musings...

I’ve been perturbed of late about discussions about new regulations for VC (old article, but there’s been much discussion in the trade).

I’m not against regulation, per se, after all these are investment schemes, but these are not investment schemes for retail investors (i.e. the person in the street).

You need to be either a sophisticated investor, or, more likely, pension fund, or fund-of-funds investor before you put your money in a venture capital partnership, so light-touch regulation has been the name of the game when it comes to venture capital.

Things are about to change. And, to my mind, not for the better.

Let’s first get a few myths out of the way: Venture Capital DID NOT cause the financial meltdown. That was banking, and the incorrect belief that there was a way to “sell on” risk.

Venture Capital, and it’s bigger cousin Private Equity, know all about risk, and have been dealing with it, and expecting it for years, the portfolio theory of their approach forms, fundamentally, part of their business model, which takes into account the risk of the investment strategy that they are undertaking. That strategy is known up-front by the limited partners, so, the managers best-guess not withstanding, this is a known approach.

Venture Capital, by definition of what it is used for is entirely “on risk” money. Good fund managers weight up risk before making an investment (due diligence) and have a plethora of help (from the fund itself and from advisors) about the investment they are about to make, and everyone goes in with a clear eye on the expectations (shareholder agreement) and terms of the investment. Regulation is going to make that harder, more expensive and, ultimately, less attractive for investors, because it is always investors who pick up the tab, and therefore see returns reduced.

As an asset class, it is fair to say that Venture Capital has been good for investors over the years, even if not as good currently.

So why add additional and, one might suggest, over-the-top regulation to the mix?

Well, from the side of the regulators, it’s easy to see that they are trying to shut the stable door after the horse has bolted. It is, generally, a knee jerk reaction to recent events, even if none of those events were triggered by Venture Capital firms, the regulators do like to be seen to be doing something.

But, in this case, it is my belief that regulators run the risk of making Venture Capital harder to manage, and hence more expensive. This might damage the asset class from the point of view of investors, yet no alternative to real investment exists outside of Venture Capital. Sure, Private Equity and Angel Investment exist, but they deal with different parts of the market (buy-outs and buy-ins in the the case of Private Equity, and early stage and seed capital in the case of angel investment).

Proposals are in the very early stage of consultation right now, so perhaps not all hope is lost, but we all need a dynamic and innovative Venture Capital market, ready and able to take risk, not a Venture Capital market that is bogged down by so much red tape they stop doing what they do well, which is making small, bright start-ups into big employers offering services we need world-wide.

What’s your take? I’d love to hear from you in the comments.

Image Credit: Money Hand by Neubie on Flickr. Creative Commons Usage.