How limited partners have been fooled in venture capital many times over

Updated Feb. 5, 2010 at 1:12 p.m.

How limited partners have been fooled in venture capital many times over

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Editor’s note: Georges van Hoegaerden, managing director of The Venture Company in Chapel Hill, is an experienced entrepreneur and venture catalyst turned venture economist by fate. His blog is the culmination of Georges' 30 years of relevant technology, business and venture experience.

By Georges van Hoegaerden, special to LTW

CHAPEL HILL, N.C. - A fantastic television ad by Ally Bank, in my view best describes how Limited Partners (LPs) as the investors committed to Venture have been fooled.

In the event you have not seen the video, it shows a slick man in a business suit sitting cosily around a kids table with two little girls.

The suit then asks one girl if she would want a pony. When she replies yes, he hands her a toy pony. He then moves on to the second girl and asks her if she wants a pony, and then calls in a real pony. Clearly the first girl is upset that she did not get a real pony and complains, upon which the man replies, "well, you didn't ask."

What Pony Did You Ask for, by Virtue of Your Actions?

That is exactly what has happened to LPs in Venture who did not ask the specific questions that could have led to their success in Venture. In many cases those LPs failed to generate impressive returns in Venture because they did not know they had to ask specific questions and should have taken control of the situation in order to get the results that the sector is able to generate.

Many LPs, glowing at the early return profiles of Bill Draper, Vinod Khosla and other early illuminaries, simply said "yes" to General Partners (GPs) who asked LPs if they wanted Venture returns, without even asking how much (see the many PPM's that do not even have clear return targets).

And of course now, many LPs are utterly disappointed and mistrust the GPs (and worse the sector), similar to how the little girl in the video now mistrusts the man.

Ask the Right Questions

To help make clear to LPs what questions to ask I have added a new section to the wildly popular presentation 2010: The State of Venture Capital, the Prelude (posted on Slideshare) describing how an LP thought his commitment would be applied, and how it was in reality. See for yourself:

You Thought You …

1. Instead in Venture Capital
2. Invested across the venture spectrum
3. Deployed top-heavy diversification
4. Invested in application of technology to “markets”
5. Supported outliers of innovation
6. Mitigated risk
7. Committed to an always-up sector
8. Would get outpaced returns

Instead You Have …

1. Invested in micro-PE
2. Deployed a narrow investment thesis
3. Deployed adverse diversification
4. Invested in a nonexistent “market” of technology
5. Commoditized innovation
6. Created risk
7. Gotten extreme economic sensitivity
8. Gotten micro-PE returns

We pride ourselves on a solid and no-nonsense understanding of the Venture ecosystem, top-to-bottom, which is crucial in leading to a permanent fix in Venture and to improve its performance. So, we back up our rational on the right side of the previous slide with the observations of how the Venture business really operates today. And here is how the rubber meets the road:

Instead You Have …

Because …

1. Deferral of early risk to entrepreneur
2. PPM’s lack segmentation/expertise
3. Over-diversification at the bottom
4. Chasing short-term technology waves
5. Single investment thesis
6. Unable to attract real innovation
7. No disruptive economic value
8. Deployed improper economic value

The bottom line is simple. It is okay to deploy your money as an LP through GPs as the arbiter, but just like many Hollywood stars have found out, if you are not signing your own checks, know what they are being spent on and how - don't be surprised your money will be taken for a ride. It is the nature of letting go of financial control (and really, you should not be surprised).

Today's Venture pipes are still being pumped full with subprime deals, which means the ten-year outlook for Venture will not look much different from its miserable ten-year past. So, the time to act is now if you expect a different outcome in ten years.

Take Control

The Venture business needs to be reigned in, with controls put in place so it can no longer be taken for a ride.

The sector has a bright future ahead, with massive market-pull from the majority of people in this world who still crave technology solutions to improve their lives. The only way we, as the most innovative nation in the world can screw it up is to deploy a piece-meal financial system that misses its intended target.

That has to stop, right now.

Dear LP, a permanent fix to Venture, by way of a new economic system you can deploy, is waiting for you. Act now or forever hold your peace.

Click here to read Georges’ blog.

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Tags: Venture & Innovation, Opinion Analysis

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