firms that have still produced healthy returns in the last two decenniums makes only nominal sense. If an LP does not have the wherewithal to understand the dysfunction in Venture, it may as well bet on the best horse in the race, even if the race ends up being a Private Equity race instead. Those LPs may make a buck (with a minor part, 10-15% of their total allocation), maybe even outpace other asset classes and care less.But the wide-open greenfield in technology and the culmination of a fantastic real-time distribution mechanism (the Internet) of technology should have made technology Venture the best performing asset-class, bar none. That is of-course, if one understand the requirements of the sector and deploys the appropriate risk, discipline and market model. Social Economic ValueMost of the money invested in Venture is (indirectly) public money, such as the endowments and pension funds (CalPERS, ~$17B) which beyond a sheer money making objective also has a strong social economic value attached to it. CalPERS needs the money, but also needs Silicon Valley to be at the top of its game to produce healthy economic spin-out (driving other asset classes as well). The new funds just deployed by the North Carolina and Florida (coming) treasurers also promise to carry the good karma spawned to aid the most important driver of the economy; innovation.Yet most meaningful innovation, that has the potential to scale big fast, does not start with or in Private Equity, it starts with the unique risks deployed by Venture Capital. And so the importance of what you as an LP are betting on, with the specific knowledge of what is Venture and what is not, is crucial in establishing a healthy conversion from technology to large social economic value, and subsequently public support and trust.The Insanity in VentureThe systemic failure in Venture to produce returns in line with the wide-open opportunities in technology is the result of the composition of its incompatible financial system. Venture today is an artificially restricted marketplace to which not the outliers of innovation are attracted, but those who are attracted to the commoditized investment thesis of the predominantly subprime VCs. But even if one knows nothing about Venture, insanity is the descriptor that belongs to the person who believes in a marketplace where the following attributes can consistently produce outlier returns:A marketplace that marries the assets of supply and demand, with the arbiter not having - or earning - verifiable meritA marketplace that marries the assets of supply and demand, using a single commoditized investment thesisA marketplace that hides behind the performance of hybrid asset classes, sectors, segments and stagesA marketplace that hides behind ten levels of diversification of riskA marketplace in which the arbiters do not compete (but syndicate)A marketplace which openly engages in price-setting and operates as an innovation demi-cartelAn in-transparent marketplace that functions like a black-box to most marketplace participantsA marketplace that appears extremely sensitive to economic aberrationsA marketplace that has not produced healthy returns in twenty yearsNo tinkering with micro-economics in the marketplace such as management fees, carries or other micro-incentives can turn a subprime VC, prime. Just like entrepreneurs are born, not created, so are venture investors with their unique intuition for taking risk born, not created. The marketplace needs to be rebuilt from scratch and embed free-market principles that allows for healthy competition between all participants in the marketplace. Any LP with $1 Billion committed to Venture can do so independently today, and reap the rewards that lies at the untapped and phenomenal foundation of the growth in technology. We owe change in Venture to those that produceWe owe it to the producers of groundbreaking products and value, to support them with a financial system that is lean and mean, nimble and modern, competitive and transparent, that dynamically establishes, monitors and corrects the merit associated with all marketplace participants. We will dramatically flatten and simplify the marketplace, remove excessive diversification and fragmentation of risk. We, the marketplace, will establish and expose the authentic merit of every participant.Venture investors with merit and foresight will thrive by ignoring subprime propositions that cannot re-establish their individual supremacy, and instead focus on those innovations that match their authentic competency and skills. Groundbreaking entrepreneurs will come out of the woodworks again once they see the development of a better custodian than their corporate overlords flourish. Limited Partners will be happy because they reap rewards that outperforms their ancient asset classes by a long shot. Groundbreaking entrepreneurs are the life-blood of this country and we better start treating them with the care and attention they deserve. We need to lift the weight of this incompatible financial system off their shoulders if we want to remain on the leading edge of innovation. We still can.
