In private equity, the term “2 and 20” refers to the traditional compensation structure for private equity funds: 2% management fee and 20% performance fee (also known as “carried interest” or “carry”).
 
In this post, we will explore management fee.
 
Historically, management fee was intended to provide fund managers with enough money to pay modest salaries, rent modest offices and incur modest expenses.  It was said that management fee was intended to let the fund manager “keep the lights on” and that the performance fee (known as “carried interest” or “carry”) was where the fund manager made its money.  While investors in private equity funds (known as “limited partners” or “LPs”) continue to take this view, terms in fund documents (known as the "limited partnership agreement" or "LPA") relating to management fee have become more complex.
 
Let’s dig in.
 
In previous posts, we have explored committed capital and the investment period:

• LP Corner: On Committed Capital, Called Capital and Uncalled Capital
• LP Corner: the Four Phases in the Life of a Private Equity Fund
• LP Corner: Private Equity Cash Flows from the LP Perspective

 
We will look at management fee in three phases of a fund’s life: the investment period, the harvesting (or realization) period and during extensions.
 
Investment period
The vast majority of private equity funds (here, we’re discussing buyout, growth equity and venture capital funds) charge 2% of committed capital per year during the investment period, which has traditionally been 3-5 years, but I’m seeing this extend to 6 years.  For example, a $200 million fund with a 2% management fee will provide the manager of the fund (also known as the “general partner” or “GP”) with $4 million per year.  Management fee is always paid quarterly in advance.  In our example, this means that the fund will pay the GP $1 million in management fee per quarter, at the beginning of the quarter.  This management fee pays for the salaries of the investment team, office staff, office rent, utilities, etc.  Part of the rationale for this fee is that during the investment period, the GP is going to be very busy sourcing and evaluating deals and making investments.
 
Harvesting (realization) period
After the investment period, the fund will no longer invest in new companies, but will continue to support and invest in existing portfolio companies.  Also, the GP will have likely raised a new fund, which will also be generating management fee.  During the harvesting period, management fee will generally decline, and there are many different ways management fee is determined during this harvesting period.  Often, the management fee will stay at 2%, but the base is changed from committed capital to invested capital.  Other times, the management fee will decline by some percent each year, so that in the first year after the investment period the fee drops to 1.75%, the next year 1.5%, the next year 1.25%, etc., with some floor, such as 1% of committed capital.  There are many different permutations of management fee during the harvesting period.
 
Extension period
Private equity funds are usually 10 year funds, but the GP often has the right to unilaterally extend the term of the fund by one or two years.  This is referred to as a “10-year term with two 1-year extensions.”  Usually, during the two GP-option extensions, the formula for management fee in the harvesting period continues.  It is when funds still have active investments at the end of 12 years, does management fee become a further issue. 
 
To extend a fund’s life after the 10 year term and the two 1-year GP extensions, the GP will usually need to obtain the approval of the limited partner advisory committee or of a majority-in-interest of the limited partners (see the Glossary for an explanation of this term).  Now that the GP needs the approval of the LPs to extend the term, the LPs will negotiate the management fee for this additional extension period.  Many LPs take the hard-line position that the GP should not receive any management fee during these additional extensions, and will vote against any extension to force the fund into liquidation.  Others will negotiate with the GP on a management fee based on the remaining portfolio.  Often this is a very reduced management fee, such as 1.25% of the lower of cost of the remaining investments or their fair value.  The management fee can also be based on a budget or some other basis.
 
Additional Notes:

