Is Venture Capital Broken? comments by David Drake

Dan Primack, on his CNN Money blog, tells us about a study claiming venture capital just hasn’t yielded the promised returns. He cites a report from the Ewing Marion Kauffman Foundation that boo-hoos the lack of reasonable return on the foundation’s investments. And that’s part of the problem — when your data set is based on poor performance,  it might be time to examine your own rationales and structure, rather than blame the entire market.

Still, there’s a “there” there. And according to Primack, it’s the difference between being a general and a limited partner in VC deals. This is because of a misalignment between the two types of investors. His recommendation: “…for many LPs, venture capital may not work best as a dedicated asset class. The industry stratification is severe, and becoming self-perpetuating as the best entrepreneurs seek out the “best” venture capitalists. If you can’t get into a few dozen of the best GPs – including emerging managers — perhaps the next-best option is a public index rather than a second-tier fund (and by second-tier, I probably mean “below top-decile”).

But another critical element is left out entirely. When investors only see a bottom line number and aren’t aware of the underlying social goods in play. Increasing transparency and seeing actual social benefits from investments  adds intrinsic value. This level of information is what LDJ Capital offers and we believe it can only help investors make better decisions.

Primack’s critique is about fund structure transparency, not specific, ground level investment activity.

For example, LPs should have information about underlying fund economics. If two senior partners get most of the carry in a firm with young stars, then that is pertinent information LPs should have when making a decision. More importantly, 2% flat management fees – as opposed to budget-based fees – create a perverse incentive to keep raising larger and larger funds, even if not merited by the market opportunity (and, remember, Kauffman believes larger funds underperform). And how come VCs put liquidation preferences on their own transaction, but generally oppose hurdle rates or waterfalls on their LP agreements?

— David Drake