Most VCs suck at being VCs

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Most VCs aren’t actually any good at being VCs. There. I said it. Can I prove it?

Definitely. Carta and Angelist just released their 2024 data, and it paints a pretty grim picture. But first, why do we care? Besides the obvious, of course.

Venture capitalists are usually very successful people. They either had a successful exit (or two) and became VCs. Or they excelled in college, then at an investment bank, then maybe in business school, and finally got hired by a VC firm. There, they succeeded (at what, I’ll explain shortly) and then were promoted to actual partner (not fake partner; there are lots of those too).

The seem successful, but the kind of success most of them have enjoyed is in fact totally irrelevant to how good they are at VC. This matters because there are two things that I think founders get wrong about VCs. First, the things that make the great ones great at being VCs have little to do with building great companies. Second, most are not very good at those things.

After you read this, you might conclude that if you can’t get a great VC to invest, maybe it’s better not to take any VC. Or you won’t conclude anything, and maybe this will just be as fun to read as it was to write.

Before I tear into VCs (and believe me, I will be tearing into VCs here) know that there are great VCs out there. If you’re a VC and you’re reading this newsletter, you’re probably one of the great ones 🙂. But there are a lot more bad VCs than good ones. Because, math. Founders beware.

The math

Before we get into what makes a good VC or a bad VC, let’s settle the facts. Carta’s latest VC Fund Performance report just came out, and says it pretty clearly: “Less than 10% of 2021 funds have had any DPI after 3 years.” In other words, 90% of funds in 2021 haven’t returned a damned thing (DPI is distributions to paid in capital). While it’s still early, this is a big change from, say, 2017 vintage funds.

What’s worse, according to Carta, the median IRR (internal rate of return) is below zero for 2021 and 2022 vintage funds. IRR takes into account non-exited investments, ie ones where the VCs could make up their valuation. This chart actually makes it look better than it really is; in 2022 the top of the gray line is the 25th percentile–which means that 75% of those funds have an IRR below 0.

Of course the high performers perform well. As I said, great VCs are great. But the math says that the egotistical, self-important VC partner judging your pitch from across their fancy South Park board room table–while checking his phone to see how many likes his latest humble brag LinkedIn post has received–is probably not very good at VC. It just might take a decade for anyone to figure that out.

Pro tip: That VC you’re pitching might not have capital to invest right now anyway. Because of the lousy returns in the above chart and the resulting flight to quality by LPs (it happens to VCs, too, not just founders) it’s harder than ever to raise follow on funds for VCs. Even good VCs. So, it’s worth asking if that VC has funds to invest before you uber over to South Park.

Angellist data also came out recently and tells basically the same story. Returns are down across the board. DPI is down because there are few exits.

Maybe all of that schadenfreude is some consolation to being rejected by VC after VC. But let’s dig deeper on what makes great VCs great, and how that impacts founders, because there’s probably something in here that is useful (besides that bit about VCs not having dry powder–that is actually useful).

What makes a VC great

Great VCs are great because they found and invested in the right companies in the first place. Then, they didn’t screw it up. That is literally all. The rest of this is just fluff. But let’s break it down anyway.

I was employee #5 at a company backed by Jim Goetz, who has as good a claim as any to being the GOAT. I especially valued that he didn’t screw anything up. He probably helped somehow, but nothing was more important than not screwing it up. I am pretty sure that other VCs on that board wanted to do things that might have screwed it up but Jim stopped them. That is how the GOAT plays the game.

Because the best VCs are looking for entrepreneurs (or companies) that don’t actually need any of their help, they don’t actually have to be good at anything besides finding those entrepreneurs and convincing those entrepreneurs to take their investment. When Facebook bought Whatsapp for $19 billion after Jim and Sequoia quietly led every funding round, Jim doesn’t really have to do much to be a great VC–except, find Whatsapp and make that investment in the first place. And not screw it up. Which is the whole game.

How people became a VC matters. The people who worked their way up sometimes had to pick a winner in order to do so. The first investment you make as a junior VC is probably the most high-stakes decision you’ll ever make in your career; I don’t envy them that task. Former founders get more leeway, but probably had a successful track record as angel investors which enabled them to raise a fund.

For what it’s worth, I talked to Jim a few times and he was insanely sharp. He understood complicated things deeply and, more importantly, immediately. He knew things I had no way of knowing from my perspective as an operator. He very much deserves the GOAT title, at least based on my interactions with him. But he didn’t have to do anything. Nor did he, really. He just has to pick winners–and win the competition to invest.

The hard thing about VC

The hardest thing about VC is the competition. At the end of the day VCs are selling money, which is fungible. They’re also raising money from limited partners (LPs), and to an extent VCs themselves are fungible in the eyes of their LP customers. So VCs do marketing.

I’ve talked to many founders who took money from a top-tier VC who promised all kinds of help–recruiting, coaching, sales, you name it–to find out once the check had cleared, Carta had been updated, etc. that in fact the “recruiting team” had a 6 month backlog; that in fact the other portcos didn’t want to buy immediately or perhaps at all; that the coach charged $10k a month; etc. But there’s no performance guarantee in the deal docs–so, caveat emptor.

In the actual moment, all of those perks and positive references and marketing in general exist because VC is so competitive. VCs collide with VCs on good deals, because very, very few VCs find companies that nobody else has found. Rather, the same VCs are competing to lead or participate in rounds that everyone else wants to be in. If you have the metrics, everyone wants in. They’re all selling money.

