In the public imagination, venture capitalists are often seen as independent wealthy actors seeding early-stage companies with their personal money. But the vast majority of VC capital is from “LPs”—or limited partners—including public pensions, university endowments, hospitals, and wealthy families. In other words, venture capitalists manage large sums of other people’s money. This makes them de facto gatekeepers of innovation, deciding what gets built and who benefits. When this system works, we end up with world-changing companies and technologies. When it fails, as in the case of Silicon Valley Bank, we risk setting ourselves up for stagnation and decline.
Historically, society has given venture capitalists wide latitude to shape and influence the innovation economy. Our laws and policies exempt VC investors from many of the rules and regulations that apply to other money managers. In the midst of SVB’s collapse, however, many people have started to question the wisdom of granting so much leeway to VC leaders.
As conflicting theories for the bank’s meltdown swirled, commenters from across the ideological spectrum seemed to all agree on one thing: VCs’ responses to the crisis were shockingly unprofessional. Some criticized VC leadership for a panicked response; others characterized the pleas for speedy government intervention as the “ravings of idiots.” The harshest critics accused VCs and startup executives of being “asleep at the switch.” They claimed SVB depositors were financially negligent, citing reports alleging that some VCs and startup founders had received personal benefits, such as 50-year mortgages, in exchange for keeping risky uninsured deposits with the bank.
Del Johnson is a venture capital investor, limited partner, angel investor, and author. He is a graduate of UC Berkeley and Columbia Law School.
As one of the only VCs who raised early concerns about the asset’s systemic risks, I was suprised by neither the VC-led bank run nor the week of finger-pointing that followed. Venture capital investors have long prided themselves on promoting a collaborative, “pay it forward” culture, guided by close networks and personal relationships. However, as a son of the Bay Area who got an up-close look at VC responses to the collapse of the dotcom bubble, I knew this narrative amounted to little more than slick marketing.
To know why the industry’s panicked and erratic response unmasked flaws at the core of how it operates, we must understand VCs’ reactions to the SVB failure as an outgrowth of the industry’s deeply ingrained cultural norms. VCs are notorious for being “herd animals,” behavior reflected in both the bank run and their response two days after the government’s extraordinary interventions to make SVB depositors whole. Over 650 firms—including prominent names like General Catalyst, Bessemer, and Lux Capital—recommended that their companies keep or return their money to SVB, despite an ongoing public conversation about the systemic risk of aggregating startup capital into a single bank. Research suggests that this culture of groupthink is the result of consolidating capital in the hands of just a few massively influential fund managers.
According to the 2022 Pitchbook Venture Monitor report, about 5 percent of VC managers control 50 percent of the capital in the United States. A staggering 75 percent of these power brokers attended an Ivy League school, Caltech, MIT, or Stanford, and 91 percent are male. Moreover, these “Big VC” firms tend to cluster geographically, with over 90 percent based in either Silicon Valley, New York, Boston, or Los Angeles, creating regional imbalances that have historically excluded promising entrepreneurs and investors from outside of these tech hubs.
To achieve such a skewed concentration of capital amongst a handful of industry actors, Big VC firms have persuaded themselves, their peers, and the public at large of their superior investment acumen. But the lack of basic financial literacy these VC leaders seemed to demonstrate during the crisis underscores serious concerns about their competence. One study found that VC investment decisions demonstrate “little or no skill either in the short or long term.” According to a Cornell University model, what seems like VC skill is just a matter of a fund being around to invest at the most opportune moments. A recent Harvard study even found evidence that investor performance erodes over time, suggesting that experienced Big VC managers might actually be worse than their novice counterparts.
If we want to unlock the true innovative potential of our society, it has become clear that we must dilute the unearned influence of Big VC. Achieving this goal requires us not only to break up the market power of Big VC funds and investors, but to reimagine innovation investing from the ground up.
We’ll need to build structures that avoid the types of financial entanglements and conflicts of interest that pervade the current system. One way to achieve this is by conducting more research that challenges venture capital conventions, such as VCs’ overreliance on personal relationships for dealmaking and the tendency of LPs to overvalue brand-name funds. This could be done through new structures, such as publicly funded innovation laboratories, or through private institutions that do not invest in VC and are not entrenched in that ecosystem. The work done at such institutions would have the added benefit of helping reform many of our public innovation programs, whose rules are often governed by the same erroneous logic, conventional dogma, and untested assumptions as traditional VC.
As we build new models, we can use legal and policy tools to reduce the influence of Big VC managers and halt the behaviors that contributed to the meltdown. For example, to limit the extent to which the most powerful actors can dominate the market, legislators should consider laws that tax VC compensation as personal income, or limit the number of funds or assets subject to preferential tax treatment. To stem the cozy relationship between startup banks and VCs, lawmakers should also consider closing VC-specific loopholes that allow banks to invest massive amounts of capital into these structures. On the LP side, we can encourage—through regulation or legislation—more investment outside of the enmeshed Big VC system. This could involve lifting the cap on the number of non-VC limited partners a small, emerging fund can have, or creating tax incentives to encourage LPs to invest in new or smaller funds raised by non-enmeshed outsiders.
Finally, if society has now decided Silicon Valley VC is structurally important, as many have argued throughout the collapse of SVB, then lawmakers must also ensure that the VCs who hold overwhelming influence over the sector are subject to professional standards and rules of responsibility. In numerous other fields—like medicine, law, or investment advising—professionals are required to demonstrate basic proficiency, particularly when incompetence could present a danger to the public if left unchecked. VCs should be no different, given the immense control they have over innovation in vital sectors such as AI, national security, and defense.
Ultimately, it is up to us to fundamentally rethink the power we have given VCs and push for meaningful reforms to ensure that the industry fulfills its fiduciary and societal duties. We must act on the lessons of this moment and break the market power of Big VC incumbents, both to save the innovation ecosystem and to ensure economic prosperity.
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Del Johnson