Jeff Bussgang, a general partner at IDG Ventures Boston, recently conducted an informal survey of about 40 VCs who have been in the venture business for six to 10 years. The results were startling. The majority of the venture capitalists surveyed said they work at firms that have never returned money to investors, which means they have never received a carry check. Every dollar they have made in the last decade has come from management fees.
This new reality—the shortage of carry in the venture capital world—has some VCs looking for another exit: the front door.
Industry watchers observe that venture capital is in danger of turning into a salary-centric business in which firms with the biggest funds and fattest management fees can attract talented partners based on pay rather than fund performance.
“It’s not as uncommon as you think for fairly senior general partners, with 10 years of experience, to have never received a carry check,” writes Bussgang on his blog (http://bostonvcblog.typepad.com). “And if they’re only working for salary, then another VC fund that offers them a bigger salary can poach them away.”
VCs were once motivated solely by performance and the millions they could make by nurturing a startup and taking it public. But with the IPO window tight for most of this decade and opportunities for big exits exceedingly scarce, VCs seem to be more willing to test the free-agent market.
For example, Scott Darling moved from Intel Capital, which typically offers a lower base salary in favor of performance incentives, to Frazier Technology Partners. And we’ve noticed a number of moves from small funds to large funds, which pay more than their smaller counterparts (see chart: Annual base salary for GPs). Mike Scanlin went from Sierra Ventures, which last year closed a $377 million fund, to Battery Ventures, which operates a $450 million fund. Yoni Cheifetz left Star Ventures, which last raised a fund focused on Israel in 2001, for Lightspeed Venture Partners, which raised a $475 million fund last year. And after nine years, Phil Sanderson left WaldenVC, which hasn’t raised a new fund since 2000, for newly formed IDG Ventures SF. (All of those VCs declined to comment on whether compensation was the key factor in their decision to switch firms.)
It’s not as uncommon as you think for fairly senior general partners, with 10 years of experience, to have never received a carry check.”
Jeff Busgang, General Partner, IDG Ventures Boston
Some venture capitalists are leaving the trade altogether, griping that there just isn’t enough money to be made. Peter Rip, a general partner at Crosslink Capital, recalls a 2005 dinner conversation that presaged today’s flurry of firm-jumping:
“Two of these guys were partners at firms. They were both complaining that venture capital is evolving into a fee-based business, due to the shortage of liquidity events. One was saying how difficult it is to lure new partners, because $2 million a year just isn’t enough to get the people you want.”
Although one of those VCs is still in the business, the other left venture and started a hedge fund, Rip says.
In what might be a prelude to a brain drain, some VCs are getting out of the industry because they feel they can make more in other pursuits. “Unequivocally, I think VCs might find better opportunities in other businesses,” says Jon Holman, president of the Holman Group, an executive-recruiting company that has conducted partner searches for a number of leading venture firms. “Without a liquidity market, sooner or later some VCs have to think of doing something else for a living. It’s very true that there are a number of venture guys who are ‘loose’ at the moment.”
Some people, such as Bill Stensrud, a former managing director at Enterprise Partners, and Aneel Bhusri of Greylock, are returning to their entrepreneurial roots. Bhusri is still in the venture game, but he recently co-founded a company with his mentor, Dave Duffield, who had a huge success with PeopleSoft. Together they’re running a new software company called Workday.
Stensrud, meanwhile, has pulled out of venture entirely. After making the Forbes Midas List with investments in winning startups such as Juniper Networks and Paradyne Corp., he left Enterprise at the end of last year and is now CEO and chairman of online content company Muze. “I spent 30 years as an entrepreneur and nine as a VC,” he explains. “I decided I’d be happier as an entrepreneur working with smaller companies.”
Despite his success as an investor, Stensrud believes the VC industry is seriously challenged. “Venture opportunities are much tougher to harvest today,” he says. “I think technology is starting to look like the auto industry. In a few years there will only be five or six major players with a supply chain underneath. Some firms will make money, but the industry as a whole will continue to disappoint investors.”
