The problem with VC Motivation

Many VC's, particularly in Europe, are disappointing in their (lack of) intensity.  They are not 24/7, passionate advocates of the businesses they fund; neither do you meet them at random conferences scouting for new companies; nor do they necessarily come across as particularly engaged at board meetings.  Why is that ?  Let's talk VC compensation and motivation for a second.

My motivation as a VC

Introspection is as good a place as any to start.  Here are my top motivations for being a VC (leaving out the personal stuff):

1. Company building: every VC is different, some like doing the deals but don't really care for the long-term relationship that ensues.  With me it's the "deal management" (as we call it) that provides me with the greatest satisfaction.  An engaged relationship with management team and co-directors towards building a great business.  That's when I feel I am part of a greater whole, of creating jobs, of the whole great forward human movement of innovation and entrepreneurship.
2. Intellectual stimulation: I am a fairly consistent guy, but I do get bored.  As a VC you get to see 100's of new projects every year and meet a ton of creative people, and understanding each one challenges your (dwindling number of) neurons in a different way.  Every company you invest in is different, and requires fresh thinking.  So being a VC keeps me entertained, frankly.  This is the primary reason why I never started a company.  The trade-off is that you work through others (the management teams you fund) and hence never quite get that satisfaction of achievement in the same way.
3. Personal recognition: Let's face it, I love being recognised for what I do.  Thankfully my wife keeps that ever-burgeoning ego firmly in check.
4. The Hunt and the Deal: I don't think you can be an effective VC if you do not like to be a Hunter, to be always out on the move looking for the next big thing, to want to win the confidence and trust of entrepreneurs and co-investors to take your money and no-one else's.  Inking that term-sheet and closing that deal gives me a great buzz every time.  After all, I grew up on a trading floor !
5. Money : more on this later.
6. Lifestyle: I work hard, but on my own terms, when and where I choose.  The less glamorous reality is that I spend 2/3 of my time on the road and that they greet me by name at hotels in at least 3 different cities, but I remain a master of my own destiny.

That's my list. 

Let's zoom in on money

Here is the issue with venture capital as a way of making money:

• It's easy to get a comfortable lifestyle (say $300,000+ a year, often multiples thereof)
• It's (really) hard to make it really big (say $20,000,000+)

The not-so-secret fact about venture capital is that it has not made serious money for 10 years now.  That means many if not most venture capitalists have not seen a large carry check in a decade.  For those who don't know venture economics, the partners in a fund contribute the first 1-3% of a fund on their own cash, which means most of us write checks worth > $100,000 every year to our own funds, sometimes a lot more.  So if you are a VC in a median return fund, you keep writing these checks vaguely hoping you will make your money back; some will tend to get more and more focused on the nice salary they can take out every year.

To generate real carry, you need to work hard with no obvious improvement in the probability that your fund will be a wild success.  In other words, the marginal return on effort expanded is not obvious and may well be zero.  You won't know until much later... And that, my friends, is the core problem with VC motivation.

Because it takes a very long time to know whether you are a good VC, partners can keep taking comfortable salaries for a decade or more before any form of verdict is placed on their money-making abilities.  In the meantime, they manage their own calendar and work at their chosen intensity, with no immediately obvious return on effort expanded.  Q.E.D.

 

The Solution

... is not simple.  As an LP you would only want to invest in partnerships that provide:

• Accountability
• Meritocracy
• Paranoia
• Professionalism
• Absolute hunger
• True Passion for the business

... and of course, deal picking skills, deal building skills, and returns !

Paul Kedrosky at Xconomy has considered this problem from the LP angle with the following recommendation: pre-agree on budgets and / or find out what your chosen partnership uses its money on.  Good advice, with plenty of practical problems but clearly sound.

In a good partnership, paranoia and professionalism mean that emulation keeps everyone on their toes.  And your passion for the business keeps you working all the time.  And you really want to make a ton of money.  And you want to be remembered for all the great business you contributed to.  All of the above !

Hence:

VC is only a lifestyle business if you do not fundamentally care about being wildly successful.  Now how do you screen for that, when every manager that comes into your office sings the same song ?

 

<--- Get Carl on your board.  He goes the extra mile.

Comments

[Paul Jozefak]

Fred, I agree with your point about intensity and "how" a VC needs to behave. Having been in the European industry now for over 10 years, there's one thing that continually surprises me though. Without naming names, I tend to find the supposedly best VC's in Europe often to be the least intense in their approach. I am presuming (without having seen the exact numbers) that they are making their LP's happy. They continue to raise ever larger funds, etc. Are they doing something different from that which you describe above? Are they working much harder behind the scenes where the rest of us don't see it? Do they simply have better networks and connections? My answer to all of the above is "I don't know." I personally like being the intense guy as well. Work hard, try to be present at events, know your stuff, build solid relationships and so forth. I still ask myself often though if "intensity" is necessarily what makes a VC great. I much rather be extremely effective as opposed to intense.

[twitter.com/nicheVC]

Great post, Fred. My partners and I are very back-end focused, and concur with at least three of your motivational points (company bldg, intell stim & the Hunt). I posted today (http://nicheVC.com) about my specific passion for a certain niche. Glad to know you're out there and hope I am able to invest across the pond some day soon. Bring on the back-to-basics phase of venture.

[Rory Bernard]

@rorybernard: I think GP's need <1% mgt fee, min expenses/subsistence - behave like a startup & align interests with LP's
@fdestin : it's an interesting question that, whether VCs would be better or worse if they made less money. not that obvious.

I think it is essential for the ecosystem that the VC's can make serious money and hopefully the returns will rise again. My issue is that if I, as a CEO of a VC funded startup, had some of the business fat that I see on some VC funds my investors would rightly want my head on a plate.

My point is that VC's should treat their LP's money with the same respect that I would treat the investors in my business.
Cash expenses at a minimum, 'C' level salaries at a minimum and ensure your upside is all on managing the exits well. This means really working with your portfolio and being the extra sales/JV hunter that they individually could not afford. Some of my best sales leads/JV introductions have been made by pro-active investors - and as a bonus they did not come out of payroll. Being pro-active though requires a lot of hard work to stay current across the portfolio.

Of course - generalisations are dangerous - there are some really good VC funds out there.

[Christian Lagerling]

Great perspective. One challenge when it comes to the money - quite possibly related - being that many of the most successful VCs have been built by people who have ALREADY made money through successful entrepreneurship and exits. This is much more commonly the case in the US...

[Elie Kochman]

Thanks for the perspective.

As the founder of a new company, I have been looking to learn more about VC (no, I am not pitching my idea yet, nor am I looking for capital at this point in time) so that I can understand how a business grows when it reaches the point of needing VC. While I have read several books and articles on the topic from the perspective of founders and entrepreneurs, this is the first time I have read about the perspective of the "guy with the money".

[Juan]

Fred,

great post,

some times I wonder about VC folks motiviation. Most of the people I have met are quite smart, so could get a much better compensation elsewhere (specially if you are based in London, you know as you used to be a trader). In addition some of the money invested in the funds some times come from development funds (and I would not call that smart money)

So I wonder about the motivation. It is clear with us entrpreneurs what we are motivated by,..so not that clear about motivations from VC folks....

do take care

Best

Juan