The VC Confidence Problem

“I don’t know what kind of a career I’m going to have in venture capital.”

That’s what I was recently told by a managing director at a well-regarded Silicon Valley venture firm. His comment had little to do with his own interest or ability in the VC business. In fact, he’s one of the more successful VCs out there, with at least one major several-hundred-million acquisition and a fistful of enviable portfolio companies. If anything, he should be one of the people who would keep his job in the coming VC shakeout.

His concern was that exits would become increasingly difficult to score, and limited partner money would dry up.

Even successful VCs think their careers are in trouble — a recent survey found that nearly 53% of VCs believe their business model is “broken — and that may be the biggest problem the VC industry faces.

So this is a problem. Would you bet on a baseball team where five of the nine players thought they were going to lose?

Finance is a confidence game, literally. One group entrusts its money to another with confidence it will produce returns.

VCs overdrew their confidence account during the dotcom boom and bounced bad companies on the public market. Limited partners were willing to roll with it, though. Confidence is sexy and boring pension fund managers still wanted a piece of the action.

So where did the confidence go?

At first, it was the “Venture Overhang.” You remember how all that capital that had been raised in during the dotcom era was all competing for too few deals?

Then there was the Chinese Wall that forced investment banking analysts to ignore newly-public companies. Bummer.

Then there was Sarbanes Oxley. Oh man, who wants to be on a public board with those onerous liabilities? You could go to jail if a company misstates earnings. Then there’s all the compliance costs that raised the revenue bar for would-be IPOs.

Then it was just that the “IPO Window” was shut. Or maybe it was the lack of boutique investment banks, as Dixon Doll recently suggested.

Now it’s the recession, the Denominator Problem and uncertainty about government stimulus.

RESTORE CONFIDENCE

There are three ways to restore confidence: project it, act on it and believe in it.

Projecting confidence can be easy. Just memorize a couple of key phrases and drop them into every conversation you have.

“We’re in the middle of the largest legal wealth creation the world has ever known.”

“Technology entrepreneurs have always led the way out of recession and into economic expansion.”

“Funds invested during a downturn have historically had some of the most impressive returns.”

“Innovation doesn’t wait for a macroeconomic turnaround.”

“We’re going to let other people wring their hands about the “model” being broken. It’s working fine for us.”

“Somebody’s going to build a dozen billion dollar companies this year and we want to be there when they do.”

Eventually these bluffs will beget reality as people start believing them. Would entrepreneurs come to Silicon Valley if they didn’t believe there was a chance to make more money than Midas?

Acting from a position of confidence is going to be a little strange at first.

Raise your carry and drop your management fee. Think of this as the Benchmark approach. Tell your LPs you’re so confident that you’ll make money, that you’re willing to forgo the management fee for a bigger piece of the carry.

Don’t offer founder’s stock, early liquidity, or even high valuations. Tell the founders you bring so value to the table in the form of “relationship capital.” Cultivate a take-it-or-leave it attitude.

Threaten to fire the CEO of any company that doesn’t accept a reasonable acquisition offer from a large, well-established buyer.

Believing that venture capital is going to make stupid money again may be the hardest part of this equation. Your hardest sell is going to be to yourself.

So get yourself a black and white–striped tie like John Doerr’s (seriously, he has one tie), stand in front of the bathroom mirror and tell yourself that the next billion dollar deal is right around the corner. Plan out how you’re going to help your companies make sales, or make connections, or just make more money as your standing in the shower.

Change up your routine to break out of recidivistic thinking. Go read “The Hero with a Thousand Faces” and “The Art of Worldly Wisdom.” Drink six cups of coffee, listen to some heavy metal and go kick ass.

For more reading on the confidence problem, check out Gladwell’s latest.