VC firms rarely take their own advice
Why do VCs operate so differently to the way they ask their portfolio startups to run their companies? As VCs should we take more of our own advice?
I’ve been thinking lately about what I’d wish for M8 Ventures’ future as a VC firm. How much do I care about how small it remains or how big it becomes? Am I in this primarily to create outsized returns for investors (and my partners and I) or does it matter more that we invest in people and companies that we believe will make the world better and help them succeed? (Should I even be public about asking myself that question?)
Is it more important to create great careers for a large team of employees in our firm, or to create great careers for employees of the companies we invest in? How much risk should our firm be prepared to take in the pursuit of our goals, and perhaps more importantly, how many years should we be prepared to maintain that risk?
A common truism for founders raising capital is that if you ask for investment, you get advice, and if you ask for advice, you sometimes get investment. That means for me and most other people who work in venture capital, we spend much more of our time giving founders advice than writing them cheques. And it seems like most of us believe our advice is worth taking.
These questions led me to the surprising conclusion that most of the advice I’ve been giving to founders on growing their business isn’t advice I’ve been taking myself. Perhaps it’s because there’s a common narrative that venture capital doesn’t scale, and therefore we don’t try to make it scale. We shoot for a better-than-market return-on-investment in each fund we raise or syndicate we manage, but when we’re done, we’re done — none of us seems to be on the same path to global domination we expect our portfolio companies to tread.
Maybe the “venture doesn’t scale” belief is so well accepted as truth that we don’t ever bother taking the advice we give to startup founders. What would change about VC if we did?
Here are some common truisms that are often passed down by VCs but aren’t applied in their own business:
Why don’t VCs strive to scale and dominate?
VCs advise companies to find a niche and exploit it — and don’t enter a super competitive space. But the venture capital industry is crazy competitive — they’re often competing with hundreds of similar or poorly-differentiated firms (that are usually staffed with super-smart people). To varying degrees, some fund managers migrate gradually to later stage investing as funds under management grow, but very few fund managers attempt to broaden their initial geographic or sector focus — they’re more likely to double down on what they think they know better than their competitors.
The world’s biggest venture capital fund managers, such as Softbank, Tiger Global and Coatue, are more often held up as examples of what happens when venture capital has failed to scale — investing way too much money into vastly over-valued companies at the top of the market. So maybe venture capital doesn’t scale? Or is it more a case of: ‘what would we need to change about the way we operate, to massively scale successfully’?
My gut feel is that most VC firms are afraid to try something new and different enough to solve the scaling problem, since its not just themselves but their LPs that they’d have to build conviction with.
Why don’t VCs have one CEO?
Startups often have a number of co founders but VC investors will usually advise startups to have one core decision-maker and appoint one co founder as CEO (in rare cases, maybe there is a co-CEO). But that rarely happens in VC — most VC firms are run as a partnership with multiple partners (though some partners may be more equal than others).
The final go/no-go investment decision in most VC funds is literally called the Investment Committee (or “IC”). They’d never invest in a company run by committee, yet that’s how they roll themselves.
One way to change would be to appoint a fund CEO and give the CEO a controlling share of the votes at the Investment Committee meeting. If the other partners aren’t happy with the track record of the CEO’s investments over time, do what a portfolio company would do, and replace the CEO.
Why don’t VCs take an ‘instant ramen’ salary?
But VCs don’t usually trade some of their short-term salaries for long-term upside. The larger the VC fund manager, the more likely their venture partners pay themselves a typical market salary out of their typical 2% management fees.
If VCs took their own advice, they would be using most of that 2% fee to build systems that scale better, and invest in growth. Or they would trade the bulk of the management fee for greater carry. Most funds run ten years before they return carry to the partners but since the carry is generated from profits when portfolio companies are acquired or listed, the founders of those companies are likely waiting a decade to see the whole of their return on investment too.
At M8 Ventures we’ve already decided to operate our firm on a cost-recovery basis — charging our investors what it costs us to run the firm each year, up to a maximum of 2% but with 1.75% as a goal we believe is achievable. But we think the mindset change is most significant — trying to run a lean, smart company, just as we’d expect our portfolio CEOs to do.
Why don’t VCs plow everything into faster growth?
