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Chamath Palihapitiya described the Venture Capital Industry as a "Ponzi Scheme" in the following interview;
Chamath Palihapitiya on rebuilding Social Capital & Silicon Valley ponzi scheme:
https://www.youtube.com/watch?v=RwRZtZQoLtQ
Chamath speaks on how Venture Capitalists (VCs) have been "lucky" in the following video;
Palihapitiya on Speaking Out in Silicon Valley:
https://www.youtube.com/watch?v=mf9mNWrAb1c
For more on Social Capital's Performance, check out the following video;
Chamath Palihapitiya Social Capital 2019 Annual Letter:
https://www.youtube.com/watch?v=PPJN68wt4pk
When people hear the phrase Venture Capital, some ask:
1). Wait a minute, what is venture capital?
2). Others who are more versed in finance, or fih-nance, ask: wait a minute, what is really going on here?
Let's tackle the first question.
Venture Capital basically means you take the capital of your LPs (your limited partners, i.e. extremely rich families, sovereign wealth funds, corporate pension funds, endowments, etc) and invest it into early-stage businesses in exchange for equity (i.e. an ownership stake) in those businesses.
You charge your limited partners a fee for managing their money.
This fee model is generally '2 and 20' - so you get 2% of the assets under management (the AUM) annually and 20% of the profits (otherwise known as the carry) on your investments.
We'll go over fees in more detail later in the video as this is a very important piece to understand.
We also need to understand some jargon:
Specifically, the funding rounds:
We have the Seed round; followed by
The Series A round; followed by
The Series B round; followed by
The Series C round; and
Some companies can go on to Series D and even Series E rounds of funding.
These funding rounds are merely stepping stones in the process of turning a successful startup into a commercially viable firm, potentially leading to an IPO.
An IPO can be like hitting the jackpot for early VCs: this is when they often join the ranks of the super rich.
Now, let's tackle the second question.
The endgame of the VC Industry is Fees.
Specifically, it is management fees that are a guaranteed cash cow.
When saying the VC firm raises a new fund, this means that they are locking in another batch of LPs money for 10 years, this is the typical length of a fund.
To clarify, the 2% fee is cash compensation, paid annually, regardless of the investment activity or performance of the VC firm.
This fixed 2% fee structure obviously creates the incentive to accumulate and manage more assets. The larger the fund, the larger the fee stream. Raising bigger subsequent funds allows VCs to lock in larger, and cumulative, fixed cash compensation.
Let's look at an example:
For a one billion dollar fund, over a typical 10 year time-frame, what are the management fees collected?
Well, 2% annually, i.e. $20MM annually - OR $200MM over the full duration of the fund.
Sure, some of that covers operating expenses, but a lot of it ends up with the Partners at the head of the firm; in all but the smallest funds, the partners make high six, and more often seven, figures in fixed cash compensation.
As we touched on earlier, the carry (the 20% of profits if it goes well) can make these partners extremely rich at IPO - however, the dirty secret in Venture Capital is that the guaranteed fees are the guaranteed cash cow.
According to Bureau of Labor Statistics, the median wage of US workers is just under $50K per year.
This means that an average partner at a reasonably sized VC firm is earning roughly 20X the average annual salary of an average American worker on just the management fee from raising a single fund, without investing a single dollar.
A study by Harvard and Yale researchers found that VCs’ abilities to pick investments and nurture start-ups “play little role if any” in long-term outperformance.
The authors analysed decades of portfolio investment and performance data to assess the mechanisms of venture capital success.
They found that investing in the right companies at the right time gives VC firms access to better deals, which often leads to long-term outperformance.
And picking those original winners appears to be a matter of luck...
What are your thoughts, is is true...or false?
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