How VC Works

When VCs are just like Start-Ups

Every once in a while you need to write a really bad and evil article. Here it goes .I think this slams 99,99% of the VC founds out there. 😉 Maybe not funny to VCs, but maybe funny to my Asset Management colleagues. And something from the heart, especially since running a VC fund became as popular as being a rapper after Vanilla Ice and Ice T hit the scene. And because the shere abundance at micro-VC funds in Europe is a clear symptom of a failing system.

Actually just right now it fell into my eyes so clearly. That fund managers have the exact same problems that start-ups have. They don’t know the environment in which they play and they have a talent acquisition issue.

I think I wrote anough about start-ups. But let’s talk about VC funds.

The Asset Management view – Getting your investors

If you are a pension fund, a insurance asset manager, Blackrock or whatever dude on the top 50 AUM Charts (those are matterful to asset managers), you are priding yourself with CFAs on payroll, how low your fund management fee relative to AuM is. You are a rockstar in building special purpose fund vehicles.

The game is quite is simple. Don’t lose money. How? Make some decent micro-returns on individual positions; have a large pile of shadow profits that you can use to level out excess losses (10% of AuM at some firms or possible more?), and most importantly: don’t lose money! Yes, absolute returns matter to people that invest in all asset classes and have debt-like return obligations. The game is about not losing money on paper and allocating a lot of capital.

If you are such a big dude, you are operating in almost all legal jurisdictions on the planet. You are able to report in all global reporting regimes.

So if you allocate money to VC, it is going to be a tiny bit of your total AuM. You will spread both in Funds of Funds – yes, that is an asset managers way to syndicate with other asset managers – and direct investments. The direct investment money iwll be limited to those that are capable and willing and able to invest in alternative and VC funds.

The important thing here is to understand risk-return expectations, asset allocation and asset exposure requirements of your LP investor, who will require a look-through reporting to his investors who will allocate based on their risk-driven allocation strategy. So you need to (a) report ideally in the many reporting frameworks your LPs are asking for, timeliness and quality of reporting must meet decently high / CFA okay standards, and you must provide look through reportin so they can pass through to their investors.

The more important thing, yo uneed to understand asset allocation and how to play that game. In your PPM discussions oyu need to understand who you are serving. Their balance sheet risk or that of their investors?

So yes, there are the things that kill your position in front of serious LPs:

  1. Your ability or inability to timely, properly and skillfully report to your investors in a proper format
  2. Your ability or inability to report with a portfolio allocation mindset in mind
  3. Your ability or inability to have a proper risk management in place which includes proper skills in multi-currency, multi-sector, beta-/vs. alpha and macro-risk driven investment
  4. Your ability or inability to cater to the portfolio construction thoughts in the asset management industry. So if you have no macro research, no trend spotting, and you are just doing “stockpicking” you are out.

 

All this stuff immediately disqualifies all those funds that minimize their opex and management fees to increase their carried interest with decent fund MOICs. Yes, if your fund structure is bad or you are not capable to consistently get to a decent MOIC and IRR on your investments, you won’t raise big game institutional money. And if you are too greedy for carry in your first fund and you are too much of a miser on fund opex, you will be classified a “partner-driven” fund. You exist for your benefit. Not LP benefit. They smell it. Processes and disciplined investment costs money. It’s good enoughif you make 2to 4x on your first funds and you manage to stay right below preferred interest expectations, but you start building a scalabe model catered to LPs if you want to increase fund volumes. Unless you are hunting dumb LP money. Real asset management doens’t look at you. Forget 10+ billion funds.

I mean I clearly remember the only people that didn’t manage to report daily NAVs were ship and real estate funds when I worked in AM. Of course, NAV didn’t change much for PE funds on a day to day basis. But at least monthly, there should have be a fair market update. If you ran quarterly, you were considered a nuisance. Because we had those guys in our client portfolios bundled with bond and equity positions and look throughs. It looks moronic if you haven’t had a price update for a quarter or year.

If we wanted to allocate a few billion on a short- or mid-term thesis, it took 2 weeks in drafting, 2 weeks in legal set-up, 2 months in hiring an entire set of personnel and we were up and running and reporting in 3-5 months. Thereby syndicating the thesis with 2-5 other asset managers. That is how we allocated 5 – 50 billions. We didn’t really even look at carry-hungry guys with less than 15 years of AM / Fund Management experience and decent return profile. 

Stop being a kid – Don’t be a local band – getting your go to market

The next thing you have to clearly recognize is that Venture Capital isn’t a stock picking game. All those long-tail guys wishing for their unique 3000x MOIC investment in a local ecoystem are kind of funny. Truly, think you have to deploy 2 trillion in assets year over year. You can spend 2% on Venture Capital. That is 20 billion. Do you want to focus this on a 5 people play in a local ecosystem in Timbuktu?

  1. Have a thesis and the money to spend on building a thesis.
  2. Look at this globally.
  3. Do real diligence.
  4. Build a network of syndication, hiring, sales introduction that helps a company you sponsor cross the chasm
  5. etc.

Ensure 10x returns on every fund and you are getting attention. You are never expected to get top picks when you are a invisibly small fund in a local ecosystem that doesn’t have the bandwith and visibility to attact the right company. You are not solving the asset managers problem if you are one of 200 other funds that all randomly pick local stocks without giving a proper look through.

Don’t hire B players – getting talent acquisition

Now comes the other funny thing about VC funds. If you aren’t able to hire away the best and brightest from Seqouia, Andreessen, Blackstone, KKR, etc. then who are you? It is like a start-up that competes with Google but cannot even hire away its own competitor employees.

And yes, hiring top talent require good economics. We all know what good economics look like. Deep 6 to 7 digit compensation packages, carried interest in very large AuM VC funds. A real shot at making carry in a decent time frame. And a real deeply-rooted passion and ability in the skills need to build a legacy in venture capital.

If you don’t have the skills to raise funds to get those guys, or you are not having the confidence of creating a fund on that level, you are one of those tier 2 to tier 4 dudes that is as boring as a founder that sells dog food over the internet.

Good luck. You are on the same level as that 17 year old female kid that is doing start-up coach in your rural start-up ecosystem.

Don’t be mad. Maybe talk to some more investors and confirm. or look at your LP cap table. Any university endowments? Governmnet pension funds? Any 500+bn asset managers? Why not?

 

PS: No offense. But more funds, lower fund sizes, equal investment universe implies lower investment tickets spread over wider numberof assets, which reduces valuations and financing raised, which implies more failing start-ups, lower Return-on-Time for founders and hence more mid-quality founders created in the ecosystem, which weakenes the geographic ecosystem development. Less qualified founders are more likely to try to learn from better ones, which leads to them exiting the ecosystem and going to the US or APAC. So everybody loses on a race for some quick wins on first and second time funds heading for decent returns. The entire system is biased to spray and pray investment models where investors of small funds are leeching of larger exit players and toast LP money by having no selection model and no divestment thesis. Thereby crippling the market even longer than needed. So time for a slam. 😀

Feedback and corrections are of course appreciated. This might just be a young kids opinion. Goal is to make everyone smarter and more humble.

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