How the current capital structure for VCs can be improved

Photo credit: Warosu

I have been thinking about this subject for a long time, and I came across a blog post precisely about this topic. A venture capitalist by the name of Mahesh Murthy wrote this article.

Let me summarize it quickly.

He is basically talking about a problem in the venture capital scene, that venture capitalists raise their funds from private investors, who may require the fund to basically reach “maturity” (for lack of a better word) in 8-12 years, and realise the returns of funds to the said private investors.

The funds are hopefully returned with huge and healthy capital gains.

This capital structure however has been under criticism by many entrepreneurs, especially those who understand finance well enough, and peers in the venture capital industry. Having a specific deadline forces venture capitalists to rush into projects and god forbid, forces them to sell the business prematurely via a trade sale or IPO.

This can cause companies to be unable to achieve their true potential, as their shareholders rush to exit the business via a trade sale or IPO.

However, before I state my opinion, I would like to acknowledge that the author of the above-mentioned blog post is a highly experienced venture capitalist with a seemingly decorated past of investing in companies.

I will share my thoughts here, and do forgive me if I am premature in my conclusions.

1. We don’t need 3-4 years to filter out good companies to invest in

I personally disagree with the fact that we need 3-4 years to filter out good companies to invest in. Part of the reason could be due to my background, as I have spoken to over 15,000 entrepreneurs in the last 15 years.

When the sample size of the companies being evaluated is large, I should already be able to differentiate the good from the bad, and I certainly don’t need that amount of time to filter out good companies to invest in.

A good venture capitalist perhaps just needs to have an in-depth understanding of the market and entrepreneurship scene.

2. The typical invest-advise-build-tradesale-IPO loop can tedious, here’s an alternative

The typical venture capitalist modus operandi probably takes the typical invest-advise-build-tradesale-IPO loop. However, I find that loop highly tortuous and laborious.

As investment capital converts from cash to shares certificate, the venture capitalist is forced to wait for years, or even decades, for the shares certificate to be converted back into solid cash via a trade sale or IPO exit.

3. The request for investors to be patient is unfair to them