Is this the beginning of the end of venture capital as we know it? Ashby Monk, executive director of the Global Projects Center at Stanford University, and a senior research associate at the University of Oxford, thinks so. "VCs will tell you that any industry with unhappy customers and highly profitable incumbents is ripe for disruption," he writes in Institutional Investor. "It's time for VCs to look in the mirror."
Monk points out a number of problems with the venture capital industry, and then presents a solution: Limited partners --the pension funds, insurance companies, and university endowments that provide the money that VCs invest--should be putting money into startups themselves, without relying on highly-paid VCs as intermediaries.
… LPs are going to have to begin doing things on their own. They need to spin out teams --from VCs, but also from other types of investment vehicles, such as family offices or corporate ventures - and they are going to have to dabble in direct investments. Crazy? Nah. With the Giants I work with, we've already been doing these things. In fact, I can think of three institutional investors that are in the process of seeding or spinning out new venture firms right now; all three are here in North America.
As you read Monk's column, you can sense that his proposals are going to meet with derision by VCs, and that he's well aware of this. So he makes some arguments about why the VC industry, as it currently exists, doesn't serve the people whose money actually makes it tick.
Fees are too high, and worse, out of proportion to the value VCs actually provide, Monk says. He notes that there’s an incredibly fertile ecosystem in Silicon Valley, which gets much of its fire from sources going back to the gold rush through the institutions and companies including Stanford, Berkeley, NASA, Lockheed, Hewlett-Packard, IBM and Apple. VCs do their bit to enhance the environment in which their companies operate--but, Monk says, that doesn't mean they should get paid as if they created the environment themselves.
Certain VCs are desirable to entrepreneurs as much for their brands as for their cash or connections, which makes it harder for anyone to innovate in the VC space. Entrepreneurs who don't need money or help will still raise money from a name-brand VC just for the legitimacy it confers; partners who leave name-brand firms and go on to start their own firms have a hard time without that big brand behind them.
Bigger funds mean more money for VCs, because VCs charge a management fee whether the fund does well or poorly. So a bigger fund means VCs can do well even if returns aren’t good for limited partners. And funds are getting huge.
Monk shows how these factors, plus others, mean that VC-backed companies are encouraged to swing for the fences, or else. As he puts it: "Every smart CEO and CTO I've known has viewed VC money as a deal with the devil: In exchange for money, you commit to constant interference and endless pressure to deliver the goods earlier rather than better."
The solution? For institutional investors to fund young companies directly.
Monk writes that most general partners don't think limited partners are capable of doing creative things by investing in companies. Monk says that's silly. LPs just need to hire "people that have been around the block as an entrepreneur or investor and know how to keep the train on the rails." That, he says, "is not so hard as GPs would have you believe."
Then he gives a list of reasons why these new VCs could succeed, and what it would take for them to do that. Two of them stand out as particularly relevant. The VC fee structure would change, of course, and the way VCs decide who gets investment money might become a lot more straightforward.
The new VCs can get paid plenty, Monk says, without coming anywhere close to the two to three percent in management fees, plus 30 percent of profits from the fund, that traditional VCs charge. By bringing down fees, he says, you change the incentive structure, and you may end up with new VCs who are happy with doubles and triples, not just home runs. Or their companies many get longer runways.
Perhaps most surprising, he thinks a smart investor could actually automate a lot of what top VCs do when they have to decide whether or not to invest in a company.
Don't kid yourself: most of the top VCs today operate in this manner. Here’s what they want to know: Who are the other VCs in the syndicate? How big is the target market? Has the management team had a successful exit? Are the off-list references stellar? You could almost put name-brand VCs on autopilot sometimes.
Is your next venture round coming from a pension fund for state employees? If Monk is right, it just might.