What’s the Purpose of Venture Capital?
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After four years in venture capital I was taken aback when I realised I’d never heard any one ask, ‘what’s the purpose of venture capital?’
The reason for this probably has a lot to do with the question being as fluffy as the answer seems obvious. The purpose of venture capital is clear: to generate financial returns by funding innovation.
But this statement — at least to me — felt just as two-dimensional (and as much of a cop-out from wider responsibilities) as the Friedman doctrine of profit maximisation. In his words,
“…there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game…”
We’ve seen this single-minded pursuit of profits fail many times over. From the Volkswagen emissions scandal to the largest bankruptcy of all time when Lehman brothers failed in 2008, thanks to its involvement in dodgy mortgage loans.
Harm of a similar magnitude is possible (and frequent) in other areas where purpose takes a less mindful and less systematic approach. Examples in venture capital are plenty enough that both insiders and outsiders are starting to call out issues that have long been ignored.
A scathing New Yorker article on the industry sums up the issue in a quote from the serial entrepreneur Steve Blank, who’s been in the technology business since the late 70s and helped pioneer the lean startup movement:
“I’ve watched the industry become a money-hungry mob. V.C.s today aren’t interested in the public good. They’re not interested in anything except optimizing their own profits and chasing the herd, and so they waste billions of dollars that could have gone to innovation that actually helps people.”
And so in thinking about the nature of venture capital — and this is mostly to help me operate more purposefully in the investment world— I’ve drafted a personal model of purpose in venture.
This is what it looks like visually.
The model can also be summed up in one sentence:
The purpose of venture capital is to responsibly generate returns for limited partners by funding innovation and serving entrepreneurs.
Inherent in this statement is a trinity of sorts, which we can explore further by looking at the role of a venture capitalist (“VC”) in the context of: (1) a duty to limited partners (“LPs”), (2) service to entrepreneurs, and (3) a responsibility to society.
LPs: they are a VC’s shareholder
The first role of a VC is a fiduciary duty to LPs — the providers of capital which VCs invest.
LPs trust that VCs will be as dutiful a custodian of funds as they would with their own money (this is also why LPs often ask VCs to personally invest in the fund — aka ‘skin in the game’) and that they’ll generate worthwhile returns.
In this way, LPs are a VC’s shareholder.
Entrepreneurs: they are a VC’s customer
Despite the power dynamic that has entrepreneurs pitching VCs more often than VCs pitch founders, the entrepreneur has always been, and always will be, at the heart of venture capital.
VCs exist to serve founders much like businesses exist to serve customers. VCs sell a product (mostly capital, with some value-add) in exchange for equity. And in this way, entrepreneurs are a VC’s customer.
Fred Wilson has a fantastic blog post on this topic here.
Society: they are a VC’s village
I left this one till last not because it’s the least important but because it’s the glue that holds everything together.
Entrepreneurs and investors thrive precisely because of a functioning society and a favourable environment within which to operate.
Democracy, public infrastructure, appropriate business regulation, and robust healthcare and education systems are a few examples of societal assets that make it possible for innovation and talent to thrive.
And since VCs (and everyone else for that matter) gain handsomely from a healthy society, there’s a duty to pay it forward by doing things that make society better.
So in this way, society is a VC’s village.
Managing the Venture Capital Trinity of Service
Working for LPs and entrepreneurs while being a responsible citizen comes with competing tensions.
Just as a company can serve shareholder interests at the expense of its customers and vice versa, so too is the case when it comes to VCs balancing their relationship with entrepreneurs and LPs.
We see this tension play out in overly aggressive term sheets at the expense of long term cap table health and founder motivation, or in excessive founder friendliness at the expenses of corporate governance.
And just as a business can generate financial returns at the expense of positive societal outcomes and vice versa, so too is the case when it comes to VCs balancing profit and responsibility.
We see this tension play out when VCs chase returns by investing in companies with questionable practices and products, or when a positive impact approach does some good but leads to unsustainable ventures.
Thankfully these tensions are not insurmountable. Venture capital has still managed to help generate high societal returns so far and it will continue to do so, as evidenced by the technology and services we all benefit from today.
And one of the joys of being an investor is having the opportunity to profitably take part in that process, all the while leaving society a little bit better off — or so I hope!
