Venture Capital Sucks

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At least that's what David Siegel thinks. While certainly not a huge name in the industry, the guy seemingly has some good firsthand experience-- and isn't afraid to disparage the model of venture capital as a whole.

I believe venture capital is broken, both for LPs and entrepreneurs. While the venture-capital landscape is changing, the sales narrative remains the same: We are the smart, experienced, (generally tall, good-looking, white, male) entrepreneurs-turned-investors who can beat the market through exclusive access and careful selection of early-stage companies ("We invest in teams, not ideas"), brilliant board work, and our networks of contacts.

It isn't a novel idea, claiming that VC returns are typically below average. We all know of Bridgewater, or Pershing Square, or Greenlight's above-average returns, and just as well we understand that those firms are abnormal performers. The same goes for VC/PE-- a majority of firms mirror their benchmark, perhaps over- or under-performing up to a few hundred bps on occasion, but very few make it to Blackstone or Andreesen-Horowitz levels. Now, I'm not saying that this is indicative of a poorly-managed fund; I'm sure there will be someone who brings attention to the "true" purpose of these alternative investment vehicles, mainly bringing stable returns across various market cycles. However, Siegel raises the point that at almost all levels, venture capital has no value-add.

Extensive professional networks? Board room expertise? Operational wizardry? According to Siegel, these elements have minimal impact on the success of a company.

After several years of study, I now believe that if there had never been a single venture capitalist (professional early-stage investor), the world would be about the same as it is today, only the logos would be different. In other words, it's market demand that creates companies, not board meetings, brilliant plans, and road maps.

Siegel includes links to many interesting articles and studies to back up his claims; there are a lot of psychological fallacies that he cites as reasons for the misappropriation, or illusion of, success. I'd recommend checking out the rest of the article during some downtime, but it makes me wonder-- how much more of a gamble is picking a successful VC fund versus, say, a HF or PE-firm? Are you putting yourself at an inherent disadvantage, or is Siegel just full of crap?

Comments (11)

 
Best Response
Apr 26, 2016 - 4:36pm

Whoever wrote that is full of crap and is arguing with irrelevant points. The best venture firms consistently generate outsized returns, most notably Sequoia, Benchmark, Greylock, and Lightspeed (not AH, which is doing a lot worse than most people realize). Outside of the top tier firms and a few small focused firms (e.g. Union Square in consumer, Lowercase in seed, Emergence in enterprise SaaS), the rest suck. There is a very steep power law in venture. But the best firms are consistently the best year after year, fund after fund. So long as that is the case, it makes sense for LPs to try to invest in the top firms, as well as newer firms that have the potential to become one of the top tier. LPs aren't nearly as stupid as people make them out to be. They are professional asset managers, who are incentivized, paid, and hired + fired based on their ability to manage capital to minimize risk and maximize returns. They are ruthless about reallocating assets and cutting managers that underperform. If venture didn't work as an asset class, they would pull out quickly.

Also, venture is essential as a long term capital source for startups. How else do they fund infrastructure, employees, etc for years while they are cash flow negative? Do you think Snapchat in 2011 would have been able to get a small business loan? Google in 1998? Market demand doesn't create companies that can't sustain themselves. High risk high reward funding sources like venture are essential to building high growth technology companies. This industry didn't get created by accident, but by design.

 
Apr 30, 2016 - 8:52pm

VC_associate_13:

Whoever wrote that is full of crap and is arguing with irrelevant points. The best venture firms consistently generate outsized returns, most notably Sequoia, Benchmark, Greylock, and Lightspeed (not AH, which is doing a lot worse than most people realize). Outside of the top tier firms and a few small focused firms (e.g. Union Square in consumer, Lowercase in seed, Emergence in enterprise SaaS), the rest suck. There is a very steep power law in venture. But the best firms are consistently the best year after year, fund after fund. So long as that is the case, it makes sense for LPs to try to invest in the top firms, as well as newer firms that have the potential to become one of the top tier. LPs aren't nearly as stupid as people make them out to be. They are professional asset managers, who are incentivized, paid, and hired + fired based on their ability to manage capital to minimize risk and maximize returns. They are ruthless about reallocating assets and cutting managers that underperform. If venture didn't work as an asset class, they would pull out quickly.

Also, venture is essential as a long term capital source for startups. How else do they fund infrastructure, employees, etc for years while they are cash flow negative? Do you think Snapchat in 2011 would have been able to get a small business loan? Google in 1998? Market demand doesn't create companies that can't sustain themselves. High risk high reward funding sources like venture are essential to building high growth technology companies. This industry didn't get created by accident, but by design.

Pertaining to your second paragraph, you obviously did not read the article.
The very first sentence of this guys post is the link to the article, just so you know.

 
Apr 27, 2016 - 2:18am

I disagree with most of the article, but one line that really gets me is: "Success in new ventures is not about product-market fit. It's really about getting lucky. It may look like skill, but you're not seeing the tens of thousands of skilled entrepreneurs who fail".

What?

This is like saying 'Producing good movies isn't about finding a winning script and understanding Hollywood, it's just about getting lucky and the audience just happening to like it. If you want proof, just look at all the movies that have flopped.' Ludicrous.

You can't just point to the general failure of several hundreds of startup ideas and say that the larger framework of venture capitalism as a whole is "broken". That's a copout. If you really want to prove this, look at individual VCs, and examine their rates of success: The number of companies they funded that went bust vis-a-vis the ones that did well. You can't just leave a vague, jargon-replete proclamation like "Cognitive biases like 'base-rate neglect' affect our ability to see true cause and effect, so we think it's about skill, when it isn't" out there without statistical backing, and expect to be taken seriously.

Also, Siegel believes "after several years of study", that if there hadn't been a single VC in the world, nothing would be different from what it is today. Peter Thiel, Andy Bechtolsheim, Marc Andreessen, are you guys listening?

Nonsense.

 
Apr 27, 2016 - 8:28am

It's not just venture capital. It's the buyside in general. The whole industry is founded on the denial of science/economics. The industry is contracting and it will continue to do so. The evidence is extremely clear: the risk-adjusted returns are shit (pre-fees), the fees are too high and there are easier/more efficient way to diversity one's portfolio.

“Elections are a futures market for stolen property”
 
Apr 27, 2016 - 1:18pm

In general, I would say that HF/PE investments are only on the efficient frontier on a very limited basis as a source of diversification (i.e. only for institutional investors that are already extremely diversified and are able to negotiate lower fees). I haven't looked at the VC data enough to be certain but I would expect VC investments are pretty heavily correlated with broader equity markets; therefore, I'm not sure clear on what their value proposition is (not to say there clearly isn't one, just saying it's not obvious to me).

All that said, that's a very different argument than the OP's article is making. I wasn't overwhelmed by the depth of the author's arguments in general.

Life's is a tale told by an idiot, full of sound and fury, signifying nothing.
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