• Smaller Fund Management Fee.  Some smaller funds ($100 million in committed capital and under) may charge a higher management fee of 2.25% or 2.5%, and larger funds (over $1 billion in committed capital and over) will charge lower fees, usually around 1.2% to 1.5%.
• Large Fund Management Fee.  Some large funds are now offering fee and carry options for LPs, such as a choice between a 2% management fee and 20% carry or a 1% management fee and 30% carry.  Some LPs prefer the latter (10%/30%) option as they feel it better aligns the interests of the GP and the LPs.
• Fee on Called Capital Only.  A few funds have offered management fee only on called capital.  This is very appealing to LPs as it means the LP pays fees only when the GP is putting the money to work.  This has happened in only a few unique circumstances, such as in a follow-on fund (a fund raised to support the investments of an earlier fund that has called most or all of its capital).
• Breaks.  Some funds offer one-off management fee breaks for “first closing” investors that invest a certain minimum amount.  This is meant to incentivize investors to invest early, at the first closing.  It’s a tool to build momentum for fundraising.  For example, an investor who commits $20 million to the fund in the first closing may pay a reduced 1% management fee for the first year of the fund.
• Successor fund.  It is customary for GPs to raise successor funds prior to the end of the investment period.  Many LPAs provide that when this occurs and the GP starts to receive management fee from the successor fund, the management fee for the current fund will start stepping-down.  
• Expenses.  What expenses are paid by the fund and what expenses are paid by the GP are often heavily negotiated terms.  Issues such as travel, compliance, administration and other items are negotiated as part of the limited partnership agreement.
• Fund-of-Fund Management Fee.  Funds-of-funds fees are usually around 0.75% to 1.00% of committed capital.  Funds-of-funds fees have been under a lot of pressure over the last several years.

I have clients who are new to investing in private equity, and one of the first conversations we have is about "what is private equity"?

Private equity, generally speaking, is an equity (stock) investment in a privately-held company.  Private = privately held company.  Equity = stock.  It's a little more complicated than that, but that's a useful starting point.

The term "private equity" can be used in different contexts and can mean different things.  I group these in 4 categories:

Asset Class.  First, the term "private equity" can refer to the private equity asset class.  An asset class is basically a group of assets that have similar characteristics and behave similarly.  Common asset classes include: public stocks; public bonds (also called fixed income), cash, real estate and private equity.  There are also others, and different investors may define asset classes differently.  This usage of the term "private equity" typically occurs when investors are discussing allocations to asset classes - for example "we are allocated 40% to public equities, 40% to public fixed income; 18% to private equity and 2% to cash."  Within the private equity asset class, there are different strategies, including venture capital, growth equity and buyouts.  For more on venture capital, growth equity and buyouts, please see my posts "LP Corner: What is Venture Capital? Here's My Definition", "LP Corner: Venture Capital vs Growth Equity - A Comparison" and "LP Corner: What are Buyouts? Here's my Definition."
 
Transaction.  Second, the term "private equity" can refer to a type of transaction – which is primarily buyouts.  However, it can also describe a growth equity investment.  However, the term "private equity" isn't used to describe a venture capital investment.  Venture capital is a unique strategy within the private equity asset class, and the term "venture capital" is used very specifically.
 
Firm.  Third, the term “private equity” can be used to describe an investment firm.  A “private equity” firm is one that primarily invests in buyout transactions, but the term can also apply to firms that invest in growth equity.  One doesn’t use the term “Private Equity firm” to describe a venture capital firm - those are simply called "venture capital" firms.

Industry.  Finally, the term "private equity" may refer to the private equity industry.  The private equity industry starts with the private equity strategies of venture capital, growth equity and buyouts and also includes investors in the private equity asset class, such as public and private pensions, sovereign wealth funds, corporations, foundations, endowments, family offices and high net worth individuals.  Also included are firms and funds - venture capital firms, growth equity firms and buyout firms, as well as corporate venture capital efforts.  Add in service providers such as attorneys, accountants, valuation firms, database firms, back office support, etc. as well as industry groups (such as the NVCA and ILPA), conference providers and the press, and you end up with a very large industry.
 
So you need to understand the context in which the term is being used.

I hope this explanation is helpful.

© 2018 Allen J. Latta. All rights reserved. ​

,This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance
• LP Corner: Gross vs Net Returns - this blog post

​
​We have discussed how to evaluate fund performance, but a common area of confusion is gross returns versus net returns.  I briefly introduced this topic in ​LP Corner: Private Equity Fund Performance - An Overview, and this post expands on that introduction.

When talking returns in private equity, it is very important to know what kind of returns you are discussing: gross or net returns.  The difference between these two metrics can be meaningful, and so it is important to know what is being discussed.  Gross returns, simply stated, are the returns a fund obtains from its investments, without deducting any management fees, fund expenses or carried interest.  Net returns are the returns a limited partner (LP) receives from the fund, after deduction of all management fees, fund expenses and carried interest.  LPs are about net returns, as net returns are the real returns an LP receives from its investment in a fund.
 
