Russell Garland reported in today’s VentureWire that “Jarrett Collins, a managing director of NeoCarta Ventures, which is winding down, has launched BoardSpring to help directors of venture-backed companies learn about best practices.

Collins, who is 49, said NeoCarta is not making new investments, has no plans to raise a second fund and is doing its best to manage its remaining assets through to liquidity. “For me, I’ve really found a passion in BoardSpring,” he said. “This is a chance to do something bigger than just personal enrichment.”

Jarrett reached out to me late last year, and we spoke and corresponded on his new venture. I shared with him the work that I have developed over the past 12 years on board governance best practices and am pleased to see someone else committing passion and personal resources to this important and underserved area of business.

I recently wrote an article, “Private Equity Investing in Trust”, featured in the July 2010 issue of Trusts & Estates magazine which points to a rising risk of exposure to personal liability for Trustees, co-trustees, and other professional fiduciaries who fail to exercise their duty of oversight before and after making investments in private equity and venture capital.

The article, which you may read in full by clicking HERE, makes the following key points:

• Sophisticated trust portfolios often benefit from direct exposure to active and passive investments made in venture capital and private equity. However, if a trustee is not a lead sponsor of such investments and cannot control the terms of subsequent financings, challenges often arise in determining whether to continue to fund these investments and how to properly assess the economic impact of a pending financing.
• One of the unintended consequences of the global financial crisis for venture-backed and other private equity companies is increased stress among investor syndicates.
• It is critical that the fiduciary show the completion of a process of diligent review prior to making such decisions in order to fulfill a trustee’s duty of oversight.
• Ongoing investment participation may also benefit from a trustee’s active board representation or, if a trustee is not a professional experienced in assessing, managing, and exiting illiquid investments, delegation of such duties to one who is.
• To properly exercise the fiduciary duty of oversight, trustees and other fiduciaries must implement far more than a cursory process of review before dismissing or choosing to continue to fund an illiquid investment.

These issues are particularly relevant to family office investors who may not be aware of their potential liability exposure for illiquid investments they have made in trusts where the trustees who make the decisions are not the only beneficiaries.

Please join me for what promises to be a stimulating, interactive conference call and live discussion on Family Wealth and Family Offices on September 28th.

Time: 8:00-9:00 a.m. US Pacific Time; 11:00 a.m. – noon US Eastern Time; 4:00-5:00 p.m. London time. (It is recommended that participants join the teleconference a few minutes before the start time).

This discussion follows the September 2010 special edition of the Family Business Wiki newsletter edited by Professor Dennis Jaffe:

The Complexity of Sustainable Family Enterprises

The old image of the family business as a two-generation, mostly male team working in a profitable business and then going home to their individual family, is only the tip of the iceberg of the real story. The family enterprise, as we have begun to call it, may contain several businesses, or a family foundation, or a family office that invests and takes care of the financial needs of several generations of a family. As generations evolve, if the family’s enterprise continues to grow, the family has to do much more than just “mind the store.

Joining me for this live discussion will be Josh Cohen, Mary Gust, Robin Hays-Haun, and Ricci Victorio, all of whom contributed to the Newsletter.  To read the posts and to register for the call, which is free of charge, CLICK HERE.

Everybody agrees that, without meaningful job growth, America will not emerge from its current deep economic funk.  There is plenty of debate, however, over what drives that job creation engine in our country. I’ve recently read several interesting reports that touch on parts of the American job growth conundrum but do not tie them together.  Pooling some compelling statistics from these various sources, I believe that the following conclusions are correct and interrelated :

(1) Job growth drives GDP growth;

(2) New company formation drives job growth;

(3) New companies create the vast majority of new jobs after their Initial Public Offerings;

(4) Increased Initial Public Offerings are required to increase job growth;

(5) If the total annual number of Initial Public Offerings (IPO’s) in the U.S. does not exceed 500, which studies show is the level required to support 3% annual U.S. GDP growth, the U.S. will not generate the job growth necessary to rekindle meaningful sustainable GDP growth in the U.S.;

(6) The most efficient fuel for this IPO engine is venture capital.