Why competition explains most of VC bad behavior

This combination of competition and picking winners means the motivations of a VC are to ensure they never have bad references. This means they’ll never tell you your idea sucks, because if you know some other founder with a hot deal, they want you to be willing to refer them. Or when another hot company entrepreneur does a backchannel reference on them through you, they don’t want you to tell them that they’re a negative jerk who you’d never want on your board.

So obviously the winning strategy is to lie, obfuscate, and never actually say no.

This also means that when things aren’t going well on a board, rather than try to make changes they’ll simply go with it. Their returns are determined by their top performers; if you’re not a top performer, fine, but they’re not in the turnaround business, so they’ll just leave you alone.

Sequoia, I’ve heard, will just stop showing up to your board meetings. Why waste time? Every start up founder dreams of getting Sequoia on their cap table. Does that dream include the nightmare of not having quorum for board meetings because their partner couldn’t be bothered to show up? Yet they are the GOAT. Maybe that’s the way?

Because the name of the game is finding companies that will succeed without much help, and then getting into the deal, it should come as no surprise that a VCs motivations on a sale are very different than the founders.

The type of sale matters

Company sales or exits come in three flavors. First, there are the write-offs. These are companies that didn’t succeed; most and especially good VCs generally don’t care what happens here, because their fund returns will come from elsewhere. In most scenarios they would rather just be done with it; it’s a board meeting that was a waste of time anyway. Not to mention, they’d hugely prefer not to have to talk about all the problems at their partnership meetings. Usually as a founder you can do more or less whatever you want; they’ll sign anything to be done. The only wrinkle is everything is under water, so it requires a lot of sign offs. Hopefully the founders do something interesting next, and they get first dibs.

At the other end of the spectrum, there are companies that are their big successes. These they want to exit for the most they can, because all of their returns come from these companies. Usually this is pretty good news for the founders, if the market agrees, because when they run a process the VCs will be engaged, everyone will be making money, and if it’s a hot space the deal will be pretty clean. It helps that these companies probably raised a few later rounds; the later stage VCs have backgrounds more like investment bankers than visionary investors, and therefore know a lot more about selling companies. Chances are the VCs will do great out of the deal and the entrepreneurs will do ok also.

Sometimes VCs are delusional about their best companies and that’s where the real tragedies happen. KPCB was the lead in a friend’s company; they got an offer for $300 million but the KP partner thought they could get more. They couldn’t; the company eventually shuttered. Nobody made anything. Well, except the KP partner, because they had lots of other companies they got carry on (though I’m not sure that specific partner is still a partner… but maybe that’s just hope, and anyway the damage is done).

Then there are the companies that are mid. They’re not write offs but they’re also not outperforming. VCs think of these as anything from waste of time to option on the future. They don’t need to sell because, who knows, maybe crypto, AR, VR, etc. makes a come back? But they’re also not wasting time here. This is the worst spot to be in as a founder, especially if you’ve raised a lot of money. It’s also where the motivations are the most opposed.

Where you think VCs would help

The great VCs actually do help in this mid category. They’ll get someone to buy the company for something, founders will get some money, investors will get some (or all) of their money back, and employees will likely continue being employed–sometimes with juicy retention packages.

But most VCs are not good at selling companies. Very few VCs have any experience selling companies. If you think of a fund investing in ~25 companies over its lifetime, and of those only ~5 will have a meaningful exit. Those exits are spread over 7-10 years. They can help but I wouldn’t count on them. Hire a banker, or advisor, or talk to a PE shop to buy them out and just run it like a normal business (if that’s still an option). Maybe they’ll help you, but more likely they’re focused on their winners.

On a positive note

Great VCs are really great. They see things other people don’t see and then they don’t screw it up. There are many, many companies out there that would not have succeeded without great VCs. Slack, for one. Salesforce, for another. Apple, also, if you go way back. Whatsapp, if you want to talk about GOAT investments (~$3 billion off of $60 million invested over 5 years).

There are times where VCs can be very helpful–intros to the next round, practicing your pitch for the next round, market data on what other VCs are seeing. I’ve had VCs get (without my asking) competitors decks and their metrics. Was it ethical? Better question: who cares? This is business. But, like I said, I didn’t ask for them. Sure did read them though (would have definitely been unethical not to at that point!)

But VCs can only help so much, and the further you get from their incentives the harder it will be to extract the help you want. Want help raising your next hugely up round? They’ll be there. Want help exiting a walking dead company? Not so much.

Also – and a VC friend asked me to point this out – if you ask your investors for candidates every monthly investor update they will start to ignore your asks. They are not out there sourcing candidates for you; they have a few, they’ll send the first time you asked, and then they won’t have any more. Stop asking.

The whole game

The VC marketing machine is a MACHINE. It makes VC sound amazing. I talk to early stage entrepreneurs every day and they idolize VC. VCs talk like they really know how to build great companies. Except the great ones don’t have to. They just have to find good entrepreneurs, and convince them to take their money. Once they’ve taken it, they really don’t have to do much–except not screw it up.

That’s the whole game.

Ironically VCs like using the tool I’m building also because they, too, have similar challenges to founders when it comes to LP outreach. 7-question survey here, great VCs only. Or, click the button 👇️