• My message to LPs in Venture; more discipline please 15 March, 2010, 12:18 pm
  By Georges van HoegaerdenThe more I look into the complete value-chain that makes up Venture (from Limited Partner all the way to Entrepreneur), the more I see the origination of its gaping dysfunction. My conversations with a $3 Trillion, a $20 Billion and a $1 Billion Limited Partner (LP) with some of its asset-under-management (generally between 10-15%) committed to Venture, yields the same fundamental conclusion. Lack of general investment disciplineIt appears that many of these LPs in Venture deployed money frankly too lazily and too hastily to a sector that was once booming, as they rushed to get in to reap similarly projected upside. Without any specific Venture expertise, they quickly deployed a me-too investment model to Venture (copied from its elderly Private Equity PE brother) that was supposed to significantly outperform its other asset classes, but it didn't. And those LPs now wonder in disappointment whether Venture scales, to which of course my answer is: No investment strategy without discipline scales. Most surprising in my conversations with LPs who are eager to improve Venture performance is that almost all of them seem to expect me to roll out a more dark and deep "Voodoo plan of Venture investing", with more complex detail and nuance combined with alternative exit structures. I do quite the opposite, as I prefer to simplify things dramatically. As an "outsider"-looking-in, my role is not just to absorb the way investing works today but more importantly, identify the way a better financial system for Venture should work. As if today is the first day of Venture investing. So rather than with a submissive attitude akin to the usual money-hungry cast of characters that approach LPs, I challenge them on the basic fundamentals of the assessment of investment risk to benefit us all, and to come up with the proper investment structure to curtail superfluous risk. Because the only risk LPs should incur is the market risk of the startup companies that are invested in, not incur incremental risk because of the sizable financial system that sits on top. Au contraire, LPs have deployed superfluous risk in Venture that "by design" underperforms:- Deflation and fragmentation of riskAs one can gleam from our 2010: The State of Venture Capital presentation, LPs have allowed the deployment of no less than ten levels of diversification (and fragmentation), before the money reaches the startup it invests in. And that means the underlying instruments are deploying excessive risk aversion and downside protection, a source of comfort (perhaps) but not indicative of a great understanding of risk nor a consistent process of great performance by the supposed investment professionals. - Lack of focus and accountabilityLPs should have deployed an upside-down pyramid in the deployment of risk, meaning they get to deploy diversification of assets and below its diversification should be dramatically reduced or (ideally) zero. So, while top-heavy diversification may be meaningful, bottom-heavy diversification is destructive and leads to lack of accountability to the investment thesis. Many Fund-of-funds that deploy Venture money for LPs, themselves have their own diversification strategy, as they also invest in PE, buyouts, pipes. So do some Venture Capital firms (VCs) who also diversify in different instruments, sectors, stages, industries sometimes aided by investment networks that can "uniquely smooth out investment commitments", clouding the performance of a specific investment thesis and the merit of the people attached to them even more.- Mediocre Private Placement MemorandumsThe composition and content of many of the Private Placement Memorandums (PPM) from VC firms I have seen is an absolute joke, and many of them are a straight copy of the plan from one of the early brand-name VCs on Sand Hill Road. No business plan from an entrepreneur with such a vague description of the ability to execute would make it past a first meeting with a VC. Yet LPs even go as far as defending why no PPM commits to a target return; "the lawyers will not allow it". But without a baseline performance index, LPs who invest in multiple VC firms have no simple way of holding VC firms to their promise, except to try and assess whether the VC firm "did their best". No startup gets sued over not making its target revenue numbers, and I am sure we can find a legally acceptable way to hold VC firms accountable for