Old VC firms: get ready to be disrupted

2010-05-02

If the U.S. economy were a company, the VC industry would be the R&D department. The financing for the VC industry comes from so-called LPs (Limited Partners) – mostly university endowments, pension funds, family funds, and funds-of-funds.

These LPs wield tremendous power, yet very few of them understand how startups or venture capital actually works. I was reminded of this recently when I saw this quote from a prominent fund-of-funds, justifying their investment in a 30-year old venture firm:

“As the amount of money raised by venture firms shrinks, older firms that were around before the dot-com bubble will benefit,” said Michael Taylor, a managing director at HarbourVest. “These firms have track records, brand names and knowledge about how to avoid making mistakes that younger firms do not necessarily have,” he said.

These older firms do often have track records – they’ve survived precisely because at one point they delivered good returns.  But it’s a mistake to assume that — because VC brands and institutional knowledge persist – past returns will predict future returns.  Here’s why.

VC brand names do not persist.  From the perspective of VCs and entrepreneurs, VC brands rise and fall very quickly. Given the excess supply of venture dollars, top tier entrepreneurs are frequently selecting their investors, not vice versa.  The VCs most sought after are mostly new firms:  big firms like Andreesson Horowitz, Union Square Ventures, and First Round, and micro-VCs like Floodgate (fka Maples), Betaworks, and Ron Conway.

VC firms don’t accrue institutional knowledge. VC returns are driven by partners, not firms. Studies have shown this, as will a quick perusal of the big exits at prominent VC firms. When key partners switch firms or become less active, VC firms retain very little residual value.  Some service firms — for example consulting firms like McKinsey — invest heavily in accruing institutional knowledge by developing proprietary methodologies and employee apprenticeship programs.  VCs develop no real IP and rarely have serious apprenticeship programs.

There is an old saying among big company CIOs that “no one gets fired for buying IBM.”  It’s much easier for a fund-of-fund partner to defend investments based on a VC’s track records. It’s a safe but bad strategy.

To intelligently invest in VC firms, you need to roll up your sleeves and dive deep into the startup world.  You need to learn about the startups themselves, assess the entrepreneurs, use their products, analyze market dynamics – all things that good VCs and entrepreneurs do. If you want to understand a VCs brand and abilities don’t look at their track record in the 90s – ask today’s entrepreneurs.  The answer will likely surprise you.

Unfortunately, very few LPs do this.  As a result, a massive amount of R&D capital is being misallocated.

Next post: Facebook, Zynga, and buyer-supplier hold up
Previous post: The tradeoff between open and closed

Views expressed in “content” (including posts, podcasts, videos) linked on this website or posted in social media and other platforms (collectively, “content distribution outlets”) are my own and are not the views of AH Capital Management, L.L.C. (“a16z”) or its respective affiliates. AH Capital Management is an investment adviser registered with the Securities and Exchange Commission. Registration as an investment adviser does not imply any special skill or training. The posts are not directed to any investors or potential investors, and do not constitute an offer to sell -- or a solicitation of an offer to buy -- any securities, and may not be used or relied upon in evaluating the merits of any investment.

The content should not be construed as or relied upon in any manner as investment, legal, tax, or other advice. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment. Any projections, estimates, forecasts, targets, prospects and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Any charts provided here are for informational purposes only, and should not be relied upon when making any investment decision. Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, I have not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. The content speaks only as of the date indicated.

Under no circumstances should any posts or other information provided on this website -- or on associated content distribution outlets -- be construed as an offer soliciting the purchase or sale of any security or interest in any pooled investment vehicle sponsored, discussed, or mentioned by a16z personnel. Nor should it be construed as an offer to provide investment advisory services; an offer to invest in an a16z-managed pooled investment vehicle will be made separately and only by means of the confidential offering documents of the specific pooled investment vehicles -- which should be read in their entirety, and only to those who, among other requirements, meet certain qualifications under federal securities laws. Such investors, defined as accredited investors and qualified purchasers, are generally deemed capable of evaluating the merits and risks of prospective investments and financial matters. There can be no assurances that a16z’s investment objectives will be achieved or investment strategies will be successful. Any investment in a vehicle managed by a16z involves a high degree of risk including the risk that the entire amount invested is lost. Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by a16z is available at https://a16z.com/investments/. Excluded from this list are investments for which the issuer has not provided permission for a16z to disclose publicly as well as unannounced investments in publicly traded digital assets. Past results of Andreessen Horowitz’s investments, pooled investment vehicles, or investment strategies are not necessarily indicative of future results. Please see https://a16z.com/disclosures for additional important information.