Top LP Getting Pickier In Shrinking VC 'Cottage Industry'
There's a lively debate ongoing among limited partners about the importance of a venture capital firm's reputation. Are the most well-known firms really the ones that provide the best returns to their LPs? Or are many coasting on past successes?
Fred Giuffrida, managing director of Horsley Bridge Partners, an influential fund of funds, tends to think reputations can be overblown - and that, in any case, the number of firms worth investing in is much smaller than most LPs think.
"Venture capital as an asset class is around the size of some public companies," Giuffrida said Tuesday in a keynote interview at Dow Jones Limited Partner West Summit in San Mateo, Calif. "A public company can hardly be called an asset class. [Venture capital] is really more of a cottage industry."
Giuffrida believes it's worth investing in some venture capital funds – his firm is doing just that with its $1.75 billion fund, raised in 2008 – but Horsley Bridge sets a high bar. "We continue to invest in great, established funds, but that's a smaller list than five years ago. They're the ones that are not in danger of creating mediocre returns, [which are] the kind of firms that are good enough to keep raising funds but not good enough to create outsize returns."
Giuffrida cites some well-known criticisms of the industry – the tendency of general partners to build investment strategies around fund size, the difficulty in gaining accurate returns data - in explaining his relative bearishness when it comes to venture capital. He still believes the top performers are still worth investing in – but he thinks the top decile is the real target, not just the top quartile.
He puts the number of true, quality top-decile firms at "40 or less," and says many of them are not the brand names with gaudy past successes. Horsley Bridge has invested in several VC firms recently that have funds under $100 million, with small teams, an earliest-stage investment strategy and a focus on capital efficiency.
That's not to say the brand-name firms aren't still some of the top performers. But LPs must be more forceful in their due diligence, he says.
"The questions that need to be asked are: 'Are the same people still around? How are the next generation of investors doing? Is there a hunger to produce great returns?' These questions can be difficult to answer."
He points to the misalignment of LP-GP interests stemming from out-sized funds and the corresponding massive management fees as red flags when it comes to brand-name firms. "As you scale funds, interests are not completely aligned. As long as [firms] continue to raise money, it can lead you down a risk-averse path."
Horsley says brand still has its advantages, citing the ability of well-known firms to recruit top talent, as well as the benefits of deal flow. For some of these brand name firms, "The game is available to continue to win," he said.
"Brand is a huge advantage. But it's not sufficient.--
The Way of the VC: Having Top Venture Capitalists on Your Board (On Amazon)
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Praise for Way Of The VC - Top Venture Capitalists on Your Board
"Yinglan gives valuable accounts coupled with insightful observations about the past, present and future of an industry that is still in its infancy-but growing up fast. It will also help entrepreneurs who need venture capital financing by showing them how VCs value-add to their companies. This book belongs in the library of anyone who has ever taken a serious interest in venture capital. "
Neil Shen, Founding Managing Director, Sequoia Capital China
"The Way of the VC" is the best book I have read on Venture Capital with thoughtful advice for the entrepreneur. Yinglan Tan captures the wisdom of the ages, with the vision of an oracle in this book that captures how a venture capitalist thinks, and how the best ones act.
Tim Draper, Managing Partner, Draper Fisher Jurvetson
This book is a practical guide to the interplay between VCs and entrepreneurs that often contributes to the meteoric rise or utter failure of a startup venture. As entrepreneurship and venture capital are slowly transitioning from ad hoc activities into professions, the common principals applied by experienced professionals are emerging as foundations. Yinglan Tan's book provides a solid account of these emerging foundations.
Noubar Afeyan, Managing Partner & CEO, Flagship Ventures
With the emergence of venture capital investment as a professional practice, understanding the way in which this industry works is critically important for practitioners and would-be practitioners, whether they are (or aspire to be) working for entrepreneurial ventures, venture firms, or large institutional capital pools. I applaud Yinglan Tan, who has distilled many interesting "war stories" and experiences of venture capitalists into a useful and effective framework in The Way of the VC.
Professor Josh Lerner, Jacob H. Schiff Professor of Investment Banking, Harvard Business School
"Yinglan gets into the minds of venture capitalists to show us how they think. There is much in common between VCs from the West and those from the East, but also much that is importantly different."
Tarun Khanna, Jorge Paulo Lemann Professor at the Harvard Business School and Best-Selling Author, Billions of Entrepreneurs: How China and India are Reshaping Their Futures and Yours
I have taught private equity courses for MBA's and executives for fifteen years, and I have seldom run across such insight. Based on painstaking research, Yinglan Tan has demystified the venture capital investment process. If you want to know how venture capitalists think, what they are looking for, and how to choose one, read this book. Venture investors looking to grow in Asia will find penetrating observations and valuable advice. I highly recommend this book to anyone interested in building high-growth companies.
Professor Philip Anderson, INSEAD Alumni Fund Chaired Professor of Entrepreneurship & Academic Director, The Abu Dhabi Centre
Top-flight entrepreneurs are blessed with terrific ideas and boundless energy. But they usually lack capital; hence they must join together with venture capitalists (VCs). The prescription is easy, the implementation tough. Entrepreneurs and VCs differ in orientation, background, and interests. In this lively volume, Yinglan Tan tells how entrepreneurs should handle the relationship from early-stage conception through to a thriving company. The pages bristle with insights gained from in depth discussions with successful VCs and entrepreneurs. It then imparts lessons distilled from intense study of the field and careful analysis. Entrepreneurs should take this volume to heart, and thus avoid missteps and grief.
Richard Zeckhauser, Frank P. Ramsey Professor of Political Economy, Harvard University.
"The Way of the VC" is a must-read book for entrepreneurs and venture capital professionals. Yinglan achieved a harmonious balance between the theory – the Commandments – and the practice – first-hand accounts by VC. The delightful stories clearly and effectively illustrate important lessons for all players in this industry.
Koh Soo Boon, Managing Partner, IGlobe Partners
Venture Capitalists rely heavily on personal judgment and experience. This extensive collection of shared wisdom and viewpoints is therefore a valuable addition to the growing number of VC textbooks and war stories. Yinglan has skillfully captured the Tao of VC practitioners and entrepreneurs in a lively and enlightening book.
Lin Hong Wong, author of "Venture Capital Fund Management: A Comprehensive Approach to Investment Practices & the Entire Operations of a VC Firm".
"Friendly, thorough, and helpful. Yinglan has shown how VC's can help an entrepreneur's business and how to attract their attention."
Dan Schwartz, former Chairman, Asian Venture Capital Journal and author, The Future of Finance: How Private Equity and Venture Capital Will Shape the Global Economy
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