The State Of Venture Capital With Farhad Mohit

A couple days ago, I wrote on the state of the venture capital ecosystem in regards to Kleiner Perkins Caufield & Byers, one of Silicon Valley’s most prominent venture funds, raising annex funds for its eleventh (2004) and twelfth funds (2006). The round was in order to have cash on hand in case it needs additional follow-on capital. My thoughts were that this news potentially shows that limited partners and VC’s may see an end to the crisis in the near future and that times weren’t really as tough as they seemed until LPs started asking for their money back. Farhad Mohit, BizRate and Shopzilla founder had this to say to me on the issue:

Remember that VCs make their money from a ~2% management fee (for the whole fund under management) and a percentage of profits generated. So, they are loathe to return any money under management because it is “sure income” for them. However, if the “Good Times” are truly at an end, as some VCs have speculated, then what are they telling their Limited Partners (investors) as the reason for holding onto their money and charging a management fee?

So, asking VCs whether the good times are over, just gets you the biased perspective of “buyers” telling you what they think the market looks like. Note, they have every incentive to tell you (entrepreneurs) that times are tough, valuations should be lowered and that you should take whatever offer then give you.

However, until I see money being returned to the LPs for lack of investment opps, my guess is that they’re telling their investors a different story…

More like: Times are tough, but with our BS “Fearmongering” presentations we’ve scared entreps into lowering their valuations to a point where we are seeing incredible investment opportunities, blah blah blah (where blah blah blah basically = “so let us keep investing your money and earning our 2% fee).

In retrospect, I have to agree with Farhad, but will a VC give the money back? Consider this; A VC who loses confidence or interest in a company can choose to cease new investments in that company and get diluted, or give the money back. But why would they? An LP who loses confidence in a VC fund technically still faces a legal obligation to continue meeting their capital calls. At best, they face losing all their capital. At worst, they have no choice but to throw good money after (perceived) bad. (EarlyStageVC). So as VC’s continue to live off of fumes (the average return is lower than a government bond, with a much higher magnitude of risk), will they continue to raise new funds, continue to take their 2% (and 20-30% of profits) in the belief that the good times are around the bend, or will they concede? With the overcrowded market, it seems that the life of the VC cannot live on as they once have before. It has been 11 years since the venture industry has returned more cash than it has plowed into investments, according to the National Venture Capital Association. The industry is now managing $257 billion, up from $64 billion in 1997. The general sentiment in the market since it has crashed is to avoid putting money into an industry than hasn’t turned a profit in that amount of time. So, the question now may be less of when will they give it back, as when will the VC’s run out of money, starting the long awaited industry shakedown? If there was any year to have it happen, 2009 seems appropriate. Look out.

(Image Via Forbes)

Tagged as: 2009, farhad mohit, Funding, limited partners, Venture Capital