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Is VC Model Really Broken? And Who Is To Blame?

Mark Marich

As the venture capital industry continues to consolidate, a new report from the Kauffman Foundation examines the cause for its poor long-term returns. But unlike some recent shots, the report's authors don't point the finger of blame directly at VCs. Instead, they issue a challenge to state pension funds, endowments, foundations and other institutional investors in those funds to require deeper due diligence and more rigorous data analysis before investing.

Why? Despite a few high-profile success stories, public stock markets have outperformed VC funds for the past decade—but limited partners (LP) continue to invest in underperforming funds.

According to the report, 'We Have Met the Enemy... And He Is Us/:
"the money trail leads right to the LP boardroom, where investment committees oversee venture capital investing. It’s in the boardroom that VC allocations are created, VC fund performance is evaluated, investment consultants are heard, and investment decisions are approved. Investment committees are partly responsible for the broken LP investment model through their setting and approving of targeted allocations to VC, an acceptance of inconsistent and not fully informative VC performance reporting, and either a lack of awareness or tolerance of the opaque economics and misaligned terms on which most investments in venture capital funds are made."

The report is based on a comprehensive analysis of the Kauffman Foundation's experience—more than 20 years—investing in nearly 100 VC funds. It illustrates a persistent pattern of inflated early returns in funds that may be used to raise subsequent funds and shows the poor historical performance of funds with more than $500 million in committed capital.

The report was written by: Diane Mulcahy, Director of Private Equity; Bill Weeks, Quantitative Director; and Harold Bradley, Chief Investment Officer; all of the Ewing Marion Kauffman Foundation.

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