The evidence:

(i) Startups are responsible for virtually all the new jobs created in the United States since 1977 (Source: Kauffman Foundation)

“The Importance of Startups in Job Creation and Job Destruction bases its findings on the Business Dynamics Statistics (BDS), a U.S. government dataset compiled by the U.S. Census Bureau. The BDS series tracks the annual number of new businesses (startups and new locations) from 1977 to 2005, and defines startups as firms younger than one year old.  The study reveals that, both on average and for all but seven years between 1977 and 2005, existing firms are net job destroyers, losing 1 million jobs net combined per year. By contrast, in their first year, new firms add an average of 3 million jobs.”

(ii) Clearing the backlog in the U.S. Patent Office (USPTO), could create 2.5mm new jobs over the next three years by contributing to startup formation.  Source:  New York Times Opinion article, Inventing Our Way Out of Joblessness by Hank Nothaft and Paul Michel, August 5, 2010 )

“1.2 million patent applications are currently awaiting examination by the USPTO …. each new issued patent creates  between 3 and 10 jobs.  Historic rates of patent grants suggest clearing the backlog could create 2.5mm jobs over the next three years.”

(iii) “Roughly 600,000 new businesses (that employ others) are started each year in the U.S.”  . . .

(iv) “Roughly 1,000 businesses receive their first VC funding each year . . .This means that only 1/16^th of 1% of new businesses obtain VC funding. . . .”

(v) “Since 1999, over 60% of IPOs have been VC-backed.  This is an extraordinary percentage considering that only 1/16^th of 1% of all companies are VC-backed.” “… it is highly unlikely that a company that does not take venture capital ends up going public. … Consistent with this success, venture capital has fueled many of the most successful start-ups of the last thirty years. … Four of the twenty companies with the largest market capitalization in the U.S.—Microsft, Apple, Google, Cisco—have been funded by venture capital.”

Source of (iii), (iv), and (v): “It Ain’t Broke: The Past, Present, and Future of Venture Capital”, by Professor Steven N. Kaplan of the University of Chicago Business School and Professor Josh Lerner of Harvard Business School.

(vi) Going back to the 1970’s it has been documented that 92% of the job growth in venture-backed companies occurs AFTER their IPO:

(vii) IPO’s currently account for 13% or LESS than all liquidity events for venture backed companies, down from 56% during the period from 1992 -2000:

(viii) The current IPO backlog and, more importantly, the poor aftermarket performance for the 85 IPOs priced in 2010 YTD, are symptomatic of a broken IPO pipeline:

According to David Weidner, author of the Wall Street Journal’s MarketBeat Blog, “Dealogic reports that the current 180-day backlog for IPOs now stands at 125 deals, a level three times higher than at the same point last year. The biggest industry waiting is computers and electronics with 23 deals seeking to raise as much as $4.8 billion, followed by finance, 19 deals, and healthcare, 17 deals. Private-equity and venture capital firms have been hard hit too. …While that door hasn’t closed, it has stalled, at least for the 125 issues waiting for the storm clouds to dissipate. So far, it’s been rough-going for most of the issuers who have taken the plunge. Of the 85 IPOs priced so far this year, only 28 are up. The total return for all issues combined is -1.97%, according to IPOScoop.com.”

(ix) The U.S. capital markets for listed equities have been in systemic decline since 1997, while every other major international equity market has been growing.  This is due to systemic regulatory failure and the unintended consequences of ill-conceived regulation that disproportionately negatively impacts startups.

For the detailed study behind (ix) and the two slides above, read “Market Structure Is Causing the IPO Crisis– And More”, by David Weild and Edward Kim, published by Grant Thornton in June 2010.

Conclusion:  If we don’t fix the IPO problem in America, we will not fix the job problem in America.  Venture capital is an essential ingredient to this recipe for success.  I can’t understand why our legislators and policymakers don’t understand this. If they did, there would be no higher legislative priority than promoting regulatory and tax reform to stimulate new capital formation and venture capital in the U.S.  The fact that Singapore, Brazil, India, China, Chile, the U.K., and other countries have figured this out should serve as strong corroborating evidence to the accuracy of this conclusion.

