Three Longs & Three Shorts

How Venture Capitalists Are Deforming Capitalism

Yet another fascinating piece from The New Yorker. Much has been written about the fun and games at WeWork, some of them have been featured in the 3L-3S as well. But this one is from the perspective of the role of the VCs involved with WeWork and how that role embodies the concerning evolution of the VC industry. Who better to author it than Charles Duhigg, the Pullitzer winning American journalist who combines story telling with indepth research, also known for his insightful book – The Power of Habit. We would strongly recommend reading the whole article to do justice to Duhigg’s research if not for thoroughly entertaining anecdotes. Some key messages the article seems to be bringing out here. Duhigg goes back to the origins of the VC industry invoking the great Tom Perkins:
“From the start, venture capitalists have presented their profession as an elevated calling. They weren’t mere speculators—they were midwives to innovation. The first V.C. firms were designed to make money by identifying and supporting the most brilliant startup ideas, providing the funds and the strategic advice that daring entrepreneurs needed in order to prosper. For decades, such boasts were merited. Genentech, which helped invent synthetic insulin, in the nineteen-seventies, succeeded in large part because of the stewardship of the venture capitalist Tom Perkins, whose company, Kleiner Perkins, made an initial hundred-thousand-dollar investment. Perkins demanded a seat on Genentech’s board of directors, and then began spending one afternoon a week in the startup’s offices, scrutinizing spending reports and browbeating inexperienced executives. In subsequent years, Kleiner Perkins nurtured such tech startups as Amazon, Google, Sun Microsystems, and Compaq. When Perkins died, in 2016, at the age of eighty-four, an obituary in the Financial Times remembered him as “part of a new movement in finance that saw investors roll up their sleeves and play an active role in management.”
But in recent times, as the article shows through several examples, VC’s much like Wall Street, seem to have fallen for the same greed, playing the greater fool game than stewards of innovation.
The industry is too homogenously staffed for any innovation:
“Most professional V.C.s fit a narrow mold: according to surveys, just under half of them attended either Harvard or Stanford, and eighty per cent are male. Although V.C.s depict themselves as perpetually on the hunt for radical business ideas, they often seem to be hyping the same Silicon Valley trends—and their managerial oversight has dwindled, making their investments look more like trading-floor bets.”
The size of investments have grown too big:
“A million-dollar investment in a thriving young company might yield ten million dollars in profits. A fifty-million-dollar investment in the same startup could deliver half a billion dollars. “Honestly, it stopped making sense to look at investments that were smaller than thirty or forty million,” a prominent venture capitalist told me. “It’s the same amount of due diligence, the same amount of time going to board meetings, the same amount of work, regardless of how much you invest.”  
It is more of a funding game:
“In the traditional capitalist model, the most efficient and capable company succeeds; in the new model, the company with the most funding wins. Such firms are often “destroying economic value”—that is, undermining sound rivals—and creating “disruption without social benefit.”
Many venture capitalists say that they have no choice but to flood startups with cash. In order for a Silicon Valley startup to become a true unicorn, it typically must wipe out its competitors and emerge as the dominant brand. Jeff Housenbold, a managing partner at SoftBank, told me, “Once Uber is founded, within a year you suddenly have three hundred copycats. The only way to protect your company is to get big fast by investing hundreds of millions.” What’s more, V.C.s say, the big venture firms are all looking at the same deals, and trying to persuade the same coveted entrepreneurs to accept their investment dollars. To win, V.C.s must give entrepreneurs what they demand.”
They no longer discipline or stand up against reckless founders:
“Particularly in Silicon Valley, founders often want venture capitalists who promise not to interfere or to ask too many questions. V.C.s have started boasting that they are “founder-friendly” and uninterested in, say, spending an afternoon a week at a company’s offices or second-guessing a young C.E.O.”    
VC’s act in cliques:
“It’s a clubby industry,” Steve Kraus, of Bessemer Venture Partners, said. “You need other V.C.s to like you, because they refer you into deals. If you get a reputation as a complainer, it can really hurt your business.”
As the venture-capital industry has become specialized and concentrated—last year, the ten largest firms raised sixteen billion dollars, nearly a third of all new V.C. fund-raising—it has become even more cliquish. Today, most major V.C. deals are “syndicated,” or divvied up, among the big firms. This cartel-like atmosphere has encouraged V.C.s to remain silent when confronted with unethical behavior. Kraus, who has been critical of the industry’s myopia, told me, “If you’re on a board that empowered some wacky founder, or you didn’t pay attention to governance—or something happened that, in retrospect, sort of skirted the law, like at Uber—you’re fine, as long as you post decent returns.” He added, “You’re remembered for your winners, not your losers. In ten years, no one is going to remember all the bad stuff at WeWork. All they’ll remember is who made money.”
So, the VC’s did make money on WeWork. If you haven’t caught up with the latest on WeWork, read the last piece of the article to see the fun and games continuing post Neumann.