Looney thoughts, perspectives, and insights on the world of business!
– By Blake Glenn
According to a recent post on the Harvard Business Review blog, large fund venture capitalists are acting, and being paid, like asset managers instead of the aggressive, risk-taking, swashbuckling cowboys (or is it pirates?) their image purports.
Apparently asset managers typically get the bulk of their fee based on the size of the funds they manage rather than the actual performance of the assets. And VCs are being paid in much the same manner according to the Harvard Business Review. Rather than the bulk of their compensation being tied to the performance of their funds, their typical 2% asset management fee compensates them PDM (pretty damned well).
For clarity, the usual VC model is to realize about 20% of the “cash out” of any startup in its portfolio. The remaining 80% goes to the limited partners that provided the investment money. But in the last several years, many VC funds have had few cash outs.
Of course the current model really works best if the fund is big … Big … BIG!
For instance, here are the compensation numbers at a 2% management fee structure for 3 VC fund sizes:
- $10,000,000 @ 2% = $200,000
- $100,000,000 @ 2% = $2,000,000
- $1,000,000,000 @ 2% = $20,000,000
So the larger the fund, the sweeter the fee. And the institutions (pension funds, college endowments, foundations … etc.), aka limited partners, that provide the money for VCs to build their funds, can be locked in for 10 years.
To compound this problem according to the post, the VC return the last 15 years hasn’t exceeded the typical stock market averages by enough to justify the investment by limited partners into these very large funds.
And as if that’s not enough to raise the big ole red flag, most of these VCs apparently only put in about 1% of their own money into any of their funds. And, if this post is accurate, that 1% is usually the money they get from the fund management fee itself, not from their own personal funds. So as this structure stands, VCs have little to none of their own skin in the game.
When you combine the under-performance issue with the 10 year fund commitment and minimal VC “skin in the game”, the potential fallout could be a nuclear winter that sees institutions shifting their money out of VC funds for better opportunities elsewhere. Combine that with the rise of crowd funding and we could see a major long-term change in the VC industry.
One final ironic twist about the VC game. The Harvard Business Review post points out that, in terms of economic structure, the VC industry has been severely lacking in disruption. You know. Disruption. The go-to word investors, entrepreneurs, and anyone else with access to the business news loves to throw around at industry gatherings, cocktail parties, and weddings. Even invoking that word at funerals has been known to lighten the mood, set eyes a glow, and bring back the formerly deceased to pitch an idea right on the spot.
When’s the last time an investor asked you:
“How much skin do you have in the game?”
“How are you disrupting your target industry?”
The next time you’re asked those questions you can simply say:
“Our goal is to minimize my own money at risk, let the suckers worry about disruption, and make lots of dough with other people’s money. Now how about we get you signed you for $25,000,000 this round? This once-in-a-lifetime opportunity will not last very long!”
Blake Glenn shares his looney perspectives, stories, and mis-adventures in The Looney Executive blog. He has interviewed hundreds (or at least tens) of people via The Looney Executive Podcasts and former TV show. He’s the founder of a tech group called IgniteTech, and claims to be a direct descendant of the original Looney Executive – Because there must be SOME explanation … right?).
If you dare, he can be reached the old school way … blake@LooneyExecutive.com
P.S. – If you’re really interested in growing the tech startup scene in SW Ohio, you’ll want to join the IgniteTech Meetup Group. Join the group. Come out to our events. Bring your energy and ideas. Build your connections.
Join us on this adventure. And help us to create a great story!