their bottom-line. Lack of Venture specific disciplineBut Venture requires a few crucially different disciplines than its elderly "brother" PE. The major difference is in the nature and the risk associated with the asset LPs (indirectly) invest in. Simply put, PE relies on more hindsight (ability-to-execute) than foresight to become successful, while Venture requires more foresight than hindsight to cross a chasm (Geoffrey Moore) that is so unique to that disruptive innovation. - Lack of relevant GP experienceWe have hit on the general lack of relevant entrepreneurial experience of GPs (that passed LP scrutiny), which is important in helping plot the risk associated with an early stage investment and with the identification of how much money an investment requires to create disruptive market value and subsequent public value. Many GPs came from PE, Wallstreet or other finance positions, or came out of a late stage technology company that made money in the hay-days, and have now slid into the aforementioned unaccountable GP role with a comfortable income, plus no downside but upside for the next ten years. Very few of them actually have proven that they have what it takes to take a company from the left side of the chasm to the right side of the chasm successfully, and therefor lack the necessary foresight that is so pertinent to Venture. - Lack of expectationsMany LPs in Venture allow GPs to hide behind the notion that startup success is impossible to predict. It is indeed when GPs have only hindsight as the instrument to project foresight. But as an experienced entrepreneur who wants to change the world, and being born with such characteristics and subsequently honed and monetized those skills for 30 to 40 years, your odds as that entrepreneur are much better than you can often articulate, and certainly much better than many of the current GPs can evaluate. Every company or product line I ran became successful beyond its expectations, and I would not even engage when my next venture (which is to rebuild venture) would not have a higher success rate than 50%. So, GPs who are comfortable with two successes out of a portfolio of ten demonstrate what they are made of, they gamble instead of have their relevant experience and foresight play the crucial role of setting a higher (disruptive) bar. LPs should simply demand more than a 50% success rate from their GPs. You get what you put in: put in $x, get $x. In Venture, put in $x + foresight, get $x times foresight.Lack of discipline turned VC subprimeSmart entrepreneurs, who do not let themselves be "abused" by unfavorable terms or partnerships that do not match the authentic experience and merit of the entrepreneur, are not engaging with the predominantly subprime VCs, waiting instead patiently until conditions improve. For the last 10 (I believe 20) years VC have treated entrepreneurs like a cheap commodity, that subsequently has overwhelmingly answered subprime VC mating calls. Subprime VC now attracts hordes of subprime entrepreneurs, convening in flashy technology flea-markets where each apply their ill-advised risk analysis in a quick dating scheme to make a buck. They deserve each others company. But the lack of relevant public value (through IPO) has deflated trust not just with the public - and thus output, but now also with those LPs managing public money to fund venture - and thus input. To fix VentureSo, to fix Venture we need to implement a mechanism that marries the needs of those with money, the LPs, with the needs of those with disruptive ideas, entrepreneurs, in a more effective fashion. We need to treat Venture as a marketplace, in which not syndication perpetuates common mediocrity but real competition amongst GPs emphasizes their merit and demonstrates their unique ability to find outliers of disruptive innovation. We are blessed in this country with very smart entrepreneurs who have found refuge from the Venture malaise in as many ways as entrepreneurs can. They will come out of the woodworks again when the appropriate marketplace for disruptive innovation presents itself. All LPs need to do is treat Venture as a special sector that can create, with the right market model and incentive structure, better returns than any other asset class. Because technology and its immediate impact on the world is at the beginning of its evolution. But Venture requires a discipline and devotion many LPs do not have today. So, dear LP: stock up on experience, knowledge and discipline and let's rock-and-roll again soon.
