Are VC Firms Too Big to Fail? Part 1


too big to fail

VC firms live and die by the small handful of key investments in their portfolios. In most cases, firms perish if they can’t find that elusive “IPO home run,” which can make or break their fund. However, it is the pursuit of these rare investments that has created an insidious culture of investing in as many companies as possible and praying to baby Jesus that a few of them make money—what I like to call “carpet bombing funding.”

No one in the VC world wants to admit it, but the 2 and 20 system is broken. Badly. I compare it to a thief (VC) who sneaks up behind you (LP), bashes your kneecaps in, takes your money and then drops your mangled body off at the emergency room to get you straightened out, only to do it again.

Despite the over-raising and funding during the tech bubble, VC firms continue to raise bloated funds in excess of $1 billion. In an industry with a high failure rate (about 75 percent of startups ultimately fail), firms will have you believe that everything is sunshine and lollipops. Except it’s not.

Imagine if you were a doctor who was only able to save 25 percent of your patients. Unless you were a Mexican doctor, having a 75 percent failure rate is totally unexpected and unacceptable. And yet, this is exactly how the VC industry is setup. It’s complete lunacy when you think about it.

Just recently, I was looking at KPCB’s website—they have more than 50 partners. Can’t you just feel a “How many VC’s does it take to screw a light bulb” joke coming? And for all their fancy Stanford/Harvard MBA educated partners, their fund performance has faltered. I also couldn’t help but chuckle when I discovered that Al Gore is actually on their investment team—you can’t get any more bloated than that!

Which leads me to another problem: management fees. Sure, VC management fees might not have the same level of largesse compared to Wall Street, but it’s a dirty secret no one likes to talk about. But we will do just that, in Part 2…

Reprinted by permission.

Image credit: CC by jonwa60

About the author: Jay Deng

Jay Deng is an angel investor and venture capitalist. He invested in two companies whose exits topped $800 million. He is also the CEO and founder of Diva For Less.

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