Venture capital’s model battle

Venture capital’s model battle

By Dan Primack September 3, 2013: 4:02 PM ET

Defending the defense of venture capital “classic.”

FORTUNE — Here are three things I believe about the venture capital industry:

1. Until five or six years ago, the venture capital model was largely unchanged from what it had been in the 1980s and 1990s. Different people and bigger dollars, but the same general structure and strategy.

2. Today there are a variety of new models. Some focus on providing a variety of non-finance services to entrepreneurs (marketing, HR, etc.). Some borrow from the crowdfunding model. Some emphasize their ability to make decisions in less time than it takes a “traditional” VC to iron his blue shirt.

3. We have no idea which model is actually better, from the perspective of generating high returns (which is the actual job of venture capitalists).This is all in the context of a weekend post by Sarah Lacy, titled “A rare defense of venture capital classic.” It sought to tamp down on the reflexive notion that newer is better, or that VC firms must become “platforms” in order to achieve future success. Instead, she argues that the fundamental characteristics of today’s VCs are the same as they were in past decades — no matter whether their model is considered innovative or traditionalist:

Yes, things have changed about venture capital since those halcyon days of silicon assembly lines and fruit orchards. Typical venture firms invest later and get far smaller stakes than they did 50 years ago. Deal flow is far less proprietary in an age of demo days, tech blogs, and AngelList. And we’ve learned that many people are just awful at the job of venture capital…

But VCs who perform well aren’t doing it, because they are jumping on the bandwagon of new marketing trends. They are doing it because they are good VCs the way Arthur Rock, Don Valentine, and Tom Perkins were good VCs. They take risk. They coach entrepreneurs. The respect an entrepreneur’s plan, even if it deviates from their own. And most of all — they have millions to invest in each company.

The reaction to Lacy’s post has been fairly predictable. “Classic” venture capitalists have publicly thanked her, while some next-gen VCs have taken her to task.

What most of the responses missed, however, was that Lacy wasn’t really taking sides. Instead, she was seeking to guide entrepreneurs through the disorienting haze of VC self-promotion.

More importantly, taking sides right now is a fool’s errand. As I wrote above, there is not yet enough data to support a conclusion about which type of model works best. Remember, it’s only been four years since Andreessen Horowitz raised its first fund.  Neither AngelList nor Dave McClure’s 500 Startups showed up until 2010. For context, the Massachusetts state pension system only discloses returns for VC funds that are at least five years-old, because it finds earlier results to be statistically irrelevant (a common sentiment, due to the so-called J-curve).

Even First Round Capital, arguably the new model’s godfather, was founded less than a decade ago. And while its returns so far have been very strong, they are not necessarily better than those produced by Foundry Group, Spark Capital or Union Square Ventures — all relatively young firms that primarily employ classic models. Or an older firm like Kleiner Perkins, which has an HR partner, marketing partner, etc. (and has for some time).

What we really need is more time to see if there is a statistical differentiation between new and classic VC, or just several outliers in both camps. If the former, then the “losing” side will need to make adjustments. If the latter, then it would validate Lacy’s central thesis (which isn’t terribly well-served by her post’s title).

In the meantime, today’s entrepreneurs shouldn’t judge a VC firm by its model. No matter how novel or antiquated.

A rare defense of venture capital classic

BY SARAH LACY 
ON AUGUST 30, 2013

One of our most popular stories this week was about the future of venture capital. It traced the asset class’s history from its boutique roots to the age of mega-brands to the rage around international expansion and into the last few years of microVCs, super angels, and accelerators. The article argued that “platforms” were the future of venture capital. Indeed, we’ve written before about efforts that Andreessen Horowitz and First Round Capital are undertaking to be more service oriented — through armies of people or software, respectively.

I grant a lot of the points Erin made in that post — particularly relating to the necessary change the industry has gone through as a result of startups becoming dramatically more capital efficient. As evidence of big systemic changes, she cites a lot of people more experienced than I.

