I love the US. Full stop. But when you love it as much as I do you need to be critical about how it is about to lose its position as the largest economy in the world and how even though it is still the most innovative economy, (according to David Rubenstein, chief executive of private equity firm Carlyle Group, we need to secure the integrity of our financial systems so its performance can accurately trace and tap into the massive and acute opportunity in innovation that lies ahead.
Critical thinking, not false positivity, is imperative to keepour leadership position in innovation. Venture capital (VC) as the primary financial instrument to innovation has failed to produce viable investor returns since 1998, has produced -4.6% 10-year returns, has performed below the consumer adoption rate of technology in the same period, is being outperformed by corporate innovation and capital, has lost public trust because of bad past conversion from valuation to value and does not make a dent in the 80% greenfield of technology adoption.
Corporates prove not only that quality money applied to innovation scales, they also prove VC has applied the improper arbitrage in selecting what constitutes innovation. Corporates have proven that investment categories previously considered by VCs as dead – online music, desktop software and consumer technologies – are alive and well under their stewardship.
And few of the made-popular investment strategies of VCs have yielded the public’s trust that makes them want to come back for more. The arbitrage of VC creates too many false negatives and false positives, with VCs desperately cheering it on. They have been blowing smoke for a long time. So, as a limited partner (LP – investor) to consider investing in venture, it is not the performance of the current players that is relevant, but the massive size of an 80% greenfield in technology adoption becomes the new index you measure general partners (GPs – VCs) against.
Which GP can identify the macro-economic drivers that yield viable technology investments, rather than push technology for technology or competitive sake. Valuations that convert to real public value creates the trust that builds rewarding returns for years to come. The best way to improve performance in venture is to redefine the index, in the same way Apple redefined "the index", or requirements of the phone – alarm clock, email, computer, web browser, music player, address book – to become the leader of the new phone marketplace. Venture capital needs reinvention so the index of its performance matches more closely the greenfield opportunity for technology innovation that its current incumbents have failed to recognise.
Gradual sub-optimisation of VC is like attempting to turn the Blackberry Playbook into an Apple iPad competitor, which will fail because it is not designed from the ground up to target a new greenfield. The Apple iPad is successful because it targets a greenfield previously disenfranchised by the incumbent technology providers.Venture capital has failed because it still targets itself (and other not free market indices) as the index. When LPs assess risk in venture they immediately look down to VC firms, as if they are accurately able to identify the risk associated with such an infant and fluid technology marketplace.
But the risk they forget about is the risk inherent to a financial system that is not a free market system that is supposed to drive businesses that are free market, and thus winner-takes-all, purveyors. Put differently, VC cannot scale in line with innovation because as a financial instrument it is incompatible with the needs of the underlying asset. Venture fails before it reaches the private placement memorandum of the VC funds. Follow the money trail in venture and the selfinduced and embedded risk becomes abundantly clear.
Venture capital can produce viable returns when LPs fix the following:
l Deploy fund-of-funds venture focus to the unique levels
of risk deployed.
l Reduce 10 levels of embedded diversification of risk to
four.
l Force GPs to deploy risk by providing full runway support
to start-ups.
l Limit the VC fund size to deploy focus and responsibility.
l Deploy investment transparency which exposes merit
and builds pre-IPO trust.
Venture capital itself needs to become a highly transparent and competitive free marketplace in which not collusion but investor competition drives merit, and automatically removes the underperformers so the marketplace of investors accurately mimics the changing opportunity in technology innovation.