One [GP] was saying how difficult it is to lure new partners, because $2 million a year just isn’t enough to get the people you want.”
Peter Rip, General Partner, Crosslink Capital
Stensrud believes he can be more successful by making what he calls “micro investments” in companies he’s involved with personally. His game plan is to invest less than $1 million of his own money and realize returns of $10 million to $15 million. “Those aren’t the type of investments you can be involved with if you work at a large venture fund,” he says.
Another VC who left the field is Ravi Chiruvolu. After exiting Charter Venture Capital for GKM, Chiruvolu last spring started a hedge fund called Top Shelf Capital. “The problem is that innovation is constant but money is not,” Chiruvolu says. “And what we have now is not enough innovation and way too much venture capital.”
Get rich slowly
Is lack of carry—and consequent movement among firms by VCs—a long-term trend, or is it simply a cycle, blowback from the bursting bubble?
Scott Irwin, a general partner at El Dorado Ventures since 2005, says that, for the committed VC, the question is irrelevant. “With regard to Ravi’s comment about innovation being constant and investment being cyclical, I guess that’s true but it’s not really an issue if you take a long-term view,” Irwin says. “Sure, some people will always think short-term and go where they can maximize their salary, but most people in venture realize this is a get-rich-slow business.”
Irwin advises firms that want to keep the churn rate down to choose the right people to begin with. “Everyone at El Dorado has the mentality that venture is a career decision not a point-in-time decision to try to maximize your earnings,” he says. “When we recruit that’s something we look closely for.”
El Dorado avoids people who are looking at the firm as a place to make a salary. Instead, Irwin says, the firm follows an apprenticeship model: Bring in talented people, teach them the business and promote them if they flourish. Case in point: Ray Schuter, whom El Dorado hired away from Pequot Ventures in 2005 and recently promoted to principal. “We wanted someone who has a long-term view of venture and who we think can be successful, and that’s Ray,” Irwin says.
Without a liquidity market, sooner or later some VCs have to think of doing something else for a living. It’s very true that there are a number of venture guys who are ‘loose’ at the moment.”
Jon Holman, President, Holman Group executive recruitment firm
Another factor in attracting and keeping talented people is firm structure, Irwin says, citing El Dorado’s flat, collaborative structure. “There’s a lot of decision making that goes on in people’s offices or sitting on sofas. I think that directly affects our retention. We’re able to show a career path and a much flatter organization to a non-GP, so we don’t have to worry about them going somewhere else.”
The same technique can work at larger firms, says Ken Lawler, general partner at Battery Ventures, which recently hired Mike Scanlin from Sierra Ventures and made him a partner. “The primary attraction for any firm, including Battery, is providing these guys with an established platform that gives them confidence that they can build a career,” Lawler says.
He explains that Battery hires associates on an annual basis, works with them over three to four years, and then promotes the people who have “long-term franchise value.” Lawler notes, though, that wise hiring and attentive training are not the only incentives you need to offer good people. “Senior partners have to make an investment in the younger people by dividing up the pie,” he says.
Of course, if there is not enough pie to go around, then firms must find other ways to hang on to their people, such as higher salaries. One partner who recently switched firms told VCJ via email: “My old firm had the common problem of the top few guys hogging all the economics (cash and carry), completely independent of performance or delivered results.”
The VC, who asked not to be identified, wrote: “My increase in current income (management fee) was modest, so that wasn’t a big motivator. My increase in carry potential was large (I’m confident I’ll perform, so this was a big motivator). And my path to a top slot (GP) is many years shorter at the new firm vs. the old firm, given the equivalent (very good) performance at both.”
Another venture capitalist who is a friend of Scott Darling says that compensation played a role in his decision to leave Intel Capital. “I believe a reason Scott left Intel Capital is that no one there was receiving performance bonuses anymore,” says the VC, who asked not to be named. “At Frazier he could make a lot more money just from the management fee,” the VC says. “I think you’ll start seeing more of these guys jump to another venture firm based primarily on the compensation they can earn from management fees.” Darling declined to comment on the matter.
