Back in 2003, Mark Montgomery from Initium Venture Capital made a statement that caught my interest. He said:
The experiment of institutionalization of venture capital operations has failed. Real venture capital business-building is largely a practice of an individual's knowledge, skill, art, and passion. None of these scale.
Was he right? And does the same apply to private equity? Are venture capital and private equity small team sports, or can they thrive within large institutions?
There have been plenty of high profile spin-outs: Morgan Stanley's venture team (Crossmark), MidOcean, Archer Capital. But other captive teams like Merrill Lynch Global Private Equity and RMB Ventures seem to be thriving.
So what's going on? Do talented, seasoned VCs or private equity investors ever willingly accept employee status? I suspect the answer is yes . . . occasionally. And I suspect they arrive at the office each morning and wonder whether it's still working, whether it's worth the pain. Every day it's a value - price equation:
Value: The two most obvious possibilities are deal flow and funding. If attractive investment opportunities come through the door because I'm part of XYZ Group, then XYZ is really delivering-- great deals are scarce, scarce, scarce.
Likewise, if the parent company anchors a fund raising, or allows the team to avoid it altogether, that's worth gallons of blood, sweat and tears.
But there's a price to pay:
Conflicts of interest: teams affiliated with investment banks complain that competing banks won't bring them deals, or they only see the junk. Some teams are required to use in-house corporate finance or leveraged finance. In these cases, investment banking fees start to drive decision making. And it's not just the banks, tech companies bully their VC units to exit investments because of budget pressures.
Compensation: most teams are willing to give up five carry points in exchange for easy access to capital or great deal flow. Maybe seven points? More than that will test the friendship. It may also scare off experienced LPs.
Some groups put their private equity team on an annual bonus, rather than carry. This is a recipe for failure. It creates a level of uncertainty which is incompatible with the long term commitment required in this business. Put simply, I'm not going to devote five years to a portfolio company only to receive a lousy bonus because corporate had a bad year (or the CEO hates my striped shirts).
Perversely, I suspect many spin-outs occur because the team does too well. They hit home runs but the rewards don't follow.
Autonomy: who influences investment decisions? If the investment committee includes members of a bank's credit department, an investment bank's advisory team, or a corporate's legal team you might as well close up shop.
Culture: it's very difficult for a large institution to offer an environment that excites a VC or private equity director. Who wants to be an employee when you can be an owner? They don't want to sit in a cubicle on level 58, they don't want to wear a tie, they don't want to argue with IT when they need a new laptop.
