You can't get VCs together in a room for a minute before the conversation turns to who's pulling down how much in management fees, who's cutting the size of funds (and who isn't) and, inevitably, speculation about what funds are about to go belly up. The latest theme is a whispered uprising among investors in venture capital funds and their reported dissatisfaction with the millions of dollars in management fees being paid to VCs.
While VC-wonks are fascinated by the arcane minutia of limited partner agreements (anyone up for discussing clawbacks?) most people working outside of the industry couldn't care less. But there's a reason why all of the participants in the high-tech industry should be paying attention.
The gyrations in the venture capital industry are starting to negatively affect the very people the industry is meant to support: namely, entrepreneurs. And when the problems of VCs start to affect entrepreneurship and innovation, it's time to take notice.
With VC spending at an all-time low, cash-starved entrepreneurs are working harder than ever to understand the Byzantine requirements for securing venture capital. This is not a new phenomenon; it's just reached new levels of vagueness.
While most VC funds claim to be "early stage," it's not unusual for the majority of start-ups to get turned away from the gates of a big venture capitalist because they are "just too early." The real crime is that most senior partners at venture capital firms are excellent early stage company builders. Unfortunately, many times the billion-dollar fund structure won't allow such smaller early stage investments.
Some venture capital funds are signaling they may downsize to allow themselves the flexibility to fund earlier stage companies. But when and how this will really happen remain unclear. So, while VCs are in the back room with their investors, trying to find the "just right" size of their fund, many entrepreneurs are still outside at the gate, business plans in hand, unsure if they fit the ever-shifting investment criteria.
What needs to happen to ensure start-ups don't get shut out by the VC shake-up? I have a few ideas:
Funding criteria communication
Venture capital firms can do a much better job communicating to entrepreneurs about funding criteria--and precisely what types of companies they want to fund. The sheer number of industry panels on venture capital funding suggests that we've created a process shrouded in uncertainty. Let's hope that once this so-called "VC shakeout" occurs, we can more clearly articulate what stage of company we want to invest in.
Focus, focus, focus
I run a small, $32M seed fund. And while I have my list of challenges, one of the good things about running a modest fund is being forced to focus. Without the luxury of billions of dollars and a large investment staff, small funds are required to concentrate on certain sectors and investment stages; otherwise we'd simply spin our wheels chasing everything. It's been said that a confusing message is worse than a bad message, and most VCs can do a much better job communicating.
Let's get the "adjustment" over with already
The current uncertainty in the industry isn't good for anyone, especially entrepreneurs. Lately, venture capital funds are starting to announce reductions in their fund size, while others have announced the cancellation of billion-dollar funds. Kudos to them, for these are the funds that can put the uncertainty behind them and can go back to focusing their energy on funding companies.
Some say the shake-up in the venture capital industry is just getting started, that it will be years before we see the final results. In the meantime, there's no denying that the current situation is diverting attention away from the one thing that's most important: entrepreneurs. Unfortunately, much of today's investment practices are based on the needs of the venture capitalists and not on the needs of entrepreneurs.
And that just ain't right.