• Silly Venture, surfing the waves 9 March, 2010, 6:31 pm
  By Georges van HoegaerdenWithout being brutally honest I believe it is difficult to build a great company or a sector (that creates sustainable jobs and value), and now with artificial borders collapsing everywhere around us, only a high degree of authenticity can prevail. No longer can people, tucked in institutions continue to make false promises or hide behind the skills of others. The merit of the individual will soon start to prevail over the bravado of institutions. Sex, lies and videotapeThe lies are everywhere in an industry as young and as quickly emerging as technology. Just like the infamous rush for gold during the Wild West, technology has become the breeding ground for more pandemonium than value. On the buy-side and sell-side of technology.Honesty is a hard nut to crack in California, where the authenticity of silicone boobs is as vigorously defended as the authenticity of silicon valuations. Years of people making good money on riding "the system" yields a formidable defense for its impending change. Yet the result of the lies in Venture are starting to surface, directly by virtue of its performance and indirectly by smart people leaving the "marketplace" and turning the remainder sub-prime. And just like in any eroding segment a surge of bottom-feeders takes care of the many scraps, making money off of anything that has the hope and desperation to stay alive. With the overhang of a wonderful past, those still in it keep holding on to what once was. Fuel to the fireI have been in Venture for more than 15 years (and technology for 30) and personally witnessed from my backyard in Palo Alto how it has destroyed itself, by not being honest, greedy, a lack of discipline or simply by not demanding the best. A mediocrity we aim to fix, systemically.Here is a small collection of what I perceived, based on multiple observations described in one example, as adding fuel to the fire of an already troublesome Venture sector that is in need of a major overhaul:Valuations without valueI witnessed a large company acquire a startup for more than $500M and after doing a post-close deep dive into its financials (ignoring strong political discourse) its actual acquisition value should have been around $100M (at best, using the same multiple). What is disturbing about this is that the mis-formed exit valuation creates the perception that the initial VC investment in the startup had merit. Its shareholders profited handsomely, have gotten themselves positioned for life, and Venture Capitalists tout their horn - all because the corporate development overlords have not been paying really close attention. A good reason why private companies should not be private in terms of how they report earnings. Private should refer only to what type of investors can participate, not its lack of transparency. Examples abound.DesperationI heard from a very reliable source in a company I know well that an acquisition of a $100M-plus startup occurred because the VCs in the deal got nervous, one of the executives at the company described it as "if our last two quarterly numbers were simply flipped, we would not have been forced to sell". With heavy dilution for the entrepreneurs (not smart enough to protect their own turf) and the external board members (with some "top brand" VCs) owning the company, sub-optimal exits are common to save already fragile VC portfolio returns. Even if it means selling for less than 2x. This is clear indication of how even the "best" VCs have become subprime. Price-settingI also heard from a very reliable source how two large Silicon Valley acquirers called each other and discussed that they did not want to compete with each other on the proposed acquisition price, and one really wanted it more than the other. So, they settled on a price (without the appropriate auction battle) together, informing the entrepreneurs at which price and by who the company was going to get acquired. Not only does this process not provide the best value for entrepreneurs, it produces a deflated return for Limited Partners (LPs) who rely on great returns to re-commit to Venture. Spinning wheels with no tractionMany entrepreneurs confuse the pulse of Silicon Valley with what creates value. While it is noteworthy for publications like VentureBeat to record all the innovation and deals that are being done, we need to remember more than 97% of all investments in the last 10 years have not led to producing any lasting public value. That in turn means that more than 97% of what is described as "hot" is really not. And thus new entrepreneurs should not base and bias their ideas on what is described in such publications. They are much better off in following their own compass and experience. Statistically entrepreneurs are better off doing the opposite of what is in those publications. Group-thinkHundreds of Technology trade-shows like DEMO and the AlwaysOn series (I have been to both once) amplify the problem of institutional VC and "entrepreneurial" group thinking even more. They harvest so-called innovation by technology segment, mimicking the intake criteria of many sub-prime investors. It is exactly for the reason Chris Anderson of TED describes in his introduction video why filling a magazine like Business 2.0 to the size of a telephone book is in no indication of the prosperity or capacity of the industry. TED