Fred Wilson and the Death of Venture Capital

Several years ago, the online version of Forbes Magazine did an interview with Fred Wilson, Managing Parter at Union Square Ventures in New York City, entitled "Fred Wilson and the Death of Venture Capital". Fred Wilson is, without question, one of the most brilliant and savvy venture capitalist of our time and a keen and insightful observer of the current venture capital and private equity scene. If you're interested in reading the original article, here's the link:

https://www.forbes.com/sites/jjcolao/2012/05/08/fred-wilson-and-the-death-of-venture-capital/#3cb7236142b1

In retrospect, what's so fascinating to me about the article is not that Fred was right at the time the article was written (clearly, until very recently, venture capital has enjoyed a tremendous boom, both in terms of the amount of venture capital raised (many times the amount that Fred estimated at the time of the article's appearance) and in the success enjoyed by the very early money in (in contrast to the disaster all those downstream have suffered, e.g., IPO disasters like Uber, Lyft, WeWork, etc. etc. etc....), but how prescient he now appears given what's happening in Silicon Valley at this moment as venture capital rethinks the model that's been so popular with it since the early part of the current decade.

To underscore this point, I'm providing a link to a folder containing a number of different articles just recently written by reputable writers who follow the venture capital and private equity markets closely. The theme among all of them is the same: the current venture capital model is broken and the high regard we've been holding VCs in is starting to slip away. Here's the link so that you can peruse some of those articles:

https://drive.google.com/drive/folders/19M4g4rUvih7-mlCvf85sPj1e81r_nlo9

All of a sudden, making a profit is back in style. And, all of sudden what's not, is the approach of simply pumping money into a questionable business model in the hope that by scaling up alone, the elusive goal of making money will finally be realized, someday, somehow, somewhere. All of this leads to a simple question: given the fact that making money is actually a pretty hard thing to accomplish, what's an investor to do? Where should that money go instead, given the fact that Silicon Valley has yet to figure out its next move.

From that perspective, several things that Fred said in his 2012 interview have become quite relevant at present (timing is everything). During the interview, when Fred was pressed by the interviewer about why he thought the picture for VC looked so gloomy at the time, Fred spelled out the forces that, in his opinion, were conspiring to make the old VC model obsolete:

"The biggest issue: there is simply too much money. Although $30 billion continues to flow unabated into venture-backed companies annually in the U.S., venture capital as an asset class hasn’t outperformed the market since the early 90’s, when only $10 billion was put to work. Things look even bleaker when you add in the additional $10 billion that angel investors dish out (a threefold increase from five years ago), growing interest from places like Russia and the Middle East (think Yuri Milner and Prince Alwaleed's Twitter investment), the rise of accelerator programs (YCombinator and TechStars) and non-equity financing options like Kickstarter. The prospect of equity-based crowdfunding, as legalized by the JOBS Act, may present an even graver threat.

Wilson then asked the interviewer to consider this scenario:

"If U.S. families devoted just 1% of their assets to investing in startups via crowdfunding, that would unleash a torrent of $300 billion annually. 'The problems with venture capital now are dwarfed by the potential problems down the line,' he observed. 'Even with just $40-$50 billion aimed at financing scalable startups (the sum of the sources listed above), VC's can't beat the markets. With nearly ten times that amount of capital let loose, the attractiveness of venture capital as an asset class will only deteriorate further.' "

As pointed out in the article, Wilson's statement coincided with the Kaufman Foundation's damning report on the industry, which effectively blames funds' lackluster returns on institutional investors who continue to pour money into venture capital despite its abysmal track record.

Wilson then went on to explain how, in his view, venture capitalists should respond to the shifting landscape, proposing a couple of options. As he saw it, VC's currently provide four important functions for startups:

1. They aggregate and allocate large pools of capital.
2. They offer advice and governance (hold board seats, help with recruitment, etc.).
3. They help with exits (offer an investment banker service pro bono).
4. They blog.

In Wilson's view, VC's will have to rethink both aspects of #1.

"In order to generate their promised returns, firms will eventually have to limit the size of the funds they raise (and take a cut in the their 2% management fees). For nearly 20 years, the industry has proven that it cannot realistically put $30 billion of capital to work. Maybe $15 billion is a more manageable number.

He continued, touching upon the issue of allocation:

"In terms of allocation, VC's may want to develop new methods of choosing companies--and rethink the herd mentality that dominates the industry. 'Maybe we’re not good at picking companies,' he admits. 'Maybe we’re funding the 50th or 100th local-social-mobile startup when we should be funding cancer research.' "

Lastly, he says something which, in light of what I've been personally dedicating all of my time to for the past seven years, is really prescient:

For those looking to shake things up a bit more, there is the possibility of working off of crowdfunding platforms. By leading rounds and endorsing companies with small increments of capital, venture firms can use their brand names to attract crowdfunding to startups they deem the most promising. Since large pools of civilian investors don't offer much in terms advice and governance, venture firms could provide such services for additional equity.

And, as Fred says as he ends his interview "if that doesn't work out, there's always blogging".

It's this last point of Fred's that's the most compelling to me. Instead of VCs and crowdfunders viewing each other as natural antagonists, bitter enemies to the end, why not have VCs raise smaller rounds, with less pressure, invest a small portion of the round leading a crowdfunded offering and, in return, get a reasonable, but not outsized, dividend. In my view, it certainly beats the strategy they've been mindlessly following for the past decade, or even longer, if you believe Fred and the Kauffman Foundation.

A small commitment for a modest return, with the focus being only on those businesses with a shorter path to profitability. Significant risk reduction with the potential for much greater diversification. A simple, straight-forward investment with a reasonable, but not outsized return. My God, what a concept!!

Ray Burrasca is the Executive Vice President and Chief Operating Officer of Archimedes’ Offspring, an unincorporated “umbrella” organization whose mission is to make “reasonable returns investing” affordable for the ordinary Joe’s and Jane’s and, in the process, to reinvent innovation in the America.He can be reached at [email protected] or by phone at (720) 535-5219.