When we talk about gross vs net returns, it can apply to gross vs net IRRs or gross vs net TVPI multiple.

The graphic below shows the difference between gross and net returns for a fund.  LPs invest in a fund.  The fund invests in portfolio companies.  Gross Returns are the returns the fund obtains from its investments in portfolio companies.  Gross Returns are before deducting management fee, fund expenses and carried interest.  Once the fund does deduct the management fee, fund expenses and carried interest, the return the LPs obtain from the fund are the Net Returns. 

​To read more, please click on "Read More" link below.

This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance - This blog post.
• LP Corner: Gross vs Net Returns
  

We have now discussed the three metrics that are primarily used to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; (2) IRR; and (3) PME.  We will now discuss how to use these metrics to evaluate the performance of private equity funds.
 
Overview
There are several ways to evaluate the performance of a fund, or a portfolio of funds, with the main methods being:

• Absolute return.
• Comparative return to other similar funds (Quartile Analysis).
• Comparative return to the public markets (PME Analysis).

 
Absolute Return
Absolute return refers to a specific threshold requirement for a fund’s performance.  For example, some LPs may say that they expect a 3.0x TVPI and 30% IRR net return from early stage venture capital funds, or a 2.0x and 20% return for buyout funds.  If a fund’s return exceeds these metrics, then it “outperforms” the metrics.  If a fund’s returns are less than these metrics, then the fund “underperforms.” 
 
A note about absolute return.  Most funds experience a J-Curve, where performance declines in the first couple of years of a fund when fund expenses and investment losses exceed investment gains, but the fund’s performance improves over the next several years.  The J-Curve is more pronounced for early-stage venture capital funds.  The J-Curve looks something like this:

For more on the J-Curve, see my post: “LP Corner: The J-Curve.”
 
The point here is that using absolute returns are really only useful late in a fund’s life or after the fund is liquidated.  If one were to apply a 20% absolute return metric to the fund in the J-Curve example above, the fund would underperform all years until the last year in the graph.

To read more, please click "Read More" to the right below.

​This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME) - This blog post.
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance
• LP Corner: Gross vs Net Returns
  

 
We have now discussed two of the three primary metrics uses to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; and (2) IRR.  We will now explore the third primary metric: Public Market Equivalent, or PME.
 
Overview
Broadly speaking, PME is a return metric that compares the return of a private equity fund (or a portfolio of funds) to the hypothetical return of a chosen public stock market index, such as the S&P 500 or Nasdaq, using the cash flows as the fund as a basis for investment in the stock market index.  For example, a fund may have an IRR of 15%, while the PME obtained using the S&P 500 as the index is 10%, suggesting that the fund has outperformed the S&P 500 by 500 basis points (bps).
 
There are several variations of PME, but these are commonly used:

• LN PME, developed by Austin Long and Craig Nickels in 1996
• PME+, developed by Capital Dynamics in 2003
• KS PME, developed by Steve Kaplan and Antoinette Schoar in 2005
• mPME, developed by Cambridge Associates and introduced in 2013
• Direct Alpha, developed by Oleg Gredil, Barry Griffiths and Rüdiger Stucke in 2014

 
LN PME
The LN PME (also known as the Index Comparison Method or ICM) is widely considered the “first” PME approach (and it is often referred to simply as “PME”).  The LN PME matches each contribution and distribution of a fund with a hypothetical purchase and sale of a reference public market index, such as the S&P 500.  The residual value of the fund is not matched to the LN PME; rather, the LN PME residual value is based on the performance of the hypothetical invested capital in the index.  With these cash flows, an LN PME return for the public market index is compared directly against the IRR for the fund.  If the fund’s IRR exceeds the LN PME, then the fund has outperformed the public market index.  If the LN PME IRR exceeds the fund’s IRR, then the fund has underperformed the public market index.  Note that the IRR generated using LN PME isn’t a “real” IRR – it’s an estimation because of the manipulation of the residual value.
 
One nice thing about the LN PME is that it is conceptually straightforward.  However, the mechanics of LN PME have some issues.  One issue for the LN PME approach is that the residual value for the PME index can be negative.  This can occur if the fund has distributions early in the life of the fund, or has a series of large distributions late in the life of the fund.  The problem is that a fund can’t have a negative residual value (technically a fund could have a negative residual value, but it would be a very rare case).  As a result, LN PME isn’t used very often in private equity.  The other forms of PME attempt to address the drawbacks of the LN PME.
 
