No less than the president and the CEO of the noted Kaufman Foundation, the $1.8 billion endowment fund that promotes entrepreneurship, are saying that the current VC model is broken.
In an article in Business Week, Carl Schramm and Harold Bradley say the prominence of American venture capital has taken a tumble from its heyday in 2000. The industry that spawned such successes as Apple, Cisco, Google and Microsoft, only invested $4.8 billion into 637 companies in 2009 (and that’s down 33 percent from 2008).
Schramm and Bradley believe the “2 and 20″ formula (2 percent of annual management fees and 20 percent of profits on exit) is to blame. The formula worked well two decades ago, when most VC investors were wealthy individuals with “patient capital,” who were willing to wait 10 years for a start-up to blossom. But in the past decade, more and more institutional money has flooded into the VC industry. These big corporate and public pension fund investors are willing to commit huge chunks of money on the same 2 and 20 terms. But the higher capital volumes generate sizeable management fees for VC funds, which encourages VCs to focus more on raising funds than on nurturing start-ups along the long road to success.
And since institutional investors are under pressure to show short-term returns, VC funds started “flipping” their start-ups after just a few years, to create quick payoffs.
Schramm and Bradley believe that forcing VC funds to hold onto their best portfolio companies longer … and forcing them to put more of their own “skin” in the game, in terms of partnership money, would help. The full article is worth reading at BusinessWeek.
You are invited to participate in Job Search Digest’s annual Private Equity and Venture Capital Compensation Survey, which we are conducting to provide information to evaluate compensation, negotiate better job offers, and benchmark firm compensation practices.
Last year hundreds of respondents from around the world completed the survey. We had participation from firms both large and small such as: Credit Suisse, Labrador Ventures, Intel Capital, Mayfield, New Enterprise Associates, and SoftBank Capital. The survey addresses issues such as the compensation earned by professionals and their work satisfaction.
A Few of Last Year’s Findings:
- Many respondents said they were concerned about their firm’s ability to raise the next fund. An anemic IPO market makes it harder to present investors with a clear path to a successful exit.
- It turns out that size does matter. Funds in the mid range raised the bar when it comes to private equity compensation.
- Working hard does pay off. An interesting finding in looking at private equity work and personal life balance is that there is a direct correlation between hours worked and total compensation earned.
Follow this link to participate in the annual Private Equity and Venture Capital survey.
Many private equity firms grew too large and were overpaid at the peak of the economic boom, and that’s going to lead to structural changes in the industry. So says private equity manager Guy Hands in a recent interview with the New York Times.
Hands is well known for his own unfortunate $4.73 billion purchase of record company EMI in March of 2007, a move that will likely cost his investors and his PE firm, Terra Firma, millions, if not billions in losses. Now he is desperately trying to keep the business afloat while delivering vast interest payments to the banks that financed the transaction, most notably, Citigroup.
Hands comments that many funds grew so large during the peak that their 2 percent management fee became just as important as the 20 percent cut of performance. Success had less to do with performance than simply bulking up on assets. And managers did not use the excess fees to invest in resources and grow the skill base of their funds.
Now he sees the industry beginning to contract, as firms struggle to raise enough new money (and corresponding fees) to support the hundreds of people they already employ. It is similar to what happened in the venture capital industry in the late 1990s, when investors realized too much money was chasing too few deals.