is so different from the previous conferences because it highlights the outliers of innovation, without categorization, and amplifies its macro-economic impact and value. False hopeAs can be surmised from my blog I am a steadfast critic of the role of Venture Capital, having turned predominantly subprime. So, it would be easy for me to align with The Funded in its attempts to rate VCs. And while The Funded is an interesting attempt to start making VCs a little bit more accountable and it has succeeded in erasing the worst of blatant VC misconduct, The Funded is really like a photography site where the ratings of who likes a photograph is in no way in correlation to how well a photograph sells. So, the portrayed VC transparency (to unsuspecting onlookers and participants) and rating is not just a little more transparent; it is wrong. Even more wrong because deal performance is no indication of the viability of producing real success down the road (see how dating doesn't produce a healthy child) or the health of the sector, especially not when the majority of VCs have become sub-prime and so have the entrepreneurs who glowingly fall into their trap.Venture Capitalists that are notI have written about the lack of relevant entrepreneurial experience of VCs, many of whom have never crossed any chasm in their own lives to be in a position to help their portfolio companies calculate the risk of doing the same. While the previous is debilitating in its own right, many VCs are also poor economists who cannot even articulate the basic fundamentals of free-market principles. That matters because it means VCs cannot see and evaluate macro-economics adequately (which supplies most of its disruptive value), nor establish the proper funding requirements of a company that depends on it, as the funding requirements of a startup company driving a free-market model is so fundamentally different from those pursuing a proprietary market strategy. So, again, to quote Einstein, "the quality of your theorem defines what you observe", and what VCs have observed and produced the last 10 years is therefor challenging their theorem. Angels that are notI have done angel deals (as well as VC) and applaud them for taking the extraordinary risk of not only being an active investor but being their own LP at the same time. It gives them more credence but not necessarily more merit. Many of them made their money when turkeys could fly or side winds blew in their favor. Very few earned their money the way a startup intends to, by having an outlandish vision and doing all the hard work yourself to turn it into success. Groups of angels are springing up every quarter now, nobly compensating for the lack-luster investment pace of VC, yet turning technology Venture even faster in a more fragmented sub-prime business than it already has become. Because of the lack of seamless runway support and deflation and fragmentation of risk, more technologies will be built that yield even fewer companies with even less macro-economic relevance. The experts that are notBetter hindsight does not translate to better foresight. Especially not in disruptive innovation, where hindsight is considered toxic waste. Time and time again do I see the people with a crafty description of how the world works today, quickly become the heralded experts of how it should work. Forgetting that a better understanding of the way the world works today, especially in Venture, is no indication how it should and actually eroding the opportunity for groundbreaking innovation. That valuations are no indication of the health of our sector, and that the number of deals done are not, nor the number of VCs, nor the number of startups. The only thing that matters is a fruitful alpha (portfolio return) for LPs, who supply their asset (money) to the VC. A journalist who takes the reports from Thomson and dissects it earlier than others, is not an expert in Venture because of it. A General Partner who is part of a brand name VC firm, and created the problem in VC to begin with, hanging on to a rambling attachment of external factors should not be crowned the expert in fixing it. With the sector in the dump, it is time to look for solutions elsewhere. The need for alpha to produce alphaNow all these aspects seem as impossible to overcome as a dog biting and barking at everyone and everything, but it is not. A dog needs an alpha-model to submit to, in the same way Venture needs the discipline of a new financial system to keep sane. For the last 20 years LPs have let VCs run around like wild dogs, and their performance now dictates that they need to be reigned in. The existing improprieties in Venture only exist because we have deployed a piecemeal market model, reminiscent of the aforementioned Wild West. Most problems in Venture will be resolved by curing its systemic disease, and by implementing a new free-market system that does not exist in Venture today.The financial system we propose implements free-market principles that facilitates the removal of bottom-level diversification, the deployment of responsible risk and the reliance on marketplace transparency to all marketplace participants to (re)define merit of innovation (as defined in our primer). Only alpha-model discipline can produce the alphas LPs are looking to generate. Venture is not too big to fail, and without that new discipline it will, to the detriment of us all.