But as an entrepreneur, I couldn’t help but groan at the concept of venture firms becoming “platforms.” Respectfully, I need a venture capital “platform” like I need a hole in the head.

You know what works in venture capital? A group of incredibly smart, connected people who have the financial wherewithal and risk appetite to make multi-million dollar bets on unproven ideas and inexperienced founders. People who can make decisions quickly, and who spend their time trying to help entrepreneurs make the most of that cash.

That’s it. I don’t care what decade we are in or what wave of technology we are talking about. That’s it.

Watch “Something Ventured,” PBS’s excellent documentary about the earliest VCs. You’ll see pretty much the same qualities that make up the best investors today also made Arthur Rock the man who helped fund Fairchild Semiconductor and Apple. They are the same qualities that encouraged Don Valentine to take a risk on weirdo Atari back when the idea of playing video games at home was scoffed at by nearly everyone else. These qualities epitomize Tom Perkins’ bet-the-firm risks on Tandem and Genentech.

Yes, things have changed about venture capital since those halcyon days of silicon assembly lines and fruit orchards. Typical venture firms invest later and get far smaller stakes than they did 50 years ago. Deal flow is far less proprietary in an age of demo days, tech blogs, and AngelList. And we’ve learned that many people are just awful at the job of venture capital. We’re in the middle of a decade-plus long incredibly slow shake-out of zombie firms that have chronically underperformed the market. The dramatically low costs of starting a company have given new access to entrepreneurs of all skill sets, geographies, ages, and risk-appetites that the industry certainly didn’t see 50 years ago.

All of this is mostly good for entrepreneurs, and has forced VCs to prove that elusive “value add” they always talk about.

But VCs who perform well aren’t doing it, because they are jumping on the bandwagon of new marketing trends. They are doing it because they are good VCs the way Arthur Rock, Don Valentine, and Tom Perkins were good VCs. They take risk. They coach entrepreneurs. The respect an entrepreneur’s plan, even if it deviates from their own. And most of all — they have millions to invest in each company.

No matter how much we want to go on and on (and on) about how cheap it is to start a company these days, actually building a sustainable company has never been more expensive. Venture studies show the time and money it takes to get public are longer and higher than ever before.

It’s no wonder that the flood of accelerators and seed funds and angels on that chart we published earlier this week immediately predated the so-called Series A crunch. Did these firms revolutionize how many people could raise seed capital? Yep. But ultimately the vast majority of those efforts still need good old fashioned venture capital to keep going. And that’s still in short supply. Indeed, it’s indecreasing supply.

I’m not arguing that recruiting partners and marketing partners and new ways to leverage other members of a given portfolio aren’t good things. But at best, they are icing on the cake. If you are deciding between two great firms, perhaps it tips the scales. And in terms of returns, that’s not trivial. This is a home run business, and the difference between almost getting Facebook and getting Facebook is a multi-billion “almost.”

But entrepreneurs wouldn’t (or shouldn’t) go with a firm they get a bad vibe from simply because they have someone in house who can help you hire people. They should go with a firm, because they trust that partner to stand by them and give them the unvarnished truth and material support in good times and bad.

And, by the way, as is almost always the case when it comes to Silicon Valley, it bears noting thatnone of this is new. The late 1990s saw talk of keiretsus and marketing partners and accelerators and incubators. Likewise, a desire to go international has come and gone a few times in the venture business. Even crowd funding had roots in Draper Fisher Jurvetson’s ill fated “meVC” fund.

Sure a lot of these trends are being explored today in more sober and sustainable ways. But the ideas aren’t new, just as the idea of classic risk capital isn’t an anachronism.

At our July PandoMonthly, Bill Gurley said that every time a venture capitalist opens his mouth these days, he’s marketing himself and his firm and how they are different. How much more entrepreneur friendly they are than the next guy. Ignore the marketing — just pick a good partner.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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