Let’s look at an example:
 
First consider the fund that we want to evaluate.  The fund is presented below:

This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two - This blog post
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance
• LP Corner: Gross vs Net Returns
  

In this post, we will explore internal rate of return (IRR) as a tool for evaluating fund performance metrics.
 
Recap
In my prior post, we discussed the basics of IRR in a fund context.  In this post, we build on that to explore what happens year by year for that fund.
 
In Example 1 in the last post, we introduced a fund, where the LP paid $30 million to the fund in a capital call at time = 0 and received $80 million back from the fund (as distributions) at the end of year 5.  These simple cash flows yielded an IRR of 22% and a TVPI of 2.67x.

​

This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One - This blog post.
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance
• LP Corner: Gross vs Net Returns

In this post and the next post, we will explore measuring fund performance using internal rate of return or IRR. This post will provide an overview of IRR.  If you already have a good grasp of IRR, you can move to part two of this series: LP Corner: Fund Performance Metrics - Internal Rate of Return (IRR) - Part Two.
 
IRR Overview
In a basic sense, IRR is the return from a series of cash flows over time.  In the Private Equity space, IRR is commonly used to evaluate the performance of private equity (including venture capital, growth equity and buyout) funds.  IRR is best calculated using Excel, Google Sheets or another financial spreadsheet program.
 
Simple IRR Examples
Let’s assume that an LP commits $30 million to a fund, and that the fund returns $80 million in distributions to the LP.  (For a discussion on committed capital, see "LP Corner: On Committed Capital, Called Capital and Uncalled Capital.") On a multiple basis, this equates to a Total Value to Paid-in-Capital (TVPI) of 2.67x ($80M / $30M) – which sounds pretty good.  But let’s explore a bit deeper.

Note that in these examples, we are looking at cash flows from the perspective of an LP - payments made by the LP and money received by the LP.  This is known as a "Net IRR" because it focuses on the cash flows to and from the LP.  For a discussion of gross vs net returns, see "LP corner: Private Equity Fund Performance - An Overview."

Example 1:  Assume that when the fund has its closing (which is time 0 for purposes of calculating the IRR in Excel), it calls all capital from the LP (in reality, this doesn’t happen, but humor me as this is an example).  In five years, the fund distributes $80 to the LP.  This looks like this:

This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI - this blog post.
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance
• LP Corner: Gross vs Net Returns
  

In this post, we will explore using multiples as a tool to evaluate fund performance.
 
The multiples are:

• Distributions to Paid-in-Capital, or DPI
• Residual Value to Paid-in-Capital, or RVPI
• Total Value to Paid-in-Capital, or TVPI

 
Here’s some important terminology that will help explain the multiples:

• Paid-in-Capital = the capital contributed by LPs to the fund.  Paid-in-capital is also known as “contributed capital” or “called capital” or sometimes “drawn capital.”  Note that Paid-in-Capital is different than Committed Capital.  Recall that an investment in a private equity fund occurs over time.  An investor in the fund, known as a limited partner or LP, agrees (commits) to invest a certain amount in a fund, say $10 million, as and when the manager of the fund, known as a general partner or GP, needs the capital.  In this case, the $10 million is the LP’s commitment.  As the GP asks for a portion of this commitment (known as a “call”), the amount paid by the LP to the fund is known as Paid-in-Capital, or PIC (this is also known as “called capital”).
• Distributions = the value of the cash and stock that the fund has given back (distributed) to the LPs.  Distributions are typically low early in a fund’s life, ramping up over time as investments are exited.
• Residual Value = the remaining value of the fund at a given point in time.  Residual value is the value of the fund’s investments plus other fund assets (cash, etc.) less fund liabilities.  So, for example, if the fund has 12 remaining investments with an aggregate estimated fair value of $100 million and another $3 million in cash, the Residual Value of the Fund is $103 million.  Early in a fund’s life when investments are being made residual value is typically high (reflecting the value of the investments) and declines over time as the fund exits its investments and makes distributions to the LPs.
• Total Value = the total value of the fund, which is the sum of the distributions and the residual (remaining) value of the fund at a given point in time.  The mathematical relationship among these metrics is:

​​​To better understand the above terminology, let’s look at the terms graphically:
​

This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview - This blog post.
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance
• LP Corner: Gross vs Net Returns
  

Introduction
How do LPs measure performance of a private equity fund?  It’s not a simple as one would think.  This post introduces a number of concepts, each of which will be discussed in more detail in future posts.
 
