All That Glitters / Nothing Ventured, Nothing Lost

The employment situation in high-tech isn't great these days, as everybody knows.

The employment situation in high-tech isn't great these days, as everybody knows. But there's one niche where the good life rolls on almost normally: the management of venture capital funds. For them, the formula is simple. Every few years a fund's management raises a new fund, taking in hundreds of millions of dollars. Then they withdraw their management fee: 2% of assets a year.

If the fund has, say, $200 million under management, the management fee is $4 million a year, or $330,000 a month, most of which goes to pay the salaries of the top managing partners.

How much, exactly? Among Israeli funds, pay doesn't fall below $100,000 a month. Crisis, recession - it's all good. Not one Israeli venture capital fund has said it's cutting pay or costs.

That might have been acceptable if the funds were delivering the goods - generating handsome profits for their investors. But they aren't. For years, very few Israeli VC funds have generated value for investors. If anything, they've destroyed it.

How is value generation or destruction measured? First, through the annual statements the funds supply to investors. They show that the value of key investments, based on accounting rules, is lower than when the investments were made.

Accounting rules are conservative and sometimes fail to reflect reality. In the case of a startup, which isn't selling anything because it's still engaged in product development, company valuation may not be revised until an equity transaction is made; for instance, when it raises more money.

The result is that dozens, maybe hundreds of startups are listed in the VC funds' books by their historic value at which the last investment was made, even if the startup's situation has badly deteriorated because of the global economic crisis. If the company has reached the point of no return, it's called a zombie, a company that formally still exists but in practice is dead in the water.

A better way to evaluate a VC fund is to assess the market price of its participation units.

There's little trading in these units, but it exists. Some investors do want to sell their holdings, others want to buy them, such as secondary funds.

At what price have participation units in VC funds, including Israeli ones, been changing hands in recent months? It's hard to believe, but if the entry price for investors was $1, the units are changing hands at as little as 50 or 30 cents. A value drop as great as 70% reflects very low confidence in the funds' managers and the startups.

Moreover, in some cases, the sellers are even willing to let go of their funds for nothing. Zero.

Why would anybody sell an asset for nothing, even if he thinks it's pretty worthless? Because when an investor gets into a VC fund, he doesn't hand over money. He pledges to invest a certain amount and signs a document that the liability is irreversible: He has to hand over the money when the fund calls for it. Some investors want to shed their commitment, even at the price of giving up their participation units, as long as they don't have to hand over another sou when the fund comes calling.

Measure it how you like, but the performance of Israel's VC managers doesn't look good, absolutely or relatively. The figures show that not one Israeli fund made the top 25% of funds around the world. Even if this or that fund achieves reasonable results, and maybe doesn't lose money, that doesn't compensate for the huge risk venture capital investors undertake. This is an industry where investors expect to make five to 10 times their investment in order to compensate for the risk of total loss. No Israeli fund even comes close.

The situation of the VC funds is so sad that many are asking, out loud, whether their business model is viable. For the managers and partners, it certainly is. For investors, it seems not.