Some limited partners believe that a major challenge for emerging manager firms is the recruitment of top quality talent to their investment ranks. Because of smaller fund size and the lack of overlapping multiple funds, emerging manager firms are sometimes seen at a disadvantage when competing with larger more established firms with $30 million or more in annual management fees.
At a recent conference for limited and general partners, a leading institutional LP surprisingly defended his support for large management fee structures by arguing that without the current management fee incentive, venture capital firms could not effectively compete for talent in the marketplace. He cited complementary vocations that compete for general partners, focusing primarily on CEOs.
As the argument went, because of the importance of operating experience to successful venture capital investing, successful venture capitalists may be drawn to CEO positions unless venture positions offer a market competitive rate of cash compensation.
Expressed otherwise, when faced with employment alternatives that include CEO positions, some successful venture capitalists would opt for that career path at the detriment to institutional limited partners who hope to attract the best talent to the asset class. As a result, only the largest venture capital firms, by virtue of their large management fees, would be able to attract the highest caliber of talent, while smaller, emerging manager firms would be unable to compete in the venture labor marketplace.
Eye of the Beholder
This argument is interesting in many ways. To start, it overlooks the total compensation package of venture capitalists, which typically includes carried interest, offering a significant “equity” upside for those engaged in the craft.
More notable is the sheer discrepancy in cash compensation between most venture capitalists and the CEOs they back. In most Silicon Valley early-stage ventures, total annual cash compensation (including salary and bonus) for a world-class startup CEO ranges from $250,000 to $350,000, exclusive of stock options.
At industry conferences and board meetings throughout the land, most of us practice and preach the mantra of cash conservation and equity alignment. In this market, a CEO demanding cash compensation above this range is unlikely to be aligned with the “owner mentality,” which makes for a successful startup.
When hiring a CEO, especially in this cash constrained environment, most of us would readily trade a large cash package for additional equity to adequately align the interests of management with those of the investors. Those interests are very clear: Achieve significant returns on invested capital via exit multiples. Salary alone will not incentivize an operating manager to achieve that objective.
Venture managers are equally unlikely to yield significant returns on equity for LPs who reward them with cash compensation. Even if venture managers could be lured away from venture firms by the promise of higher cash compensation, it wouldn’t be to CEO positions. With total cash compensation for venture managers at large firms in the millions of dollars per year, the prospect of CEO compensation hardly seems attractive.
In fact, cash compensation is just half the story. As many venture capitalists recall from their operating days, operating roles in startups require 24/7 schedules, tremendous amounts of travel, two or three weeks of annual vacation, coach airline travel, Holiday Inn hotels, cubicles or offices with college-grade furniture, the occasional doubling up in hotel rooms for conferences and travel, and hierarchical organizations to which most venture capitalists do not naturally gravitate.
Add to this the prospect of a cash compensation reduction of 50% to 90% and venture seems an attractive proposition at any price. To an entire class of richly compensated venture capitalists, the craft is more lifestyle than profession. Why trade it away, especially for a workingman’s lifestyle?
GP or Ceo?
It is fair to assume that the LP in question may have been uninformed about the levels of cash compensation for CEOs in most venture-backed startups, but perhaps he had in mind competitive CEO offers from established, Fortune 500 organizations. While it’s improbable that most venture capitalists are well suited to such large organizations, it is interesting to compare GP compensation to CEO compensation in 2002 in large technology corporations.
As seen in table below, the cash compensation of CEOs at some of the most notable technology companies was lower than the cash compensation of some associates at large venture firms.
The message here is quite simple. On the basis of their large funds and commensurate management fees across multiple funds, many venture capitalists are drawing cash compensations that far exceed the most consistently highly paid position in the United States today: CEO. Some might argue that these companies underperformed and the executives are being rightfully penalized. That should sound vaguely familiar to LPs, yet few GPs have taken a cue from John Chambers.
Instead, many of the largest firms havereduced fund sizes and right-sized their investment teams, but they continue to pay GPs without any linkage to performance.
So, is an emerging manager firm handicapped when competing for venture investment talent? With larger pools of current capital, larger firms can attract and compensate managers several times more generously than operating roles. But do those managers have the “owner mentality” alignment necessary to achieve above-market returns for limited partners?
Meanwhile, smaller firms, like their portfolio companies, are able to recruit venture talent that is focused on equity returns and aligned directly with the incentives of their limited partners. Smaller firms can attract experienced and hard working professionals who are hungry for the upside of venture capital yet not harmed by the complacency of gargantuan compensation.
Most of us in the GP community continually search for startup talent and ways to align it with the startup ethos. Long ago we discovered that gargantuan cash compensation is not the answer. LPs are apparently still looking for the answer.
George Hoyem and Bart Schachter are managing partners with Blueprint Ventures. Based in San Francisco, Blueprint is an early-stage venture firm with two funds under management. Hoyem’s investment focus is software, wireless, security and other IT and communications infrastructure companies. Schachter focuses on communications and IT infrastructure, wireless technologies, nanoelectronics, software, and communications semiconductors.