The following are the basic metrics used to evaluate fund performance:

• Rate of return.  This is also called internal rate of return, or IRR.
• Multiples.  These multiples include Total Value to Paid-in-Capital, Distributions to Paid-in-Capital, and Residual Value to Paid-in-Capital.
• Relative performance.  This is performance relative to comparable funds (also called quartile performance).
• Public market equivalent performance.  This is known as PME, and has a number of variants.

 
Each of the above performance metrics have positives and negatives.

To read more, please click on "Read More" to the right below.

​First time investors in private equity funds are sometimes alarmed / confused / surprised to learn that their fund investment has a negative return in the early years of the fund’s life.  Then, to their relief, as the fund ages, the fund’s return increases.  This is known as the ”J-Curve” and it is a common phenomenon in private equity, particularly early-stage venture capital.  

​A simplified hypothetical representation is of the J-Curve is below:

The private equity world has a lot of terminology.  In a prior post, I discussed the structure of a private equity fund, and introduced the terms "limited partners" (or "LPs"), the "general partner" ( or "GP") and the "management company."  In this post, we'll explore fund "sizes" and a little bit of how investments in private equity funds work.

The "size" of a private equity fund is based on the total amount of money all investors commit to invest in the fund - known as "committed capital."  Because a private equity fund invests capital over time, the fund does not need all of the investors' money at the inception of the fund, and so the fund "calls" capital over time.  Private equity funds typically have initial terms of 10 years, but most of the new investing occurs during the first several years (usually 3-5 years) of the fund, known as the "investment period."  As a result, the fund calls the bulk of capital from the investors during this investment period.
​
​Let's use an example.

To read more, please click "Read More" to the lower right.

Basic Limited Partnership Structure
In a basic limited partnership, there are several passive investors (known as "Limited Partners" or "LPs") and the manager of the fund, (known as the "General Partner" or "GP").  The diagram below illustrates this basic structure.

Private equity funds (buyout, venture capital and growth equity funds) are typically structured as limited partnerships, which have two types of partners: limited partners, or LPs, which are passive investors in the fund; and a general partner, or GP, which is the manager of the fund.  As I evaluate funds, one of the fund terms that receives special attention is the amount of money the GP will commit to the fund - which is called "GP Commitment", "GP Capital Commitment" or "GP Commit."  ​

To read more, please click "Read More" to the lower right.

The Fortune article "Snapchat Actually Isn't the Hottest IPO This Year" argues that MuleSoft is actually a hotter initial public offering than Snap.  This argument is based on post-IPO trading metrics, such as first day "pop" (first day closing trade price vs IPO price) and price-to sales metrics.  It's an interesting article.  Link: http://fortune.com/2017/03/30/snapchat-ipo-snap-stock-mulesoft/ 

In a prior post "Mike Moritz on Private Equity (aka Leveraged Buyouts)" an opinion piece penned by the famed venture capital investor was discussed.  Now there's a rebuttal to Mr. Moritz's article.  ​

Stephen Davidoff Solomon's opinion piece "A Venture Capitalists's Misguided Critique of a Trump Adviser" rebuts Mr Moritz's article in a number of ways.  Whether you agree or disagree with the opinions of Mr. Solomon and Mr. Moritz, this very public debate is pretty fascinating.  

​Link to prior post:
http://www.allenlatta.com/allens-blog/mike-moritz-on-private-equity-aka-leveraged-buyouts 

Link to Mr. Solomon's article:
https://www.nytimes.com/2017/02/14/business/dealbook/a-venture-capitalists-misguided-critique-of-a-trump-adviser.html
​
Link to Mr. Moritz's article:
https://www.nytimes.com/2017/02/07/opinion/stephen-schwarzmans-bad-business-advice.html 

Mike Moritz, the famed venture capital investor at Sequoia Capital, has published an opinion piece on the New York Times called "Stephen Scharzman's Bad Business Advice."  In this opinion piece, he takes a swipe at the leveraged buyout business, which is now known as private equity.  He focuses on the amount of debt used in these transactions and the attendant cost-cutting that often includes layoffs.  I have met Mike Moritz on a couple of occasions, and found him to be a very smart and opinionated person.  His piece is worth a read, even if you don't agree with his positions.  