Darling himself says he left Intel Capital for Frazier to “work with a great team I have known personally for nearly a decade.” He declined to talk about compensation.
Certainly people, for economic reasons, are deciding that venture capital may not be for them. Some of them are moving outside of venture capital to new areas like growth equity and hedge funds. I think it’s a good thing for the industry.”
Barry Eggers, General Partner, Lightspeed Venture Partners
Other VCs are jumping the fence and leaving the field altogether, often for the very alluring returns now available in private equity and hedge funds. This is where the real money is made today. These groups, which manage an array of multibillion-dollar funds, are reaching ungodly compensation levels. Partners can earn tens of millions of dollars, while associates straight out of business school can collect nearly $400,000 a year, according to the “Private Equity Compensation Report” produced by Glocap Search and Thomson financial (publisher of VCJ).
Armed with almost limitless resources and a limited number of places to put them, private equity and hedge funds are starting to encroach more and more on the venture world. Hedge funds AllianceBernstein and Maverick Capital, for instance, recently led a $59.5 million series C round for BrightCove, an Internet TV service. And hedge fund D.E. Shaw has made at least six venture investments since August 2006, including two in February: It took part in a $27.6 million round for wireless LAN provider Meru Networks and a $45 million round for display media company Reactrix Systems. If hedge funds start doing more venture deals, it’s not unreasonable to believe they will start to poach more talent from traditional VC outfits.
“Compensation at hedge funds is structured very differently from the VC world,” says Bill Burnham, a former partner with Mobius Venture Capital who now runs a hedge fund called Inductive Capital. Unlike venture funds, where ownership is shared equally among partners, hedge funds reward individual portfolio managers regardless of what the overall fund does. People get paid for individual performance, which allows these funds to cherry pick the best talent. “Theoretically, they can also cherry pick talented VCs to run their operations, especially if they decide to launch a VC-type fund,” Burnham says.
He cites the example of Alex Wong, a former venture investor with Apax Partners who recently joined D.E. Shaw to make VC-type investments. To date, the major private equity and hedge funds have not shown a substantial commitment to venture capital, but they’re starting to eye the venture world more closely. “You could see some really interesting talent wars being fomented between VC firms and new-money hedge funds,” Burnham says.
That wouldn’t necessarily be a bad development, says Barry Eggers, a general partner at Lightspeed Venture Partners. There is still a lot of room for “rightsizing” the venture industry, he says. “Certainly people, for economic reasons, are deciding that venture capital may not be for them,” Eggers notes. “Some of them are moving outside of venture capital to new areas like growth equity and hedge funds. I think it’s a good thing for the industry.”
Chip Linehan, a managing partner at New Enterprise Associates, also is not worried about a VC brain drain. He says people interested in venture capital tend to be very different from those attracted to private equity. “Venture requires a different skill set,” he explains. “It’s less about spreadsheets and quantitative analysis and more about having a passion for technology and helping companies develop. There may be some overlap between venture and buyout firms when it comes to recruiting, but it’s not a huge amount.”
I believe the compensation and rewards structure we have in place at NEA makes everyone feel they’ve been fairly treated–from the most junior to the most senior people at the firm.”
Chip Linehan, Managing Partner, New Enterprise Associates
Still, NEA and other firms are feeling the pressure to attract and retain talented investors. In fact, the “Private Equity Compensation Report” states that larger VC funds are boosting compensation to entice some of the same people who are predominantly the targets of buyout funds. Junior staffers and freshly minted MBAs are benefiting the most from this development.
Spread the wealth
“The general trend in the industry is that more carry has been moving downstream toward non-partners,” says the report. “Whereas about five to 10 years ago probably about 85% to 90% of the carry was held at the partner level, looking forward we project that 75% to 80% will be more common.”