In a Wall Street Journal editorial, Otellini’s Lament, dated August 27,2010, the editor quotes Intel CEO Paul Otellini’s recent comments: “…Otellini . . . warned a technology forum this week that without a change in U.S. government policy ‘thenext big thing will not be invented here.  Jobs will not be created here.  And wealth will not accrue here.  Ultimately, we will face an inevitable erosion and shift of wealth– much like we are witnessing today in Europe.’”

I agree with Mr. Otellini, and it is no coincidence that my first book, Venture Capital: Theory & Practice, which I co-authored with Professor Mannie Manhong Liu of Renmin University of China, is in Chinese and is being published in China in October.  For more on the book, see my next blog post.

I was recently invited to join the Family Business Wiki’s Town Square by founder Don Levitt and have just posted my first contribution, which is titled: How Family Businesses and Venture Capital Backed Companies Face Similar Boardroom Challenges.

The National Venture Capital Association and executive recruiting firm SpencerStuart recently released a white paper, “Emerging Best Practices for Building the Next Generation of Venture-Backed Leadership”.  One of the key points from the paper is the increasing preference by VCs for CEOs who have ‘been there and done that’: When seeking talent for emerging sectors (such as clean technology) with a limited CEO pool, 2010 survey
respondents clearly favored proven venture-backed CEOs from unrelated sectors (58%) over sector entrepreneurs with no CEO experience (31%) or industry leaders from large companies who lack experience in an entrepreneurial environment (11%).

This is also consistent with the challenging, resource constrained environment in which VCs must now operate– it doesn’t make sense to have an inexperienced CEO cutting their teeth on your funds if you can avoid it as the next financing round will be painful– especially if your management team has not executed to meet the company’s board approved operating plan.

The paper makes a number of interesting observations, several of which I summarize below:

* “Vision and fundraising skills are more important than they were a decade ago.”

* “VCs increasingly prefer to find executives who already have a small-company education.”

* “Despite the sea change in the venture capital landscape over the past decade, firms haven’t significantly changed their approach to evaluating senior-level talent.”

*”Firms remain less systematic . . . about conducting formal assessments of their CEOs and top managers after the hire.  Only 25% of respondents to our 2010 survey conduct formal, ongoing management assessments after the investment has been made.”

*”In addition to expecting more of their board members, venture capitalists are also recruiting more independent board members.  Seventy-five percent of 2010 survey respondents said they are recruiting more independent/outside board members now that they face a longer path to liquidity.”

From my fourteen years of experience as a venture capitalist, I can say with conviction that  I have consistently seen the most ill-suited incipient entrepreneurial CEO’s come from large company backgrounds.  When the going gets tough, executives who have grown up in the comfort of the large enterprise typically  are uncomfortable with the difficult actions required to cut significant cost– they tend to be reactive as opposed to proactive about making these changes. Fundamentally, newcomers to VC management who do not have small company experience simply aren’t as self reliant as they need to be to successfully lead a group in a small company.

I was most disappointed to see that venture-backed companies continue to avoid the formal process of reviewing executives after they are hired.  Again, in my experience, I have consistently found that the review process is one of the most important tools for aligning interests between the board and the management team.  We have reaped major benefits from doing this in our portfolio companies, and we have worked with outside organizational consultants to do it.  It is money well spent.

I’ve been associated with the Aspen Institute’s Socrates Society for 14 years and co-chaired the Steering Committee for this program from 2006-2008.  James Beldock, who is both a Socrates Society alumnus and an Aspen Institute Crown Fellow, recently posted on his blog about the important role the Aspen Institute plays in developing strong leaders.

In his post, James draws a parallel between private sector CEO leadership qualities evident in comments made by Aspen Institute Rodel Fellow, Atlanta Mayor Kasim Reed, and D.C. Public Schools Chancellor Michelle Rhee as they discussed how they approached significant challenges:

Mayor Reed, a Rodel Fellow of the Institute, and Chancellor Rhee spoke candidly about the leadership challenges they face.  When asked by David Gergen (who doesn’t know how to ask an easy question) how he handled the structurally unsound pension liability that he faced literally within weeks of stepping into the Atlanta mayor’s office, Mayor Reed provided the evening’s most clear moment of “cross-fertilization.”  He put his CEO hat on and described the meetings he had with union leaders in which he explained the financial realities—just as a CEO must when he must change benefits or even adjust the size of his workforce.  Especially in today’s age of tight budgets and high unemployment, financial pragmatism may not be popular, but it affords a serious public leader a unique opportunity:  to make difficult decisions which result in long-term benefits, even if they attract short-term criticism.

