David Siemer Highlighted in 89.3 KPCC Article that Discusses VC Investing Concerns

Good money after bad: CalPERS and the crisis in venture capital

By Matthew DeBord for 89.3 KPCC

May 15, 2012 (Los Angeles, CA) — Pretend, for a moment, that you’re a computer science student at Stanford University. Chances are good that you’ve thought about taking your degree — or even not waiting to get your degree — and starting a technology company.

It’s the new American Dream. It attracts the most talented international students to our major research universities. It’s made the likes of Jerry Yang, Sergey Brin, Larry Page and, more recently, Facebook’s Mark Zuckerberg and Instagram’s Kevin Systrom (both under 30) multi-millionaires if not multi-billionaires nearly overnight.

Technology. The Internet. Mobile. Innovation. Disruption. Entrepreneurship.

These are the things that make America great in the early 21st century. Many of these new businesses are located in California. And they all have one thing in common: They live and die based on the investment decisions of venture capitalists, arguably the most important reallocators of wealth in the global economy.

Venture capital is the rocket fuel that gives scrappy tech startups in Silicon Valley, Los Angeles and San Diego (and other cities outside California) their liftoff velocity. Wanna be a tech tycoon? Then you’d better meet some VCs.

But where do VCs get their billions? For the most part, from foundations, endowments, pension funds and high-net worth individuals. And as the VC business has gotten tougher in the years since the bursting of the dot.com bubble on the late 1990s, those big funders have begun to ask some serious questions about what kind of return they’re getting on risky, long-term investments in the startup economy.

We Have Met the Enemy…And He Is Us

Last week, the Kauffman Foundation published a paper, jointly authored by Diane Mulcahy, Bill Weeks and Harold Bradley, titled “We Have Met the Enemy…And He Is Us: Lessons from Twenty Years of the Kauffman Foundation’s Investments in Venture Capital Funds and The Triumph of Hope over Experience.”

It didn’t mince words. The conclusion was that Kauffman hasn’t just been investing unwisely in VC — it’s been perpetuating a myth that venture capital is a good way for investors to beat the public markets.

The foundation knows what it’s talking about. “We have structured a compensation system that rewards fundraising,” Mulcahy said of dynamic between VCs and funding sources, and of the way VCs are paid.

So VCs aren’t creating the returns that they’re supposed to. And you might see the headlines — “VC Doesn’t Deliver on Its Promises,” “VC Is a Bad Investment” — and conclude that VC has lost its mojo. That VCs, despite their professed expertise, kind of suck at finding the next Facebook.

But Kauffman tells a different story, one of VCs and their funding sources locked into a dysfunctional relationship that’s actually preventing VCs from doing their jobs — and making it likely that funders will keep failing at theirs.

Bottom line: funders have put so much faith and money into VC that they’ve encouraged VCs to excel at…raising money, lots of money, not at finding great companies that will deliver market-beating returns. And the winnowing of VC over the past decade, with far fewer firms chasing many more dollars, has made the situation worse.

Kauffman is uniquely situated to study this issue. The foundation was started by healthcare tycoon Ewing Kauffman with a mission to promote and enable entrepreneurship. Based in Kansas City, Missouri, it’s been around since the mid-1960s and has been very successful, with an endowment of nearly $2 billion.

But more importantly, it’s been investing in VC for 20 years and has amassed an enviable pile of data on this asset class.

A decent chunk of the Kauffman endowment — almost $250 million — is invested in a portfolio that’s riskier than run-of-the-mill stocks and bonds. In order to garner higher returns, it’s invested in such alternative investments as venture capital and private equity funds. The VC component is the focus of the Mulcahy-Weeks-Bradley paper, which draws on Kauffman’s experience investing in innovative, entrepreneurial startups — quite literally putting its money where its mouth is, as Kauffman’s mission is to promote entrepreneurship.

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Why It’s Hip to Be Small

However, in an additional negative wrinkle, she and her co-authors discovered that for the Kauffman Foundation, smaller VC funds have performed better than the big boys. “No fund greater than $1 billion has returned more than twice the capital invested, net of fees. The best-performing funds are consistently smaller funds.”

That makes it simple to figure out how to fix the problem of VC in alternative investment portfolios, right? Just concentrate on small funds.

But that’s easier said than done. For starters, smaller funds may not be prepared to deal with large capital inflows — they have to find good startups to invest in, after all, and while they may not put all of a fund to work right away, they don’t necessarily want to sit on their money. So they can have too much in the bank.

They may be able to solve this problem by becoming “followers rather than leaders.” David Siemer of Siemer Ventures in Los Angeles told me that this is how his $35 million fund prefers to operate: joining with other VCs to invest in early-stage companies, taking some of the pressure off, letting others assume the risk of finding the next big thing.

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