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VC Bill of Rights Article 2: The right to allocate our time to where we can generate the largest returns for our customers December 16, 2009

Posted by Lawrence Lenihan in Uncategorized.
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We are in business for one reason: to make returns for our customers, our Limited Partners.  We love our companies, but, in the end, we have a fiduciary duty to generate returns for our investors.  If we don’t, we won’t be in business anymore.

For our investors to be happy, we need to generate dollar returns.  Venture capital is a yield game.  As harsh as it sounds, it is.  Not every company that forms is successful and not every company that is venture-backed is successful.  We will and should spend our time where it will generate the highest returns.

How does this fit into the amount of capital a VC needs to invest?  Well, it doesn’t.  At least is shouldn’t.  We get paid two ways: management fees and carried interest (for those of you unfamiliar with carried interest or, simply, “carry”, it is where the VC receives a certain percentage of the profits that are generated from an investment).  The typical terms for a venture firm is 2% management fee (2% of the total capital committed by LP’s) and 20% carried interest.  Over the past few years, these economics have provided the incentive for larger funds (more management fees and more carried interest on a dollar basis) and the incentive for a VC to have a larger fund has driven the need for larger investments in companies.

While fund sizes increased, in technology-based companies, the dynamics of internet connectivity and low cost computing platforms has enabled companies to grow faster and consume far less capital than ever before.  In short, our market drivers got out of sync with the entrepreneur’s market drivers.

This is a long-winded way of saying, we should not require you to take as much money as we want or suffer dilution that we require.  But, on the other hand, we are here to make money for our investors and we are going to invest our time where we can generate the most dollar profits for our customers.  That means that we need to either have a large amount of capital at risk so a small percentage returns can drive large dollar returns or smaller investment that can drive large percentage returns (and, consequently large dollar returns).  We can tell you that everyone is equally important, but they are not.  You are most important immediately after the investment when we feel we can make the most impact and when the potential value of the investment is high (of course it is – otherwise we would not have made the investment!!!),  when you are cratering and we have a load of money in you and we are trying to save our bacon, and, last, when you are riding to the moon with success and the value of our investment is growing.  Is this truth pretty?  Maybe not, but it is one thing that is very important to know: it’s the truth!  And anyone who tells you differently is not telling it to you…

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Comments»

1. Tim Yue - December 17, 2009

The start-up needs to survive firstly. It needs to be find a balance point.
Your other articles are good. But always there is a tradeoff. It is really hard to say which one is right. Or no one is right.
Mr. Lenihan, I have a bp you may have interest, but I can not take your class next semester. Could you give me a few minutes to talk about it?
Thank you.

Lawrence Lenihan - December 17, 2009

Life is a series of trade-offs! The point is that both sides are right but there is always common ground that can be found that can enable both sides to succeed and prosper. You just have put yourself in the other’s shoes to understand what is important and why it is so.


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