As a follow-up to my last post Silicon Valley still matters, I have posted below a portion of an article by Valley entrepreneur and finacier Georges van Hoegaerden.  I believe it to be a spot on assessment of the past decade of venture invesment, and I share his views on how venture will need to “behave” in order to rebound.  As I alluded to in my previous post, venture will need to get back to its roots and invest in truly innovative business opportunities where the technologies and market approaches represent a fresh approach with genuine promise.  Venture investments have always been risky, but the potential payout has traditionally been worth that risk—not so with VC investments generally over the past decade.

The systematic risk of venture capital

As a result of a lack of meaningful segmentation and guard rails by many me-too VC funds, LPs have actually invested deep rather than wide in information technology (as the included chart points out). For the last nine years that has created a massive number of false positives and false negatives and a continued downward spiral that attracts only entrepreneurs that comply with this risk-deflated investment mold, rather than attract entrepreneurs with truly disruptive ideas (that hold their value in any economy). So, for the last 9 years LPs have invested deep in a risk-averse technology sector while they expected their 10-15% venture share of total allocations to be applied to the inverse.

Moving forward
Many LPs are ready to cut all but their top quartile VC funds from their portfolio by flushing them through (i.e. letting them run their course without re-upping new commitments). That means over the next 5 years we are going to see many VC firms disappear, some replaced with new VC firms with more relevant entrepreneurial pedigree and investment models that are as unique as the strategies of the entrepreneurs.

New regulations by the government and tougher practices by LPs will make our industry more transparent and aim to create a platform in which the old aristocratic VC model will be replaced by a model that supports a meritocracy at every level of the investment pyramid. That is a fantastic development for entrepreneurs and VCs who are attracted by - and deserve - the merit.

Big stakes, big returns, fewer players, better innovation
LPs expect bigger returns (before larger commitments) from their allocation in venture and the only way to get it is to deploy risk. VC is designed to be the intermediary between the LP and the entrepreneur to mitigate that risk for LPs. Yet because of the aforementioned commoditization of VC investment strategies the VC model has failed to produce.

With LPs retrenching (to perhaps another asset class), the VC firm that wants to survive better articulate a clearly differentiated investment strategy with new GPs that can recognize and attract more disruptive (and sustainable) innovation, knows how to commit and helps make its portfolio companies work.

A new day
To create better returns for LPs, VCs need to rethink how to pick better companies with more disruptive (and sustainable) innovation and invest in upside rather than downside. The smart entrepreneurs are out there (we talk to them), waiting patiently for the right investment climate to light up their flame. Remember, great innovation can afford to be patient.