I have been kicking around the GP/LP debate in my head and it finally struck me as to why GPs don’t have a leg to stand on. Forget about the contractual agreements and the weasel words being spouted by attorneys. It comes down to something really simple. GPs have been holding entrepreneurs’ feet to the fire for years to produce results. “We’re not a charity!” is a common refrain. Well, guess what? Limited partners aren’t a charity either. They invest in venture capital partnerships to make money. Lots of money. They understand the risks involved, because it’s an alternative asset class. But that doesn’t mean they’ve written blank checks to general partners to spend freely.
If an entrepreneur should be held accountable for his poor performance, why shouldn’t a GP? The answer, if you talk to a GP who has been in the business for any length of time, is that venture funds should be held to the same standard. Who could defend a CEO who’s out golfing while his company is going down the tubes? And yet LPs are asked to stay quiet about GPs who go skiing on their dime while their funds are under water. You won’t hear them complaining in public, but they air their frustrations to me off the record, and they’re getting more vocal when they talk to GPs in private.
Why are some GPs so intent on keeping things the way they are when they know darn well that they’re operating under a double standard? If you look into the matter closely, you’ll find that it’s not the veteran GPs who feel that LPs are out of line for demanding changes. It’s the young bucks who made a killing on the Internet and now feel like they deserve the lifestyles they’ve become accustomed to the corporate jets, mansions under construction and the fastest cars money can buy. They raised big funds to fuel their egos, and now they’ve gotten themselves into a pickle because they’ve collected too much money in fees. They can’t cut their funds to the proper size because they’d have to take money out of their own pockets to pay for operating expenses for the next five to seven years. I’m sorry, but I can’t feel bad for someone who’s that irresponsible. Just like I can’t feel bad for an entrepreneur who takes $10 million in good faith and squanders it.
Apologists tell me I just don’t get it, that I’m not thinking about the long term. It’s true that we won’t know how a current fund is going to fair for another seven years, but we can get a pretty good sense of where it’s going after two or three years. I’ve seen enough anecdotal evidence to know that too many GPs are still carrying near-death companies at inflated valuations.
Before you get the posse together to lynch me, I want to emphasize that I’m not talking about all GPs. Venture capital is like any business. Most of the people are good, some are beyond reproach, but some are pretenders whose sole motive is to get rich at any cost.
If there’s an upside to “The Big Squeeze,” it’s that the pretenders will eventually be squeezed out of the business. Ta-Lin Hsu, chairman of H&Q Asia Pacific, recently told me over lunch that he expects just 35% of VCs to make it through the contraction. Ouch! And you thought I was a pessimist. Whatever the figure turns out to be, the main point is that only the real VCs will survive. Like true entrepreneurs, they are the ones quietly going about their business and they respect the fact that they’re working with other people’s money.
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