Long-term investors can help break VC’s short-term trap

Venture capital funds need to “break the tyranny” of their typical 10-year cycle as it is choking the funding for innovative sectors whose commercial value takes longer to be realised, said Harvard Business School professor Josh Lerner. 

Speaking at the Top1000funds.com Fiduciary Investors Symposium at Harvard University, Lerner – who is also director at not-for-profit Private Capital Research Institute – said the fact that VC portfolios are increasingly concentrated in a narrow band of sectors is a worrying sign. 

The number of US startups receiving a first round of funding from VC is highest in the software and business and consumer product sectors. Since 2015, more than 3500 – and sometimes more than 4000 – companies have received VC funding each year, while that number is 1500 or less for startups in biopharmaceutical, medical devices, telecommunications and other hardware sectors, according to Lerner’s research.  

“If you think about the venture [capital] game, a lot of it is putting a little money in, figuring out whether something works or not, and putting a lot more chips on the table,” he said. 

“The problem is, for much of this tough tech area, that game just doesn’t really work as well.”  

For example, Lerner said, investors might have to sink billions of dollars to build a fabrication plant before knowing if it can produce viable chips or if there is market demand.  

“Unlike code, which has this beauty of if you get it to run once, it’ll run an infinite number of times, the real-world is a bit of an ugly place,” he said.  

Lerner acknowledged that reasons why these so-called deep tech ventures, such as healthcare and clean tech, are difficult to invest in are multifaceted. Venture capital funds’ 10-year set-up and the need to return investor capital within that time frame is only one of them. 

They also tend to have lower relative returns compared to highly commercialised areas like IT due to capital intensity and the time needed to de-risk the underlying technologies.  

In addition, the broader deep tech industry structures present challenges – energy, materials and the majority of healthcare markets are often complex, ridden with regulations and with low margins. The government is also an important and sometimes primary customer. 

While venture capital and corporates have never historically been big funders of long-term innovation, Lerner said what’s added to the challenge in recent times is the pullback of government money which has been the backbone for the development of hard-to-monetise but societally important technologies.   

Between February and April 8 – less than 40 days – the Trump administration terminated 700 National Institutes of Health grants worth $1.8 billion, according to analysis published in medical journal JAMA. 

This is where asset owners have a critical role to play as providers of patient capital and encouraging investments in line with that philosophy, Lerner said. 

“I think in some ways it’s easy to beat up on the GPs and say, ‘look at these stupid, greedy people’, but in many cases, many of the pathologies that you see on the GP side have their reflections on the LP side,” he said. These include personnel changes leading to a re-evaluation of capital commitment, Lerner said. 

“In general, I think that there really is a mismatch between many features of the venture system and many of the really large technological challenges that are out there,” he said. 

“It’s hard to get from one equilibrium to another one, but certainly this is a challenge that we can think about.”