Friday, March 8, 2013

#IWD Post: Women on VC Backed Company Boards

Women on Venture Backed Company Boards

In the context of International Women's day, indeed any day for that matter, the low percentage women of Venture Capitalists (VCs) should be a source of real concern to the VC community. As should the directly related and equally low percentage of women on Venture backed Boards. To the outside world (in both domains) this representation suggests a closed culture (not good for investors since that drives groupthink) and one that fails to acknowledge the intellectual (e.g. close to 60% of BAs) and commercial impact women (approx. 75% of consumer purchases) have on society and the economy. Plus it just doesn’t seem “right” to employees and other stakeholders.

Rather than focus now on the low numbers of women VCs, and what might account for that, I want to focus on Boards in this post. The start point being that the case for increasing the proportion of women on Boards generally is now widely recognized. In just one example a study by the Committee for Economic Development last year noted:

“Without a serious commitment to bringing more women onto boards, U.S. corporations will find themselves falling behind international competitors that are getting the most out of an expanding pool of talented women by opening to them more opportunities for success and advancement.”

The connection between Board diversity and business results is also backed by a growing body of evidence. A detailed study from Credit Suisse investment research last August entitled “Gender Diversity and Corporate Performance” concluded:

In testing the performance of 2,360 companies globally over the last six years, our analysis shows that it would on average have been better to have invested in corporates with women on their management boards than in those without. We also find that companies with one or more women on the board have delivered higher average returns on equity, lower gearing, better average growth and higher price/book.

VCs are at risk, in my view, of garnering increasingly unfavorable attention over time on the issue of the composition of the Boards of “their” companies. Public company shareholders have become more concerned about governance issues and have started to pressure their Boards because of concerns about the impact of lack of diversity on decision making and performance. In due course LPs (in many cases the same organizations) may start to ask more of the same questions about Venture backed Board composition and governance. And, with the media paying more attention to listed company Board diversity, at some point that spotlight may fall more on the venture backed world too. Combine that with the power of social media, as Facebook found heading into its IPO, and the level of criticism could get pretty intense.

In the world of corporate Boards, in Europe especially, diversity has been come a major and ongoing topic of not just debate but action. Indeed it is a high profile public policy issue. In Norway and now, France, Spain, Italy and other countries legislation has been passed to mandate companies to add more women to their Boards via a quota system. And last year the EU Commission proposed a 40% objective for the “underrepresented sex” by 2020. In the UK, widely regarded as having the highest standards of corporate governance, a legislated solution is not popular but still leading Government figures have spoken to the need to address female Board representation. In 2011 a goverment commissioned report led by Lord Davis set out voluntarily goals of 25% female Board representation for the FTSE companies 100 by 2015. 

In the US the public policy debate is muted but a number of groups are making the case for change, for example the National Association of Corporate Directors (NACD), the 30% Coalition and 2020 Women on Boards. Last October the NACD issued the findings of a “Blue Ribbon” Commission on Board board diversity authored by CEOs and corporate governance experts and Women Corporate Directors has also issued its own report. Board recruiters are on the case, for example Heidrick and Struggles, while activist shareholders are putting forward proxy motions challenging Boards with limited diversity. Finally the media, both traditional and social, can make its voice heard. Note for example the furore that started after Carol Hymowitz of Bloomberg News wrote an article challenging the lack of women on the Facebook Board ... with the Board eventually reacting by adding Sheryl Sandberg.

For all the activity at the pinnacle of the corporate sector, large listed companies, there is essentially zero focus at the start point of the corporate lifecycle. Namely the early stage high growth companies that drive job creation and from which will come the leading businesses of the future. Here high growth company Boards are typically dominated by VC nominated directors from their investor firms, given the leading role of VCs in early high growth company stage finance. 

This VC factor results in even higher proportion of men on Boards at this stage than for public company Boards. (16% for the S&P 500. I have not been able to identify a good source of statistics for venture backed companies but anecdotally VCs I polled said in their view it was definitely less than 10%, probably even less than 7%.) Yet in contrast to the level of focus on Board composition in the public company arena "no one" seems to care, or at least make commensurate noise, in the private domain  - not the shareholders (obviously the VCs for the most part) or for that matters the media or the organizations campaigning for public company Board diversity. 

But one can argue that that early stage VC dominated Boards have much more influence of how companies develop, given these are the most formative years for their corporate culture. This is because by the time you get to the public company stage the Board transitions to much more of a monitoring and oversight function. 

