

Venture Capital in Danger - yummyfajitas
http://www.nytimes.com/2009/08/31/opinion/31patricof.html?ref=opinion

======
maxniederhofer
Disclaimer: I'm a VC at Atlas Venture (<http://www.atlasventure.com/>).

The Patricof article echoes pretty much exactly the position of the National
Venture Capital Association (its statement to congress is here:
<http://bit.ly/M92Ux> [PDF]).

Essentially:

1\. Venture capital firms are not interdependent with the world financial
system - we don't trade public markets, we don't rely on banks, we don't
insure things

2\. The venture capital industry is small in size and thus not "systemic" in
relevance

3\. Venture capital firms do not use long-term leverage or rely on short-term
funding - i.e. we don't punch above our "equity" weight

4\. Regulation under the currently proposed act would significantly increase
costs and change the way venture could operate - insofar the parallels drawn
to SOX or anti-money laundering are correct

In particular, we'd have to add more administrative staff and would
potentially face issues in performance-based contractual relationships with
some of our investors (limited partners).

The argument in a nutshell is that the Act seeks to address problems caused by
buy-out and hedge funds. We're being lumped into something because of our
similar structures, not because of what we do. Transparency is a laudable goal
and I think the venture capital industry as a whole would be more open to
thinking about making itself more transparent if such regulation recognized
that venture is actually not a part of the problem, but an essential catalyst
for growth in our economies.

I am personally a subscriber to a libertarian, subsidiarist principle of
legislation. There is no need to regulate VC in the way intended by congress:
why should we erect barriers to entry, dissuade new investors into venture
capital, make it less profitable (than it already is)?

~~~
sachinag
Figure out and adapt a fundamentally different legal structure and this issue
goes away. The cost of writing a law full of loopholes that allows hedge and
PE funds to "look" like VC funds is higher than the added costs to firms like
Atlas. (Let's be honest: this ain't gonna drive Atlas out of business, nor
will it affect angel investors. It would only kill the crappy $20-50MM funds.)

And if anyone thinks I'm crazy, I want to point out that Mitt Romney has
always described himself as a "venture capitalist," as far back as his 1994
Senate run, although everyone knows that Bain Capital is a PE shop.

Disclaimer: I did my time on the dark side at a healthcare VC firm, and now
I'm on the entrepreneur side.

~~~
mediaman
Couldn't a threshhold level of debt usage be a line of delineation?

Debt is a complex subject, but FASB has well-defined means to determine
whether a security instrument is debt or equity.

~~~
sachinag
You can have leverage without debt through the use of options and other
derivatives. The leverage is the systemic structural issue, not the notional
amount of debt.

~~~
mediaman
True, leverage comes in many forms. But what form of leverage could a VC firm
engage in that they could not easily be restricted from in order to qualify
for less onerous regulation?

Restrictions on the use of derivatives is as easy to restrict as debt
instruments.

------
tc
People often don't consider how regulation decreases the number of new
entrants into a field.

In the present case, we tend to spend all our time talking about how this will
impact current VC firms. _Existing_ VC firms have the advantage. The real
question is how this will impact VC firms yet to be formed (or even yet put on
a napkin).

At some level of regulation, new competition will be completely thwarted
(imagine having to spend the first $10M and the first year of your startup
achieving regulatory compliance), but what is often missed is the marginal
effect. _Any_ marginal increase in regulation will create a corresponding
marginal decrease in new entrants just as assuredly as if you could
artificially raise their expected cost to get to profitability (because that's
exactly what regulation does).

This is why existing players in a market often lobby for regulation of their
own market, or at least acquiesce to it without too much of a fight.

------
anamax
Is there any reason to believe that regulators who can't figure out how to
handle institutions that they've been regulating for decades will know how to
handle VC firms?

We know how this is going to play out. VC firms with ties to congress critters
are going to get special treatment, just like banks with such ties do. Firms
that don't make such ties are going to be penalized.

~~~
sachinag
Well, we have some decent regulators. The issue was one of regulator-shopping.
You've got AIG, the world's largest insurer, under the Office of Thrift
Supervision _exactly because_ AIG bent the rules to qualify for OTS oversight.

Reading Felix Salmon et al, the solution is for one large regulator with the
sophistication to match the large and diverse financial institutions, to
eliminate the turf wars and jurisdiction shopping of the past. Combine the SEC
and the CFTC (which, guess what, knows how to regulate derivatives), and give
the new SEC sufficient enforcement powers.

Furthermore, the regulation only makes VC shops (as well as PE and hedges,
which all have the same GP/LP structure) file the _exact same stuff_ that
Vanguard, Fidelity, and other mutual fund companies _already file_. I love how
the VCs never once mention this. Probably because it sounds so reasonable.

~~~
anamax
> The issue was one of regulator-shopping.

Which will always be a problem, so you've just told us one of the mechanisms
for regulatory failure.

> You've got AIG

Bzzt - AIG was not just under OTS, they were also under insurance regulation
and a couple of others. And they were regulated in several countries, often in
multiple ways, not to mention states. And these agencies cooperated.

AIG was pretty much a best case for regulatory success.

And now it's a conduit for payoffs to Goldman Sachs. (Yes, I know the
collateral story. I'm hoping that someone will post the details so I can show
how it doesn't mean what they think it does. GS should have been left holding
the collateral.)

------
jacquesm
What are they in danger from ? Having to open their books ?

That seems like a pretty stretchy way of using the word 'danger'.

If venture capital would truly be in danger then that would imply that funds
would be forbidden to operate, but that is not the case at all.

There is simply a shifting of allowing funds to operate without oversight to
one where the authorities have an inside view at what is going on.

Since the IRS and other arms of the government already have this insight what
is wrong with allowing the SEC access to similar information ?

~~~
yummyfajitas
It costs money to comply with regulations. SOX, for example, costs on average
of $1.7 million/year.

[http://fei.mediaroom.com/index.php?s=43&item=204](http://fei.mediaroom.com/index.php?s=43&item=204)

While (hopefully) this regulation won't be as burdensome, it doesn't need to
be that large to cause problems. VC funds aren't that large.

There is no benefit and potentially large cost to regulating VC.

~~~
jacquesm
The article you quote there to make your point clearly states that the 1.7
million dollar figure is an average taken over a group of companies, to make a
meaningful statement about this you'd have to take in to account how big the
revenue streams were in order to gage the impact.

taken by itself the 1.7 million figure is useless.

There is a cost to running a VC operation, reporting is part of that cost.
_if_ \- and it remains to be seen if it really will go that way - these laws
will be made to bear on VC companies then you can bet that the cost of
compliance will be a small fraction of the size of the fund.

No need to start saying that 'venture capital is in danger'.

Venture capital companies _possibly_ slightly less profitable would be a
better title.

~~~
yummyfajitas
The problem with SOX is that it has a large fixed cost component. This
disproportionately hurts smaller companies. You may bet that costs will be
proportional to the size of the fund, but I see no reason to expect that.

There are also knock-on effects: if VC becomes less profitable, some investors
will put their money into other instruments. The problem isn't just that we
might get smaller profits on existing VC funds, the problem is that we might
get fewer investments into VC.

The sole benefit is that congress and the president get to pretend they are
doing something about the financial crisis.

If you want to say my title was a little overblown, fine. But it doesn't
change the fact that this proposed regulation poses a significant risk of
reducing the amount of VC invested into startups.

