Many bloggers have been saying recently that the VC Model is Broken. One of the most important reasons is that Venture Capital Firms are just too big.
Why Venture Capital Firms Got Too Big
In the 20th century, technology companies often required tens or hundreds of millions of dollars to build out and prove. Companies like Intel, Microsoft, Amazon and Google required hundreds of millions of dollars to scale up to the size where they were proven winners. This was one of the factors that led to venture capital firms becoming ever larger.
Being a VC fund manager was also a great job for the fund principles, once the fund was large enough. Most VC funds are structured so the fund managers charge a management fee of about 2.5% of the value of the fund each year. The management fee pays the salaries of the fund managers and their support staff. A small VC firm usually has four partners and some support staff. This means that the annual operating budget for even a small fund quickly grows to more than $2 million per year.
Most VC managers believe a fund under $100 million isn’t economical. The goal of most VC managers is to grow the fund to several hundred million, in part, because then they can start pull down some very attractive compensations. This is another reason that venture capital firms have continued to grow.
The graph below shows how these trends have led to the phenomenal growth in the size of venture capital firms over the past 30 years.
Each VC Partner is Managing More and More Money
As VC funds have grown larger, the amount of money that each VC principle has to invest has grown even faster. Most VC funds can’t invest less than a few million in each portfolio company.
What This Means for Entrepreneurs and Angel Investors
This necessity for venture capital firms to invest more and more in each company has profound implications for entrepreneurs and angel investors.
For most startups it means that venture capital firms probably aren’t the best source of funding – or that they aren’t even a desirable source of funding. The full post, on Venture Capital Firms Are Too Big, begins the explanation of why this is. This is also an important part of my upcoming book: “Early Exits – Exit Strategies for Entrepreneurs and Angel Investors – But Maybe Not VCs“.