The idea of founders running around in a mad dash to get the highest growth possible is not something new to the world. However, investors in these companies are equally accountable. Here’s how
This post is in reply to an opinion piece published in a major national newspaper which appeared to put the blame for recent scandals in some startups on the founders. Founders who are running wild is not something new to the realm of early-stage investment. It is a matter of who is accountable for their actions. Founders? Investors? Both?
A venture capitalist model as it was originally intended to be
To to answer this question one must delve into the origins of venture capital (VC) business.
The rationale behind the economics of VC managed funds is based on three fundamentals. One is that VC fund managers are able to use their social and intellectual capital to identify and assess a wide range of opportunities for investment. They also invest in a select group of selected businesses that have a thorough understanding of the potential rewards and risks associated with these investments. Three It is an important difference in this discussion: they possess the organizational and personal ability to manage risks in their investments by actively engaging with the businesses they invest in.
The third of these considerations is the most important. The entrepreneur who seeks VC could possess a great knowledge in the subject matter of business or technology however, he will require plenty of guidance, support , and supervision as he expands the company. That is the essential benefit which an VC fund manager must add.
VCs seek out investors who trust them. They rely on the VC fund manager for impressive returns through the execution of those three types of tasks that the investors might not be able to complete independently. As a reward to their assistance, VC fund managers receive an unassailable management fee which is 15% of the funds investment portfolio as well as 20 percent of capital appreciation generated by the investment. In comparison the investors of actively-managed mutual funds are charged an expense of no less than 3 percent funds under their management.
The VC model is a modern perspective
Can managers be legally authorized to fulfill their duties? Absolutely. The contracts which VC fund managers sign with their fund-funded companies provide them with the power to influence not only aspect of strategy of an business but also the operational aspects. Some analysts believe that those powers are as a bit draconian.
Are VC investors now doing their job as they should? Because of the lack of transparency among privately owned businesses, it’s hard to anyone who is not an insider of the investment to get an accurate solution to that question. In a sense the answer to this question is in the piece of writing.
It is due to the reality it is the case that VC fund managers manage the management of ten and more investment at once. The conventional wisdom of VC fund management suggests that fund managers not manage more than five companies at the same time, if they want focused on the companies.
It’s all about incentives
Why do fund managers supervise more investments according to what the article appears to suggest? This is due to the financial aspects of fund management. The classic method that was used in VC was that the fund manager made only enough in fixed costs “to keep the lights burning.”
Commissions and errors of omission?
The current method of investing seems to be about identifying the perfect founders, then throwing a massive amount of cash at them and then letting them show off their competitive nature to pursue expansion at any cost, even when it’s not financially profitable. This is the normal approach to take if the VC fund manager must oversee an array of investments simultaneously.
If the failure to supervise the management of a company funded by a fund is an oversight error of some sort, recent stories in the press suggest there could be a commission error too and on behalf of VC fund, but this is hard to prove. Investors appear to push entrepreneurs to follow seeking out hypergrowth to the point of causing harm, as their investment funds are subject to set time frames within which they must take their investment.
It’s tempting to portray the incompetent founder as the culprit in the story of poorly-governed startups that have been popping up recently. But, as I’ve previously stated investors in these businesses are also accountable. Based on an old tale of children that the one that pays the piper is the one who has to play the tune. The obligation to ensure good governance lies equally with both the investors and the founders. How else do you justify the high costs that VC fund managers pay?