I mean quite simply that VCs have raised far too much money. As Paul Kedrosky observed, if you adjusted pre-bubble fund sizes for inflation, an average VC fund in 2008 should have about $100 million instead of the current average of $200 million.

Throw in the fact that there are too many VC funds and you have all the makings of a vastly overfunded “asset class.”

A lot of the glut that you see in the form of stupid startups (and clones) being funded is a direct result of this. I’d also observe that outside of Web 2.0, this is resulting in a glut of cleantech startups whose technologies will never scale commercially.

This is a problem of economics. VCs have to put the capital they raise to work and when you have a large fund, the economics dictate that you have to invest larger amounts (i.e. a firm with a $500 million fund reasonably can’t invest it in $500,000 chunks).

When you have a valley full of VC firms each with lots of money, the picture becomes clear – you have a bunch of guys running around with suitcases full of C-notes and they can’t give them away fast enough.

While it’s true that most startups that seek VC funding don’t get it, that does not detract from the fact that VCs are still putting too much money into too many startups.

At the end of the day, there just aren’t enough good investments out there to support the amount of money that VC firms have raised and the number of VC firms that exist.

Most companies who seek funding from VCs don’t get it, like less than 1% of all who seek it. Obviously many of them don’t qualify at all, but there are many who might be worthy that don’t get funded b/c they don’t know the right people, don’t have the right board, not in a “hot” at the moment space, etc etc.

So just curious about your comment.

I think we’d both agree – if VCs were earning great returns, their management fees would look a lot less problematic. 2% of committed capital and 20% of carry is really only “expensive” when you’re getting sub-par returns for the risk you’re incurring.

Of course, I think we’d also both agree – the flaws in the VC model (too much money chasing too few startups, etc., etc., etc.) and the realities of the world we live in make it pretty damn difficult for VCs to earn the type of returns that justify their fees.

As such, the venture capital asset class is, for practical purposes, less-than-appealing.

i think you compare apples to oranges

hedge fund managers charge huge fees but the 2% is on *invested* capital — money put to work. VCs charge 2% of *committed* capital – money that for years is not even under management by the vc!

also — hedge fund investors can redeem (withdraw) periodically, often every 90 days. they can and do vote with their feet. so hedge fund managers are paid for performance – money under management that can leave

vc investors are stuck for 7-10 years.

i agree big performance is worth paying big fees. and thats exactly why vc’s should radically shrink management fees (how about working off an operating budget, just like their portfolio companies?) while radically increasing carried interest — and so properly align their own incentives with their limited partners?

In theory I personally don’t have a problem with management fees provided that the people doing the managing are competent and make investors money.

Just look at John Paulson of Paulson & Co. He personally made $3.7 billion last year. One of the hedge funds he manages returned nearly 600% because he bet that the credit markets were going to run into problems.

Some of the hedge fund managers like Paulson now charge far more than the typical 2 and 20 but investors aren’t complaining because the returns justify the higher fees.

Of course, there is always the risk that many of these high-flyers won’t be able to deliver such returns over the long haul (and there is certainly no shortage of incompetent hedge fund managers) but unlike their VC counterparts, top hedge fund managers are extremely knowledgeable and they have the flexibility to adjust their strategies based on their analyses of the markets.

The real problem with venture capital is that it’s so limited and really only works under certain conditions. The fact that these conditions don’t exist most of the time is becoming readily apparent.

Like you, I would not be surprised to see an eventual decline in the amounts investors allocate to VC funds.

remember they collect 2% (or more!) PER ANNUM of the total *committed* capital. (so: a $200 million fund yields fees $4 million/year for 7-10 years, or $28 million at minimum!)

given the durations of typical VC funds (7 years plus) thats a whopping 14% of a funds capital, off the top. meaning only $0.86 of every dollar raised actually gets invested

moreover VCs make portfolio companies pay for legal costs of fundraising — a cost which VC fund management fees should pay. further lining VCs pockets with fee dollars, and further eroding how much of every dollar raised actually gets invested — gets to go to work trying to create return

any case, in addition to glut of dollars and an embrassment of me-too copycat investments, add in the horrendous drain created by management fees and its no surprise the VC asset class is a dog

fund LPs enjoyed huge returns from hedge funds and LBO funds for many years until last year — masking the huge void where vc returns were supposed to be. but now that the wind has gone out of those sails, it wouldnt be surprising to see asset allocations shift away from vc

also, just likie mutual fund managers, vc partners at most cough up 2% of their funds capital – a mere pittance, and financable entirely thru the management fees, so they never actually put much or any of their own dough at risk