The following post was contributed by Katherine Barr, General Partner at Mohr Davidow Ventures.
I moderated a Limited Partner (LP) panel at last year’s PreMoney event similar to the one that I will be moderating again this year. When asked about the attractiveness of venture as an asset class last year, one of the panelists presciently said, “We’re at a cycle point in venture again. The investment opportunity is great and the overall Limited Partner psychology is weak. It’s a great, uncrowded market.” A year later, it’s not such an uncrowded market anymore. 58 U.S. venture capital firms raised $8.9 billion in new commitments during the first quarter of 2014, the strongest fundraising quarter since 2007. And 10-year venture capital returns hit 9.7% as of the end of 2013, beating out several public-market benchmarks, according to the latest Cambridge Associates data.
It struck me over the past year that, even though LPs aren’t directly involved in company building on a daily basis like we, the fund managers, are, there are still a lot of similarities between their job and ours as they drive to generate value for their investors, universities, beneficiaries, pensioners, and multigenerational wealthy families.
One of the panelists from last year’s PreMoney “LP POV” panel emphasized the importance of investing in individual or a team of fund managers they strongly believe will provide great returns: “We’re in the business of judging people who judge people.” We, as venture investors, look to invest in companies with strong tailwinds behind them and that pursue large market opportunities, but first and foremost, we invest in the entrepreneur who is going to build each company. We need to be able to look her or him in the eye and make a judgment call that he or she will be a great partner to work with and be able to build a company that generates a great return for our LPs.
Venture investors hold (or at least should hold) our entrepreneurs accountable, expect that they will be transparent with us, and utilize the money that we invest wisely. Similarly, a LP panelist from last year said that a key question he asks when doing diligence on fund managers is, “Has the VC done what they said they would, and have they owned up to what hasn’t worked? We value integrity.”
There are both early risk takers and those who are more risk averse among venture investors, similar to the Limited Partner community. One of our panelists from last year commented, “The LP community is very herd-like, but there are leaders willing to make independent decisions.” Direct investing in select portfolio companies through the venture firms in which LPs have invested is on the rise among many segments of the LP community, with funds of funds particularly active. Many of the funds of funds who took a thought leadership position, did their diligence and built a relationship of trust with the venture managers they invested in have done particularly well when they have been early movers thus getting proprietary access to strong direct investment opportunities among their venture portfolio.
Just as the landscape has been shifting among venture investors with varying sizes and stages of funds, there have been changes among the LP community as well, with public pensions embracing venture in a larger way as a group, generally. States including Georgia, Oregon, and Ohio have created programs to incentivize venture investing in-state as an economic stimulus. And, due to the varying sizes of venture funds these days, some large public pensions are creating programs for emerging managers to deploy capital in smaller amounts than their traditional large bite-size.
Generational transitions have been fairly common among venture firms over the past number of years. One LP panelist from last year said that in some cases, firms should run their course and just not have a generational transition. However, he advised, if you don’t intend to close shop when the current general partners retire, then make sure you have a good mentorship and transitional system in place in order to not disrupt fund returns: “Promote young people early and keep the bar high. Keep the average age of the investment team steady.”
Overall, LPs are stressing accountability, transparency, and partnership more than ever before with the number of LP advisory councils for venture funds on the rise and strong scrutiny of venture fund track records. With a new generation of investors building their reputations, a variety of venture fund stages and sizes to fit various startup company and LP needs, and a new wave of innovation upon us, it is a good time to be part of the venture industry.