Once again another capital cycle rotates. As with the passing of every civilisation, certain durable (or lucky) relics and memories survive into the new age. This is why we have giant myths, pyramids, 20% management carry structures and limits on bank CEO salaries. And I guess this is why crypto will hang around as an asset class. Amidst this turmoil and post Great Bull Market (GBM) contemplation I’ve been wondering why VC hasn’t been truly disrupted yet. It seems ironic (or maybe just weird, I so often get these concepts confused) that the capital delivery ecosystem designed for those pioneering disruption is itself remarkably stuck in time.
The Fermi Paradox of Venture Capital can essentially be explained as ‘if there is so much money going into the rapid advancement of AI, de-fi, software and automation why has venture capital itself, an entirely manual activity, not been replaced by something more efficient?’. I feel the concept of an VC index fund is some kind of great filter for progress in financial markets. Either the ecosystem manages to get beyond that stage and all VC is replaced by some AI-driven equivalent of passive index funds or it all collapses back to the mutual-fund level of technology (basically human stock picking) where the power rotates back to the capital.
Today, if I want to invest in the public markets (e.g. S&P 500), I can buy a passive index fund. Extremely low cost, buys every stock, tracks the overall performance of the market. Beats the majority of human fund managers. Victory. Take a bow, Jack Bogle. It remains astonishing to me that if I, a human living in 2022, wanted to replicate this strategy in the private markets my only two choices are a) angel investing (vast amounts of manual work) or b) trying to access a combination of VC funds to give me a market spread (but even then they only really give me access to time-based cohorts, rather than a true index. Also they need rather large minimum cheques). It’s probably not an unrelated fact that you could take much of the marketing from 1970s-era mutual funds and paste it into an entirely convincing 2022 VC blog post (btw if you’re interested in the history of mutual funds birthing index funds, I suggest you read Robin Wigglesworth’s excellent Trillions).
Yes, of course there have been various attempts to disrupt venture capital. Generally this is about either increasing investor access (e.g. Moonfare) or improving the operating model e.g. reusing fees to build services, paying higher prices to win deals or outsourcing diligence (note: not all of these have worked out equally well). But all of these tweaks still retain the core model of subjective decision-making in (mostly*) time-limited funds. It isn’t close to my utopian dream of a passively managed private company index fund. Considering most funds are taking 20% (or 30% in some cases) of the returns to investors from deployed capital, that’s quite a profit margin to go after (and excludes management fees!).
The hand-wavy/magical thinking solution initially creates an index e.g. the Dylan 500 which is the top private companies by market cap and then an indexing mechanism to purchase and auto-balance shares based on pricing movements (so the fund holds the right proportion of each company). Obviously the mechanics of this kind of share purchasing in non-public companies is the hard part. I suppose in theory some kind of synthetic crypto thing could be constructed? Not quite an ETF but also not quite a ponzi scheme. Alternatively maybe something like a Founders Pledge model, albeit with slightly less altruistic leanings.
I’m setting a calendar entry for seven years from now, when we have the next GBM cycle to fix this.
*The perpetual/evergreen capital models that Sequoia and Tiger have been proposing (and which Molten Ventures operates in the UK) break free of this time-based cohorting.