The Kauffman Foundation just released an indictment of the way big investors (like pension funds and foundations) place their money with venture capital firms. In a report entitled, "We Have Met the Enemy ... and he is us." Kauffman calls into question some of the VC world’s most accepted ideas.
"To fix what’s broken in the LP investment model, institutional investors will need to become more selective and more disciplined investors in venture capital funds. The best investors will negotiate better alignment, transparency, governance, and terms that take into account the skewed distribution of VC fund returns." says Kauffman in their report.
To that end, Kauffman says its new approach to venture capital investing will be:
- Invest in funds of less than $400-million (mc: like FloodGate, USV and 500Startups?).
- Develop a small portfolio of direct investments in startups.
- Directly co-invest in later round deals.
- Shrink the size of their allocation to venture capital.
If you are sitting in Canada, this sounds familiar. Last year OMERS (Ontario Municipal Employees Retirement System) made similar moves creating OMERS Ventures. That had fund managers, like Rob Chaplinsky at Bridgescale, worrying out loud that "OMERS is going to muck up the eco-system." It's only one year later and two Bridgescale partners have already left to join the OMERS Ventures team.
The impact this could have on startups, both good and bad, should not be underestimated.
On the plus side, if institutional investors start investing in a greater number of smaller funds then competition for deals will surely increase. If they start holding startup portfolios themselves then the impact will be even greater.
That being said, if institutional investors decide to pull back on their overall venture capital investment, then that Series A round could be a lot harder to get than the seed round was. Most VCs won't publicly admit to this possibility, but it may already be happening. In a recent letter released to debate funding gaps in Canada, CVCA President, Gregory Smith says, "Major funders have all but disappeared and the venture capital industry itself is in a capital drought. For instance, in 2011 not a single dollar from outside Canada found its way into our funds."
Still not convinced? Look at this video of Kauffman's Harold Bradley using their investment in AngelList as an example of why he is in favour of institutional investors making direct angel investments.