The report attributes the trend to the next generation of leaders, who are seeking increased ownership in the franchises they help build. It follows, then, that the positions seeing the biggest gains in total average compensation at VC firms are vice presidents (up 16%) and associates and senior associates (up 12% each).
Paul Kedrosky, a venture partner with Ventures West, concedes that junior staffers are starting to get a larger piece of the carry. But, given that there really is no carry to speak of, the exercise is meaningless, he says. “Firms are being more generous with the carry because it’s like handing out wooden nickels,” Kedrosky says. “The real gold in the venture world is now management fees, and partners are guarding that with their lives.”
Linehan, who joined NEA straight out of college, says his firm has always had a philosophy of “aligning incentives” so that it’s not just the people at the general-partner level who reap rewards. “I believe we are at the forefront of the venture industry in terms of carried interest and ensuring that everybody at NEA shares in the success of the firm,” he says.
Though he declined to cite specific numbers, Linehan says part of the mission of NEA from the start has been to build a firm that will outlast its founders. Unlike most other VC firms, which hire associates and expect most of them to be out the door in two or three years, all associates at NEA are hired with the hope that they’ll one day make partner, he says. Linehan himself rose from the photocopy room to general partner over 15 years at NEA.
You could see some really interesting talent wars being fomented between VC firms and new-money hedge funds.”
Bill Burnham, Founder, Inductive Capital
“I believe the compensation and rewards structure we have in place at NEA makes everyone feel they’ve been fairly treated—from the most junior to the most senior people at the firm,” Linehan says. “From the beginning, I was fortunate to be the beneficiary of some of these rewards, which have proved lucrative for me.”
Tomorrow the world
The ultimate solution to the evaporation of liquidity events in North America may lie overseas. That’s why VC firms with ambitious goals are looking to markets in China, India, Israel and elsewhere, where they are starting offices and kicking the tires of startups.
Lightspeed recruited Cheifetz from Star Ventures, a leading Israeli venture capital fund, to focus on investments in Israel. In China, it recently hired general partner Eric O’Brien, who previously worked with InterWest Partners, and partner Ron Cao, formerly of KLM Capital.
“There’s a growing trend among top-tier firms to be global in scope,” he says. “It’s important to demonstrate that your horizons aren’t limited, that you go where you need to go to access high-growth markets,” says Eggers.
“The world is opening up,” adds Tim Draper, managing director of Draper Fisher Jurvetson. “Geographic borders are falling and entrepreneurship is everywhere.” Firms that recognize this and move quickly to take advantage can provide more opportunity to promising young VCs.
“I know of several firms that aren’t raising any more money because of lack of deal flow or lack of returns,” Draper says. “DFJ is flooded with deals from all over the world.”
This keeps the firm’s employees happy and helps attract bright new prospects. “It has to do with mission,” Draper says. “Talented people are smart, and they want to go with a group that has a purpose. Venture capital firms have to change to adapt to the new world of entrepreneurship. It’s global and connected.”
As the VC world expands, some old-guard firms are losing their pull. These days, Eggers says, talented VCs look at more than brand when deciding where to park their nameplate. “It used to be that brand carried more weight. Now people look beyond the brand.”
He checks off what he sees as the attractions of Lightspeed. In addition to its international reach, it is made up of relatively young investors, which means the team is likely to stay together for a while, and it has a flat structure, meaning VCs beyond the chosen few get to participate in quality deals. “Behind the brand, people look at those things: platform, track record, economics,” Eggers says. “And the best players want to play for the best teams.”
In other words, if you’re a young football star, you probably won’t go play for the Oakland Raiders. Taking the sports analogy a step further, Eggers laughs and offers a proviso: “Well, if the Raiders pay you enough you probably will.”
Tom Stein and Tim Devaney are Silicon Valley-based freelance writers who specialize in covering technology startups and venture capital. Stein may be reached at email@example.com. Devaney may be reached at firstname.lastname@example.org.