Link:  https://www.nytimes.com/2017/02/07/opinion/stephen-schwarzmans-bad-business-advice.html?_r=0

The bottom line is that too much money is going into venture funds and companies, and too little is being returned to investors.  In my view, this will lead to overall lower returns for the venture capital industry and will highlight the need to be very selective when investing in venture capital funds in order to select only the best managers who can deliver exceptional returns.

Link:
https://www.bloomberg.com/gadfly/articles/2017-01-11/silicon-valley-startup-pipeline-needs-shot-of-drano

Now Fortune has published an article "The Ugly Unethical Side of Silicon Valley" which discusses scandals at portfolio companies.  I found this to be an interesting article.  My opinion is that scandal is likely more probable at startup companies than venture capital funds for a few reasons:

• Opportunity.  There's likely more opportunity for a startup executive to commit fraud, as accounting, sales and operating systems are typically not in place or if in place, not robust enough at startups to prevent fraud.  Venture Capital funds have fewer opportunities for fraud, as there are fewer moving pieces.  A VC fund pays the GP management fee and carry, pays for certain fund and transaction expenses (legal, accounting and insurance are typically the largest fees), makes capital calls and distributions, and makes investments - and that's pretty much it .  A startup has many more moving pieces.
• Culture.  Startups in many instances are like the Wild West - immense opportunity, gun-slinging attitude, and young entrepreneurs who typically don't have a lot of management experience.  Compare this to a venture capital fund, which typically has an in-house CFO and back-office team that is experienced and establishes a more structured, professional culture than many startups
• .Accountability.  Most startups fail.  If a startup executive realizes that the company isn't going to make it, there may be a temptation to maximize personal gain over doing the right thing (shutting the company and returning money to investors).  If a company fails, the winding-up process is typically very quiet and private (known as an assignment of the benefit of creditors).

"Fraud by Venture Capital Fund Managers" can be found at:
http://www.allenlatta.com/allens-blog/fraud-by-venture-capital-fund-managers

The Fortune article "The Ugly Unethical Side of Silicon Valley" can be found at (copy and paste in browser):
​http://fortune.com/silicon-valley-startups-fraud-venture-capital/ 

The Wall Street Journal has two articles today that are of interest to shareholders of startup companies, primarily former employees who hold shares of these startups.  The articles "Startup Employees Invoke Obscure Law to Open Up Books" and "Own Startup Shares? Know Your Rights to Company Financials" discuss laws that may require some startup companies to deliver certain financial data to shareholders which may help these shareholders value their stock.  

Specifically, the articles reference Section 220 of the Delaware General Corporations Law, Section 1501 of the California Corporations Code and Rule 701 of the Federal Securities Act of 1933.  These provisions may provide certain shareholders of some private companies the ability to obtain selected financial statements.

Links:
http://www.wsj.com/articles/startup-employees-invoke-obscure-law-to-open-up-books-1464082202

http://www.wsj.com/articles/own-startup-shares-know-your-rights-to-company-financials-1464082203

Business Insider had an article this week called "The steroid era of startups is over -- here's what 8 top VCs think will happen next" that made a number of good observations.  In this article, eight venture capitalists discussed how the environment has been changing, and the article identifies a number of ways the changing environment will impact startups.  The main categories are:

• VCs may not be as supportive in the future
• Expenses (and headcount) will be "slashed:
• Some companies will fold
• Startups that mainly sell to other startups will have problems
• Large companies may acquire startups, but only if it's strategic and at a discounted valuation
• Some startups will suffer a down round
• Other startups will be forced to recapitalize, wiping out early investors and employees
• Employees with huge paper profits (from options and/or restricted stock) will suffer
• All of the above signals a return to normal

Each category is discussed in the article, with comments from the VCs.  It's a good article and worth a read.

Link:
http://www.businessinsider.com/what-happens-when-tech-boom-turns-to-bust-2016-5