The Smart Money? Silicon Valley VCs Outperformed By Market Averages Over Ten Years

The incredible shrinking return. For a couple of decades we have bowed before what we have been assured is the superior wisdom of the professional investing class: hedge funds, private equity, venture capital. They had, we believed, the knowledge, the skills, the experience and well, not to put too fine a point on it, the avaricious ambition required to prevail in an acutely competitive global market.

Success for investors has been measured in above market returns. But a host of recent studies about all three arms of the 'excess returns industry' suggests that this confidence may have been largely misplaced.

The hedge fund and private equity underperformance data has been evident for some time. And, truth to tell, there was always a whiff of puffery about it. The fee structures were exorbitant: just reward, all were assured, for their risk and knowledge. But as returns have decreased and indictments have risen, the problems inherent in attempting to beat the various arms of the market have become manifest.

Venture capital has managed to retain some of its aura of invincibility even in the face of declining activity and liquidity events. The industry benefited from the belief that investing in tech required people with exceptional education and intelligence, especially of the electronic/digital/network kinds. But this latest report lays bare the same issues faced by the hedgies and private equity types: too many people with the same backgrounds, outlooks and equipment chasing too few opportunities. This raises prices for the few, actual potentially bankable investments and stimulates interest in a whole bunch who might otherwise be better off enjoying the obscurity they so richly deserve (to paraphrase JK Galbraith).

The implication is that financialization has its limits in whatever end of the market one explores. At some point, someone actually has to create something that someone else values enough to buy and use, not just admire from afar. What a concept. JL

Tom Foremski reports in Silicon Valley Watcher:

The National Venture Capital Association (NVCA) and Cambridge Associates recently released a study showing that VC funds returned an average of 7.4% annually over a ten year period. For early stage funding it was just 6.4%. This compares to 8.5% for the S&P 500.
The VCs of Sand Hill Road have an unshakeable belief in their investment skills, despite the study's Big Data showing they can't outperform a grandmother investing in an S&P Index fund.
 It's easy to see how "smart money" VCs end up with dumb money returns, when they herd into the same types of me-too startups and ruin the market for each other; or force their portfolio companies to pivot their business plans based on the trend du jour in their Twitter streams.
Add to that, imposing toxic term sheets onto a startup's founders -- and it's no wonder they are increasingly despised in startup communities on both coasts.
Random picks
The VCs are extraordinarily bad at picking winners. It might be better to assign investments to a wide variety of startups on a lottery basis.
I can guarantee there would be far fewer me-too startups funded; and the next big thing is always the ugly duckling no one wanted so you might just get lucky and get that black swan event -- an extraordinary return on investment. It certainly won't happen by following the groupthink of the gulag.
A funding lottery for pre qualified startups could work. Random acts of funding will hit gold some of the time and probably about the same number of times as "smart" funding.
A long line...
There's always been plenty of people that would love to prick VC egos but lately, their numbers seem to be rising. Others see it too.
R. Scott Raynovich at The Rayno Report writes that, "a quiet attack is building on the VC industry."

"Entrepreneurs and tech-company executives I have been speaking to lately have turned up their griping about VC investing, pointing out that it's dysfunctional and overrated."

Mr. Raynovich points out that a small number of VC firms have done well:

"Accel Partners, Sequoia Capital, Andreessen Horowitz, and Greylock Partners, which was recently profiled in this interesting Bloomberg BusinessWeek article... Greylock was invested in Facebook (FB), LinkedIn (LNKD), Pandora Media (P), Workday (WDAY), and Palo Alto Networks (PANW). That seems like more than luck."

However, the lack of data on individual VC funds makes it hard to judge performance; how much luck or brains, separates the cream from the whey.
Every VC company is a media company...
Keeping up the VC myth of "smart money" is tough when the Big Data shows it's clearly not. But there are tried and true methods to keep the hot air pumping up the hype using traditional means: PR and media.
Andreessen Horowitz, with more than $2.7bn under management in three funds, is leading the way. The firm recruited Margit Wennmachers, the co-founder of PR firm OutCast Communications as a partner; and more recently, it hired Michael Copeland, a senior editor at Wired magazine.
Some its partners have made private investments in PandoDaily, the tech news site, and in local media stars such as Michael Arrington and his CrunchFund.
It's paid off well. The firm's founders have been regularly featured in the New York Times and other leading media outlets such as CNN. It's making other VC firms jealous and I hear that other VC firms are scrambling to do the same and boost their time in the spotlight -- rather than their startups.
Because it is all about the dealflow. Yes, you might turn down the next Google or Facebook --every VC firm has it's stories -- but at least you had the dealflow to turn down. Being constantly in the media is key to getting to see the best of the startups and that means more chances at beating the S&P500.
Hiring good journalists could be a good strategy for VC firms to differentiate themselves from the herd but I doubt it will work. The journalists will be simple employees at the beck and call of masters that always know better.
Inside the mirrored bubble their reflection looks so very good -- which is why we need an independent media -- to point out any distorted fantasies. It's good for all.
And there's no point in hiring journalists to produce puff pieces about the "Princes of Sand Hill Road" when there's plenty of PR people expert in kissing frogs.