Andreessen Horowitz's New Structure
VC are LPs First, Startups Second
Yesterday, Forbes posted a lengthy profile on Silicon Valley VC firm Andreessen Horowitz (a16z), enticingly entitled, Andreessen Horowitz Is Blowing Up The Venture Capital Model (Again). In summary, a16z is registering itself as a registered investment advisor (RIA) instead of a traditional venture capital firm.
The reasoning is that becoming an RIA would allow a16z to have more flexibility and freedom in its investing activities. Whereas traditional venture capital firms are restricted by a cap on non-private-equity investments — 80% of funds must be deployed in private equity, with only 20% allowed for other types of investments. Specifically, the SEC mandates that VC firms are allowed to hold "no more than 20 percent of the amount of the fund's aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments." Qualifying investments here refer to equity positions in portfolio companies that were bought directly from those companies.
By registering as an RIA and renouncing its old VC structure, a16z no longer has to be bound to this 20% cap. Instead, a16z is now able to participate as much as it wants in investing activities that would not be considered "qualifying investments," such as cryptocurrencies, public markets investing, and buying shares in the secondary market rather from portfolio companies themselves. With the RIA structure, a16z can pursue its newsworthy cryptocurrency investments unfettered. It gains access to the important secondary markets through which it can acquire more equity in startups to its heart's desire. On the flip side, "'if [Andreessen Horowitz] is becoming an RIA, its cost structure just went way up' ... [and] a compliance officer will have to sign off on everything an employee at the firm does."
Underlying this shift is a reminder of who comes first in the business of VC. It is important to note that shifting investment to “unqualifying investments,” (stuff other than purchasing equity from startups) means that there will be less focus on deploying capital to support startups. That is in spite of the age-old mantra of VC’s existing to back startups and founders. Why is this okay? Because it is the Limited Partners (LPs), the investors, not the founders, to whom the VC firm is beholden to at the core — there is literally a fiduciary duty on the part of VCs like a16z to make decisions in the best interest of their LPs. After all, without investors, VC funds would not exist. The foundational purpose of a VC fund is to serve as an asset management vehicle through which it can provide investors with returns.
Oftentimes, this gets lost in the propaganda of VC firms existing to empower founders and spur innovation. a16z itself was founded by two successful startup founders, Marc Andreessen and Ben Horowitz, and much of their edge as a successful VC firm comes from the unique operational support they give to founders. Definitely, this model wields powerful incentives that do indeed lead to increased innovation and startup growth, and that should be applauded. But again, the ultimate goal of all this founder-friendliness and support is to help the portfolio companies scale and become profitable, hopefully leading to a profitable exit and good returns.
We can see this in a16z's decision to go RIA. Let's dig deep with some questions.
Question: Why would a16z want to go RIA?
Answer: To invest more in those other types of "unqualifying investments."
Question: Why would they want to invest more in "unqualifying investments”, even if it means less focus on those “qualifying” startup equity investments?
Answer: They see opportunities in those unqualifying investments.
Question: Why do those opportunities matter?
Answer: Because they would help to generate returns for the fund and for its LPs.
It's a shift that has considerations of returns to LPs at its core. Because to maximize returns is what the core mission of any asset manager is, regardless of how founder-friendly or shrouded in Silicon-Valley aura it is. LPs first, founders second.
Yesterday, Forbes posted a lengthy profile on Silicon Valley VC firm Andreessen Horowitz (a16z), enticingly entitled, Andreessen Horowitz Is Blowing Up The Venture Capital Model (Again). In summary, a16z is registering itself as a registered investment advisor (RIA) instead of a traditional venture capital firm.
The reasoning is that becoming an RIA would allow a16z to have more flexibility and freedom in its investing activities. Whereas traditional venture capital firms are restricted by a cap on non-private-equity investments — 80% of funds must be deployed in private equity, with only 20% allowed for other types of investments. Specifically, the SEC mandates that VC firms are allowed to hold "no more than 20 percent of the amount of the fund's aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments." Qualifying investments here refer to equity positions in portfolio companies that were bought directly from those companies.
By registering as an RIA and renouncing its old VC structure, a16z no longer has to be bound to this 20% cap. Instead, a16z is now able to participate as much as it wants in investing activities that would not be considered "qualifying investments," such as cryptocurrencies, public markets investing, and buying shares in the secondary market rather from portfolio companies themselves. With the RIA structure, a16z can pursue its newsworthy cryptocurrency investments unfettered. It gains access to the important secondary markets through which it can acquire more equity in startups to its heart's desire. On the flip side, "'if [Andreessen Horowitz] is becoming an RIA, its cost structure just went way up' ... [and] a compliance officer will have to sign off on everything an employee at the firm does."
Underlying this shift is a reminder of who comes first in the business of VC. It is important to note that shifting investment to “unqualifying investments,” (stuff other than purchasing equity from startups) means that there will be less focus on deploying capital to support startups. That is in spite of the age-old mantra of VC’s existing to back startups and founders. Why is this okay? Because it is the Limited Partners (LPs), the investors, not the founders, to whom the VC firm is beholden to at the core — there is literally a fiduciary duty on the part of VCs like a16z to make decisions in the best interest of their LPs. After all, without investors, VC funds would not exist. The foundational purpose of a VC fund is to serve as an asset management vehicle through which it can provide investors with returns.
Oftentimes, this gets lost in the propaganda of VC firms existing to empower founders and spur innovation. a16z itself was founded by two successful startup founders, Marc Andreessen and Ben Horowitz, and much of their edge as a successful VC firm comes from the unique operational support they give to founders. Definitely, this model wields powerful incentives that do indeed lead to increased innovation and startup growth, and that should be applauded. But again, the ultimate goal of all this founder-friendliness and support is to help the portfolio companies scale and become profitable, hopefully leading to a profitable exit and good returns.
We can see this in a16z's decision to go RIA. Let's dig deep with some questions.
Question: Why would a16z want to go RIA?
Answer: To invest more in those other types of "unqualifying investments."
Question: Why would they want to invest more in "unqualifying investments”, even if it means less focus on those “qualifying” startup equity investments?
Answer: They see opportunities in those unqualifying investments.
Question: Why do those opportunities matter?
Answer: Because they would help to generate returns for the fund and for its LPs.
It's a shift that has considerations of returns to LPs at its core. Because to maximize returns is what the core mission of any asset manager is, regardless of how founder-friendly or shrouded in Silicon-Valley aura it is. LPs first, founders second.
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