Portfolio startups should invest in growth and market dominance over profitability. Well, sure, but VC firms themselves, if they’re successful at all, are extremely profitable.
They don’t hire aggressively, they don’t invest in much technology aside from off-the-shelf SAAS tools, they don’t spend as much time on automation, or make any of the other investments in themselves that they would expect their portfolio companies to make to scale faster and dominate their space. In fact, most successful VC firms seem like they’re happy they haven’t failed, and seem content to exist in a relatively steady oligopoly with their nearest competitors.
Why don’t VCs expand into other markets?
VCs want companies to hire great people and continually level-up the management team. Yet the VCs grow their own businesses much more slowly than they expect their portfolio companies to grow and often approach investing with a risk-minimisation focus. VCs rarely move into adjacent markets, expand their brand’s presence, pivot into a different business model, or start investing in other sectors and stages?
We’re still just getting started with M8 Ventures and we should probably wait for evidence that we can succeed in our starting niche of early-stage investment in product-led startups from Australia and New Zealand before embarking on expanding into adjacent markets.
But if we can expect our portfolio companies to learn about market, regulatory, tax and employment law in other countries and start going international a few years out from launch, shouldn’t we? I think maybe we should.
Why don’t VCs keep operating expenses low?
I need to admit a mea culpa here — I’m 195cm tall and broad, and I will spend more to avoid flying economy, when I can. I try to upgrade using points first and pay the company back the difference between an economy and business class fare if I can’t upgrade on points. Anyway, I travel much less for work these days, and will get most deals done over a video call from my home office.
Yet many VCs I know do the opposite with their own expenses — often spending lavishly on office rent, travel, entertainment, offsites, and more. Patagonia, Allbirds, ski resort offsites and fully-stocked fridges don’t come cheap!
M8’s going to keep the leash pretty tight on expenses with our planned cost-recovery approach to management fees and I’ll be interested to see whether we can persuade any of our peers to follow suit.
Why don’t VCs plan to outlast their founders?
Many VCs set up their firms in a short-term oriented way. VCs often have much bigger key-man risks than the companies they invest in. And VC firms — even successful VC firms — rarely outlast their founders. If you’re an LP in a fund that’s lost one or more of its founding partners, you should be rightfully unhappy.
M8 Ventures needs to stay lean but also needs to spread responsibility and skill development widely across our team so that the loss of any one of us doesn’t slow us up or reduce our success rate. We all need to practice documenting what we do, collaborating together so we can all practice, stay sharp and learn from each other’s methods.
Why don’t VCs have better governance structures?
VCs think it is wise to have investors and independent directors on a company’s board. But VC funds themselves often have much less oversight. Many thrive on potential conflicts of interest. Many don’t have a board, just a partner team. ICs often include outsiders but they determine where the cheques get written, not how the firm runs.
M8 Ventures needs the best governance structure we can design, and we can afford. Work to be done here.
Why don’t VCs plan to go public or to be acquired?
Companies should go public and being a public company is very good for the long-term.
But venture capital firms themselves rarely go public, and VC funds are rarely positioned for acquisition by bigger fund managers.
M8 Ventures is a long way from being something you could IPO but could theoretically be an acquisition target at any future time, if the future value of our portfolio or the performance of our team was well known and the firm was designed to be easy to acquire.
I once was able to initiate and close the sale of a company I co founded in only two weeks, because my co founder and I worked out a five bullet point summary of the non-negotiable terms we’d need to see in any acquisition offer. When one lobbed across my desk late one night on a Skype call, I literally copied and pasted those five bullet points back to the person enquiring. Two weeks later, the deal was done. Work to be done here for M8 Ventures too.
Why don’t VCs make acquisitions?
The growth of a synergistic merger often can outweigh the dilution that comes from growing the firm. Yet VCs rarely acquire other firms. What sort of acquisitions could make sense for a larger M8 Ventures in the future?
Off the top of my head, I think we could benefit from acquiring small professional services firms we have a trading history and a shared culture with, such as our accountants, our lawyers, our marketers, our recruiters and our PR providers. If we acqui-hired individual angel investors and their portfolio, could that be better than just hiring the individual? In what circumstances would it be better to acquire another VC firm vs enter a new market ourselves from scratch?
As always… work to be done!