Going back to the where this post started, the underlying issue is the lack of women (especially senior women) VCs. For now this sits outside of the public and mainstream media spotlight. Similar to initiatives in the public company space, my guess is that VCs need to look beyond their current tight networks and broaden their list of qualified Board candidates to include more women. However this is only relevant for non VC independent expert Board positions ... obviously for an investor seat taken by a VC, the demographics are a function of the number of senior women VCs. 

As reported in the 2011 National Venture Capital Association Census survey, only 11% of investment professionals at VC firms are women. This glaring gender gap, as experienced by a woman entrepreneur, was captured in a recent post by Jules Pieri who likened visiting a VCs office to going back in time to the Mad Men era. And at a senior (ie key decision maker) level the disparity seems worse. Take for example the Forbes 2012 ranking of the Top 100 Tech VCs. Only five of the 100 are women and only one of those is in the top 70. The overall metrics seem little changed from the findings in the Kauffman Foundation Diana Project Report on the participation of women in the VC industry published nearly 10 years ago. So … it looks like the VC community needs to work harder to change its demographics, and in turn its Board demographics, in the interests of their companies, LPs and indeed themselves.

Thursday, March 7, 2013

The Question(s) of VC Returns PART 2

I mentioned in part I of this two part series that there are two questions you need to separate out if you want to look at published VC returns and draw some conclusions set against the performance of public market equities. The data source being Cambridge Associates.

First are VCs making good investments? i.e. what do their gross returns look like vs. other equity categories? Here we can’t answer directly from the CA data but the answer it seems to be “not really” especially adjusting for higher risk. Second are the realized net returns achieved by LPs competitive with public market alternatives? Here the answer seems to be more of a “No” on 1, 3 and 10-year time horizons and “Yes”, but not by much on a 5 year horizon.

1. Looked at on a like for like gross return basis are VCs making good investments? The good news for VCs: by taking the VC numbers net of fees ... their actual achieved gross investment returns are materially understated in the Cambridge Associates numbers. For example, adding back VC carried interest and management fees the overall CA VC index probably matched the S&P 500 (as opposed to lagged by approx. 200bp) over the last 10 years.

In the context of generally disappointing performance there are a couple of important sub questions that you can't pull out of the high level data:
i)  Are VCs actually good at picking winners vs. losers (hence demonstrating investment skill.)
ii)  Are they over paying (hence hurting their returns because exits valuations are unable to deliver a decent IRR?)

2. After fees are the returns LPs get from their VC investments competitive with public market alternatives?
The CA numbers can be used to answer this question ... and as Fred pointed out ... things don't look great. Of course this is the answer that matters to the investors in any VC fund. LPs might see the gross returns reported but they can only take their net returns to the bank.

Clearly net to investor returns over 10 years say are disappointing and an important part but not all of the answer is fees. In fact the numbers would look even worse if you accept that VC investments should earn a premium for risk, not least liquidity risk. Hard to say what that risk premium should be but add a few 100bp and gap between a target risk adjusted return and actual achieved returns grows commensurately. (For example if the S&P earned returned a return of 8% over 10 years and you take the view that, to be compensated for risk, should have earned 10%+ as an LP … then overall VC returns of 6% are even more adrift.)

Interestingly the conclusion that these private investment pooled vehicles (taken on average, clearly individual funds did much better - and worse) have had a hard time in recent years "beating the [public] market" is pretty much the same finding as for the two big classes of public market equity investment vehicles ... hedge funds and mutual funds.

In particular hedge fund returns having fallen off as their number and size has grown - hence their ability to outsmart “the market” has eroded as they have effectively become “the market”.

A key reason neither public equity mutual nor hedge funds on average beat the public market indices over time is most likely that the underlying public markets are "efficient" enough to mean security selection (aka stock picking) doesn't add much value. And certainly not enough value to overcome the drag caused by the level of fees these vehicles charge. This of course explains the dramatic rise in interest in Exchange Traded Funds (ETFs) in recent years.

While it is tough to apply the same concept of market efficiency to private equity investments perhaps a similar story applies in early stage private investment land? Namely that angel and VC investments are, on average, pretty fully and fairly priced. If that is the case then individual fee-free angel investments could well have a decided advantage!

Footnote on benchmarks
As an aside it is worth noting that, while tech investors love to talk about the NASDAQ index, it isn't representative of anything other than the companies NASDAQ gets to list there. In my view it only really makes sense to benchmark against a broad index. We can debate which one, but the Russell 2000 probably makes most sense of the ones CA lists. i.e. how have VCs done vs. the alternative of diversified investments in a smaller US public companies? And if you do are a tech investor and want to judge performance with a more representative public market tech index then S&P has plenty to choose from.