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Why Is There So Much Turnover In Venture Capital?
“I have exciting personal news.”
“I’m thrilled to announce that I’m joining [New Firm] as a Partner where I will continue to invest in great Founders across the industries I care about.”
“I am pursuing an idea that I’m excited about and and happy to be back on the entrepreneurial path.”
These are literal quotes from social media and email announcements over the past six months from VC Partners moving on to other competitive firms, and, well, just moving on. Hearing this news is certainly unsettling to Founders aligned with a specific Partner and can be a massive headache, especially since they probably (and hopefully) picked the investor based on the individual and not just the halo of the firm.
In any professional service industry, there is natural shuffling in the junior roles, as the race up the pyramid towards a Partner title is like musical chairs. But even at the Partner-level, the amount of transition in Venture Capital is much more than you perhaps would expect… especially in a business which should have a long term orientation with portfolio investment-hold periods and Partnerships lasting more than a decade.
So why is there so much turnover in Venture Capital?
Partner turnover in VC is a result of three confounding factors:
- VC has an extremely long feedback cycle. As noted above, while the horizon of any one fund is long range overall, the feedback cycle on what really matters, liquidity in specific investments, also takes years. The median average investment time period to liquidity for a venture investment is currently 6.5-7.5 years. Yes, there are intermittent points of feedback along the way, like valuation marks from subsequent rounds of financing. However, as we’ve seen from recent salient stories, these can be ephemeral and don’t end up mattering in the end… they’re really just approximations based on the market for buying a piece of a company’s cap table, not buying the whole thing or making it public. As a result, paper markups are weak and temporary signals of feedback, at best.
- VC performance signal-to-noise-ratio is low. Venture is a field with a power-law distribution of outcomes. Notably a majority of investments lose capital rather than appreciate. And that’s for the successful investors! It’s been documented repeatedly that the mean/median fund (let alone an individual investor) faces subpar performance, and the true winners in the space are outsized. This situation creates a lot of noise in trying to determine patterns of success rather than just a datapoint of it.
One or two company outcomes in the positive or negative column doesn’t share much insight into how strong an investor an individual is, as opposed to how much the outcomes were determined by luck (or lack thereof). Moreover, it is quite cloudy to discern between VCs who are bad at the job in the long run but get short-term lucky on one company VS. those who are actually good at the job, but may have a few unlucky breaks in the beginning.
- VC economics are backward–looking rather than prospective. The economics of a Venture Capital Partnership and the corresponding power structure tend to be highly concentrated in a small number of individuals and is retrospective-looking. The primary driver is that fund economics are set at the beginning of a decade+ fund based on who had the track record credibility to raise it. So the most productive Partners in the current day often don’t get rewarded relative to their present contribution. Instead, those in power can get away with hoarding it for a long time.
Coupling all of the above factors, the true feedback cycle for an investor is one which requires both a decade tenure, and enough investments to determine a directional pattern. However, most Partners at venture firms don’t last that long or have the opportunity for that many shots on goal.
So instead what happens is that VC becomes a game of perception, and not necessarily reality. Especially in the larger firms, there is a greater diffusion of responsibility among all of the players involved, and the attribution contribution distinction between the firm as a platform, and the individual VC is muddled. This situation creates strong incentives for a VC’s personal career goal to shift from one that’s oriented towards long-term gain to one that’s oriented towards short-term survival.
Ultimate performance is years out and the attribution of it is cloudy at best. The politics inside a VC firm drive tenure, just like in any professional organization, but it’s less tied to an objective measure of contribution. And as a result, survivorship bias reigns, as success has many parents and failure is an orphan. Whenever a positive outcome happens, whoever is left standing naturally can take credit regardless of the original input and ongoing contribution into the investment years prior.
A corollary to that conclusion is that if an individual is able to persist through a long cycle, their tenure then becomes self-reinforcing. And with that tenure accrues power in the firm, which translates into economics. Building a venture capital firm isn’t about continuing to scale talent aggregation over time like most businesses, rather it’s about having a consistent right amount of talent and scaling AUM over time.
This result also exacerbates the other side of VC turnover, not forced departure, but voluntary ones in which “good” talent leaves looking for a better deal.
What does this mean for entrepreneurs?
There is a reasonable likelihood that your Partner, your liaison to a firm, your advocate, will leave that VC shop during the time when you’re building a successful company. (And if that happens, here’s what to do.) But how can you get ahead of it and minimize that risk?
There are number of signals to look at, in order from most obvious to subtle:
- Tenure. The easiest and most direct observation: the longer they’ve been there, more likely they’ll be around. Bonus points if they’re a Founder of the firm.
- Track record. If a Partner is (especially publicly) associated with a winning company with momentum, then the case for stability is there. This correlation does, however, present a challenge if the Partner doesn’t feel like she or he is being rewarded internally for this contribution to the firm’s asset and subsequently becomes loose in the saddle looking for a better economic deal at another shop. A set of seemingly positive but not blockbuster companies is fine, as it’s much better than a situation where a Partner had a previously winning company star which has fallen substantially.
- Title subtleties. Partners aren’t all the same. There are Managing Directors, Senior Partners, and various other levels & shades of the Partner title. These distinctions convey internal firm status and signal potential for tenure duration (or lack of it).
- Recent deal velocity. It’s the most simple & straightforward question to ask and tough to spin – how many investments have you made in the past year? Calibrated against the firm’s overall velocity (which can vary), this metric is a tell-tale about a Partner’s standing with their peers. VCs that are on their way out aren’t making a ton of new investments.
- Fund cycle. VC Partner turnover typically occurs in conjunction with fund cycle. Most often firms make team changes just as they’re gearing up to fundraise for a next fund, or immediately thereafter a new fund is closed. So, if a Partner made it through a recent fund transition, you can bet on her staying around for a least a few more years. And if it’s been more than a few years since the firm has announced a new fund, there should be increased sensitivity around the four above factors.
Given the tenure risk, Founders should keep in mind that although they are primarily picking an individual Partner, they are of course also picking a firm. So it behooves them to ensure they have some relationships with others in the firm and generally synch with the team & ethos of it.
That being said, it doesn’t mean that Founders shouldn’t take a chance on a younger or newly minted Partner with a more limited tenure. Even though departure risk is greater, it can be outweighed by their hunger to show positive signs in their personal portfolio, so they may contribute more value in the first few years post investment than someone who is long-tenured.
Instead, a sound firm relationship strategy is to proactively try to organically build bridges to others in the firm, without “going around” your point-person. Attending the optional firm social events/gatherings, accepting the invitation to speak at LP meetings, and offering to update the Partnership on progress in subsequent follow-on rounds of financing even if it isn’t required – these are just a few tactics on how to accomplish this goal naturally.
The reasons for Venture Capital Partner turnover are structural given the dynamics of the business, and so I don’t see them going away anytime soon. In both up and down markets, the extended feedback cycles, low signal-to-noise ratio, and backwards looking economics create a dynamic which facilitates forced and unforced turnover. Understanding the why behind this phenomenon helps in determining how to proactively mitigate the associated risks with any Founders’ individual VC Partner relationships.