Everyone back off Tom Friedman

This weekend Tom Friedman wrote an op-ed piece in the NY Times postulating that the $20 billion of government money that GM and Chrysler are asking for would be better utilized by the top 20 venture capital firms in the U.S. because they fund companies that drive innovation and create jobs.  Tom gave a strong endorsement to the venture capital model.  Yet VCs all across the country took offense and backlashed at the suggestion.  Below I will list some of the reasons the VC community gave for their pushback, along with my humble two cents on each.

1)  The venture capital industry does not need a bailout, especially the top 20 firms.

  • True.  But Friedman’s post is not about bailing out VCs.  It’s about the wisest allocation of $20 billion.  The only statement he makes that could potentially be misinterpreted as a suggestion the VC industry needs a bailout is regarding LPs having trouble keeping their funding commitments.  This is a well-known fact and does not suggest the VC industry needs a bailout.

2)  The top 20 firms don’t need help raising money.

  • Usually true.  But that doesn’t matter.  I don’t need help opening a door but I do appreciate when someone holds a door open for me.

3)  There is already a glut of capital in the VC system.

  • Perhaps true over the entire industry, but not necessarily at the top.  Several prominent firms are raising annex funds or are concerned about their levels of dry powder.  Kleiner, Bain Capital, Onset and Battery are just a few of the firms that fit this description (though it is a seed fund, First Round is also raising an annex fund).  Admittedly, the $20 billion Friedman writes about is a large amount for the VC world, given the average amount raised annually by the industry over the past four years is $30 billion.  However, Friedman used this number because that is the latest amount under consideration for GM and Chrysler.

4)  Government money would lead to reckless investing.

  • This is ridiculous.  The best VC firms enjoy that reputation because they invest judiciously in companies that exhibit strong upside potential.  These VC firms then nurture these companies with industry connections and a Board presence.  I cannot imagine Sequoia making imprudent investments just because it received a large injection of investable capital.  These firms aren’t the nouveau riche types.  They’re not like hip-hop stars who blow all their money on cars and yachts the first chance they get.

5)  Government money would have lots of strings attached.

  • Possibly.  Given the restrictions placed on banks receiving TARP money, this is a safe assumption.  Yet it is not certain.  Besides, LPs invest in a VC fund under the premise that the partners will invest that money within parameters defined in the fund’s charter.  These parameters can be broad or specific, and there are always exceptions, but general partners are accustomed to considering the charter before making an investment.  Furthermore, from an administrative perspective, it is much easier to have a small number of LPs in a fund.  Having the government as a fund’s sole LP would be far easier to manage than a roster of hundreds of LPs ranging from institutions to wealthy individuals.

So everyone should back off Tom Friedman a bit.  He made a statement that speaks highly of the venture capital model and the role venture capitalists play in driving the country forward.  As a taxpayer I would be delighted to be an LP in the country’s best venture capital funds.

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2 Responses to “Everyone back off Tom Friedman”

  1. Mark LaRosa Says:

    Great points.

    Lets play this one out…

    Lets say your firm suddenly now had a fund with a $50M LP investment from the government. I agree that you wouldn’t reduce your standard for investing, but would you really have any more bandwidth to do any more investing than you already are? Or would you see yourself putting $4 million in a company rather than $2 million. Is that the right move? Would you expand the team of analysts?

    I agree that entrepreneurs will be the way out of this, and the VC’s can help. So how would you see it working?

    • dremoran Says:

      That’s a good question Mark. In this event our criteria for investing would remain the same. We would still seek capital-efficient companies with scalable business models that solve a real pain point in sufficiently large markets and led by strong teams. However, additional capital allows us to have a larger appetite in any round we participate in. Rather than investing our typical $1-1.5 million in each of two financings for a company, we would be able to invest $2-3 million in each round. However, since it is best to have other investors at the table, many of our investments would be less than this threshold. As such we would likely bring on one more General Partner to help with Board presence in portfolio companies, and one or two Associates to analyze opportunities.

      The net of it is that we would be able to deploy more capital in more companies. And we would be able to increase the amount of dry powder we hold in reserve for each portfolio company. The key is that we wouldn’t throw money at an investment that did not meet our criteria. In baseball, a player does not want to strikeout regardless of how far a lead his team has. A strikeout in the top of the ninth inning hurts his average even if his team is winning by ten runs. As investors we take pride in the IRR we can report to our LPs. A failed investment hurts that IRR regardless of where the invested capital comes from. Even if the government money goes into its own fund, the IRR associated with that fund will still be considered by potential LPs in future funds.

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