That venture capitalists push the legal fees during a funding round on to their new portfolio companies is often seen as illustrative. It is used to support the view that venture capitalists are vultures and freeloaders who believe they are entitled to operate without consideration of either cost or conscience. Remember that word: entitlement.
Recent changes to the European funding landscape do nothing to dispel the impression that VCs are taking none of the risk themselves but skimming off very comfortable salaries to play with large amounts of taxpayers’ cash. The socialisation of venture capital in Europe continues apace, reducing the onus on funds to make returns.
Many European venture capitalists are in it for the management fees, since they’re not deluded enough to imagine there’s a reasonable prospect of returning money. And let’s face it: the Government doesn’t give a shit whether it sees the money again or not, so long as the incumbent administration can point to its “investment” in a fashionable sector.
There are two important questions to be asked about the present situation. Should the taxpayer be funding such high-risk endeavours? And is extending a life-line to venture capital, in any case, the best way for the public sector to foster innovation in technology and support the economy?
The first question is easily dealt with. We have written before about why European venture capital is structurally hamstrung and unlikely ever to make money. It is a failing asset class, whose performance compares embarrassingly poorly with stocks, commodities, you name it. Even American VCs, excluding the top quartile, return less than the S&P500 – in some cases, less than inflation.
It’s worth reflecting on that statistic when deciding whether the taxpayer should pick up the bill for this risky endeavour: 75 per cent of funds perform less well than picking random stocks from a list. We must therefore ask: is the state’s investment into venture capital an effective form of economic stimulus, or are there better ways to help the technology industry?
And if it’s not the most effective use of money, why do policymakers and politicians advocate it? How has the European venture capital industry managed to wangle such colossal subsidies?
Hypocrisy and hopelessness
Government money represents almost the entire capital of some funds: Notion Capital, for example, recently raised a $100 million round that included both European Investment Fund (EIF) money from the continent and Enterprise Capital Fund (ECF) money from the UK’s Department of Business, Innovation and Skills. Some funds in Europe are 100 per cent government hand-out.
European money is now present in almost every venture capital fund on the continent, with the exception of the most prestigious firms: the only ones who make returns, who have managed to avoid the lender of last resort. For the others, the legendarily arcane amount of paperwork, atrocious track record and comically poor governance of public honey-pots must be delicately and tirelessly negotiated.
European venture capitalists cannot comfortably be accused of laziness: they are operating in a very hostile investment landscape. But they can certainly be accused of hypocrisy, operating their funds in a way they would never allow a portfolio company to be run.
They do not scale – by choice. They keep their returns secret. They rely on government money. Very few of their in some cases very wealthy partners put skin in the game by doing angel deals with their own money. The root of the problem is the lack of family offices and pension funds with a passion for VC – which is understandable. The result is a necrotic environment that encourages entitlement culture and dependence on the state.
Thus we see the rise of what are effectively highly-paid, but off-the-books, civil servants: unaccountable men on huge salaries gambling away public money. It would be less galling, of course, if the businesses they were investing in were not so very often make-work businesses.
Generational wealth transfer
The European venture capital industry, particularly in the internet sector, is, in effect, a dole queue for the middle classes: a massive generational transfer of wealth into economically unproductive people and companies—start-ups with no hope of an exit because their products, work ethic and business skills are so desperately lacking. This is true regardless of the origin of the venture capitalist’s money, and it’s the reason that VCs’ own investors are still in the process of turning away from the industry.
When magic cheques are fluttering down from the sky, a debasement, real and perceived, to the value of money occurs. And when cash becomes devalued, people like to turn their currency into hard goods. Those frenetic Asian women scooping up armfuls of Louis Vuitton handbags in Knightsbridge are converting their renminbi into an object that can’t be devalued.
Investment managers are engaged in a similar exercise. They enjoy the management fees, of course. And it’s better to have something in play than nothing at all. The result of their actions is that money is being scattered down the food chain from rich people and the government. Entrepreneurs should perhaps ask themselves who they are to boast about personal risk they take when, in fact, most start-ups are simply the last step in a long line of people transferring cash, each of whom takes a piece of the action along the way.
The soft landing “acqui-hires” so beloved of angel investors, if not VCs, represent a further instance of value extraction in the chain. They’re subsidies for angels using money from shareholders in public companies: more evidence of a generational transfer of wealth that dishes out ever-increasing dollops of cash the further down the chain you go.
It’s hard to think of a better analogy for it than the welfare state, transmuted for the middle classes, with a burden increasingly shared or even taken on completely by the taxpayer, with venture capitalists the new unaccountable fat cat civil servants.
Perspective and prognosis
When you look at how much money governments spend on venture capital, it’s true that the figures are dwarfed by dying or more fashionable industries that have greater political clout. Yes, it’s a pity that the EIF is run by people who are never seen out in the industry, whose governance is, shall we say, rather lacking and whose track records are terrible.
And it’s a self-cancelling cycle: the VCs prepared to submit themselves to the horrors of public sector paperwork and to jump through the absurd hoops presented by public sector chequebook-wafters tend to be the ones with little hope of success. Plus, it’s hard enough for the private sector lenders of last resort to choose which VCs to back, let alone the public, which has proven itself time and again incapable of picking winners.
But – and this one is at the feet of our entrepreneurs, I’m afraid – since Europe doesn’t produce entrepreneurial champions, governments are left asking themselves whether to continue to invest in venture capital to prop up the sector, or whether to address more systemic failings by pouring funds into research and development and education.
The reality is that money poured into R&D and better higher education would be profoundly transformative. But that doesn’t concord with our politicians’ electoral cycles, and it’s a lot less easily measurable. Politicians like to underscore their success with readily available numbers: we’ve invested x billion in venture, creating y companies.
But how short-sighted and how foolish they are if they think that turning VCs and start-ups into a branch of the state is the way to rescue their economies.
Rather than addressing the deficiency in R&D spending – the UK spends far less than Germany or the United States – the present administration in Britain has gone for politically expedient wins – the Tech City Investment Organisation, the ECF scheme and pleasant sounding but insignificant tinkering with red tape - while not fixing serious problems like visas. But it is not for the state to keep mediocre venture capitalists running fee-driven businesses (“scams” and “Ponzi schemes” are some of the more robust monikers sometimes thrown around) in Mayfair apartments and BMWs.
Supporting venture capital is easy, relatively cheap, public and measurable. That’s why politicians love to do it. But it’s also one of the very worst ways to create businesses like ARM, which are built by great engineers and businesspeople. What’s needed is heavyweight investment into our best universities and structures that allow the private sector to take these innovations to market, not the adverse selection on steroids that is publicly-funded venture capital.
Such investment into engineering and research operates over decades, not electoral cycles. Its influence is felt many years after the money has been deployed. We can only hope to one day live under the aegis of politicians who care more about the continent’s long-term economic well-being than their own facile and pointless boasting about meaningless clusters of hipsters in east London.
The withdrawal of public sector funding from the venture capital industry would be no bad thing. The weak, currently staggering along on life-support from the state, would die. Formerly great funds like Amadeus Capital, now on their knees begging for scraps, whose chief executive appears to spend most of her time these days lobbying for more government money and sitting on British Venture Capital Association committees, would be compelled to reimagine themselves or shut up shop.
Creating more companies is not enough: the economy must be retooled with engineers, architects and businesspeople who can build profitable global businesses. You do that with R&D spend and investment into world-class educational facilities, not with cosmetic and profitless posturing. There are great venture capitalists in Europe who deserve to be celebrated, but there is also a great deal of fat to be trimmed.
So let’s get trimming.