To read the full post, click HERE.

This is the sixth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: You had some thoughts about contract terms. Do you think the trend is shifting in favor of institutional LPs to receive better terms?

Answer: Certainly as the sources of capital have become more  selective and scarce, the GPs have had to become more aware of LP concerns over terms. While  the GPs in top tier funds will still be able to maintain favorable terms (and  LPs will always want to get into their funds), even these GPs have made some  concessions to maintain a supportive investor base. For example, recent press  reports have indicated that at least two prominent funds had lowered their  ”premium” carry structures, and made the payment of a 30% carry rate subject  to the return of a multiple of the investors’ capital. For those other funds  that are not oversubscribed, there will undoubtedly be some pressure on  terms. Though there has been a lot of talk about the terms suggested in the  recent guidelines published by the ILPA, these guidelines have not fully  caught hold (and some proposed terms –like joint and several liability  on clawbacks — may be seen as too extreme). Still, in the current fundraising  environment, there will certainly be some movement to provide an  alignment of interests between LPs and GPs, while trying to maintain the  appropriate incentives for the GPs.

This is the fifth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: Please differentiate between the governance of a VC fund versus the governance of companies in a VC fund’s portfolio? Is one more important than the other?

Answer: This is a very important question, and it starts with recognizing that VC funds, as partnerships, are governed very differently from portfolio companies, which are corporations.  The VC fund may have one managing partner that sets the tone and controls the entire firm, or it may have a collegial distribution of governance among several senior partners.  The best way to understand how a VC fund is governed begins with an analysis of the fund’s investment committee, its deal due diligence process, and the specific allocation of the fund’s investment capital among the individual partners.  An important question to ask is, do the partners evaluate themselves and each other on an annual basis or at all? You might be surprised to learn that many VC funds lack an internal feedback loop, that the partners may not communicate openly among each other, and that the partners themselves may lack a formal measure of accountability among each other, even though the economics are divided formally in the management company agreement.

Turning to portfolio companies, the board of directors is responsible for the governance of the company, and here we have a very interesting dynamic which often leads to board dysfunction—the VC directors have inherent conflicts of interest as representatives of their funds and as fiduciaries who must act in the best interests of all of the shareholders.  In addition there is a major tension and conflict between the management team and the VC directors—the management wants more share ownership, and the common equity is at the bottom of the seniority stack behind the various series of preferred equity rounds.  The VCs want capital efficiency, which means they want management to do more with less.  Compounding the complexity is the fact that most VC-backed companies replace their CEOs twice between the founding and the liquidity event.  So you can imagine that the VC boardroom governance equation is very complex and rife with opportunities for problems.

This is the third in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: Given recent instances of VC-backed company fraud and questions about the management team, how can institutional investors protect themselves from key person risk?

Answer: You are asking a fundamental question here about trust, which relates to your prior question.  I could restate your question by saying, how do I know that I’ve backed someone as a GP who is trustworthy?  The answer is, you have to do your homework on that person, which means that you have to make a full range of reference calls to people who are not on the person’s reference list.  This takes resources and time.  If you are not equipped with the resources to do the work, then you need to rely on someone else’s process—but again that has to be an independent third party whose due diligence credentials are also trustworthy.

Let me turn the table on you a little bit because I sit in your shoes all the time– as a venture capitalist who bets on entrepreneurs, my greatest challenge is to sit across the table from a very enthusiastic person and judge their credibility—will they actually do what they say they are going to do?  Will they work 24/7 to get the job done?  How will they behave when unforeseen challenges occur—which they always do?  Institutional investors have to do the same thing because they are betting on people, and they need to establish a considerable measure of trust if they are going to sign on to a 10 year commitment to invest in illiquid assets.  This is the toughest part of our jobs—as I look back over my the 14 years I have spent in venture capital as part of my 29 year finance career, the biggest mistakes I have made have always been related to key person risk, as opposed to picking the “wrong” technology.