Lessons on VC investing

Source: Techcrunch

Had an interesting meeting with a venture capital partner about investing in the tech space. 
Some insights:

• Setting up a fund is tedious.  Fund sizes are small ($30m is normal), fees are minuscule.  Establishment and running costs must be controlled to be sustainable.
• If you have $5-10m and would like to invest (while also learning/getting your foot in the door), you're better off coming in as an LP with a good manager.  The fees you're paying would be cheaper (2% of committed capital + 20-30% carry) than even hiring one decent person.  Ask for co-investment rights if possible.
• VC returns (even realized ones) look teriffic, maybe 3-5x all around.  But it's mostly just paper returns.  Many, many funds never generate enough returns to justify the opportunity costs.  If ever there's a chance to get cash back, take it.  Don't be greedy.
• By nature, many VC deals will blow up.  You're really investing in people, not companies.  People get distracted: they get married/divorced/kids/other personal situations.  So VC funds need to spread whatever they raise to 20-30 deals including follow-ons.
• The job of a VC is not just to do deals; they need to work with founders & management to "unlock value"(TM).  This is time-consuming and often underestimated.  Remember the old adage: fund managers spend 80% of their time with their 20% worst investments.

From Techcrunch:

"[The problem is that] VCs and LPs aren’t aligned. The current industry standard for VC compensation is “2 and 20 percent.” Meaning VCs get paid 2 percent of the fund size in management fees (salaries) and an extra 20 percent of any liquidation event that might happen. So VCs get paid even when they “fail” to return adequate returns. LPs only get paid when VCs do an amazing job (rare). The end result is that both parties have separate agendas that don’t necessarily overlap. The ancient “2 percent and 20 percent” should be killed off and replaced with something that endorses higher alignment. Let the VCs fight for their supper. 

... This may be hard for many VCs to read, but many of you out there should be killed off.  Low-performing funds shouldn’t be able to raise additional rounds. This burden is on the shoulders of the LPs. They should take a cold hard look at the performance of their funds. Instead of looking just on the return rate (IRR), public market equivalent (PME) should be used to see how they performed compared with the market. For example, if a fund returned 13 percent IRR in 2014, but the public market actually did 14 percent, is that a sign of high performance? Nope. LPs need to smarten up and stop reinvesting in additional rounds seeing actual returns."

Now is it a bubble? Well, VC-funded companies have a habit of boosting their performance in many ways.  For instance, several porftolio companies of a VC firm may buy from/serve each other to boost their headline GMVs/GTVs.  And there's also anti-dilution, which VCs use to artificially boost their company valuations -- without which, the valuations may be more modest.

The big question is of course, when it is going to burst....