On my own at eighteen, I self-funded my college education at both the undergraduate and graduate levels. I am a huge supporter of knowledge as an economic equalizer. As a former tenured university professor who later returned to industry and corporate training, I understand the challenge of teaching students who, through no fault of their own, lack basic skills in writing, math and logic. Therein lies the rub.

The United States spends much more per capita than other developed countries at the same time proficiency tests show American students lagging international peers in “the literacy, numeracy, and computer-age problem-solving skills needed to compete in the global labor market.” This is not good nor is it sustainable or desirable.

At the company level, employers are grappling with the real problem of too few people who can do the jobs they must fill. According to CNBC’s website, a Colorado construction firm, Oakwood Homes, jumped into action by creating its own school. Students learn to “saw, tile, drill, plaster and paint.” The CEO of this Berkshire Hathaway-owned company, Pat Hamill, laments the worsening worker shortage, saying “if we don’t do this, we’re not going to have a labor force to meet the needs of our industry.” I talked to a construction manager a few years old who told me his young workers could not convert measurements when asked to cut wood into certain size pieces.

From a financial perspective, the numbers are staggering. The National Center for Education Statistics reports that taxpayers funded $634 billion for public elementary and secondary schools during the 2013-2014 period or “$12,509 per public school student enrolled in the fall (in constant 2015-2016 dollars).” Inside Higher Ed tallies college and job training at $1.1 trillion.

While taxpayers are scratching their heads about oft anemic investment returns from the national education sector (recognizing that performance varies by region), venture capitalists are clapping with glee at opportunities to make money by solving existing woes. In 2015, Bertelsmann SE & Co announced its $230 million investment in a learning technology company called HotChalk. EdSurge Research chronicles “edtech” funding of K-12 focused start-ups since 2010 of $2 billion.

In an ideal world, young people graduate with adequate skills to land a job and progress towards eventual financial independence. To the extent that improvement is needed (just look at the data), let’s hope that outside investors and clever entrepreneurs can help drive reform with their contributions and independent insights.

No sooner had I written "Financial Technology and the Fiduciary Rule," an invitation to the Future of Finance 2016 appeared in my in-box with the call-out that "Technology is about to revolutionise financial services." (Note the British spelling for this Oxford conference.) Based on session titles, attendees will hear about topics such as how technology can:

  • Be "used to build trusting relationships with clients" and increase transparency;
  • Substitute for "expensive human intermediaries" to lower costs; and
  • Encourage the creation of "simpler and cheaper" insurance and savings products.

Increasingly, angels and venture capitalists are waking up to the fact that the global retirement marketplace is big and ripe for innovation. Earlier today, Goldman Sachs Investment Management Division announced its intent to acquire Honest Dollar. According to CrunchBase, this transaction follows a seed financing last fall to further build a web and mobile platform that allows small businesses to cost-effectively set up retirement plans. Expansive Ventures led that round that includes former Citigroup CEO Vikram Pandit and will.i.am, founder of The Black Eyed Peas musical group.

Yet another indication that investors see "gold in them thar health care and retirement plan hills" is a $30 million capital raise for a company called Namely. Its February 23, 2016 press release lists Sequoia Capital as the lead venture capital firm for this round, bringing its total funding so far to $107.8 million for this "SaaS HR platform for mid-market companies."

Interestingly, in articles about both Honest Dollar and Namely, the tsunami of complex regulations is cited as a reason why employers need help from financial technology organizations. With mandates growing and becoming more muscular, no one should be surprised if cash-rich backers write big checks to financial technology businesses. As Xconomy reporter Angela Shah points out, multiple start-ups are "trying to compete for the 80-plus percent who don’t offer benefits."

There is no doubt that the competitive landscape is changing and will prompt more strategic soul-searching for vendors and policy-makers alike. I’ve listed a few of the many questions in search of answers as things evolve.

  • Will other large financial service organizations like Goldman Sachs swallow up smaller start-ups? If so, does that change the role of angels and venture capitalists?
  • If enough of these companies pop up to serve small businesses and self-employed persons, is there still a need for the product offered by the U.S. government – myRA?
  • Will the U.S. Department of Labor fiduciary rule, if passed into law, accelerate the formation and growth of financial technology companies? If so, how?
  • Will there be a need for more or fewer financial advisors as the financial technology sector grows?
  • Will individuals buy more insurance and savings products? If not, why not?

Life in financial services land will never be dull.

Whether the proposed U.S. Department of Labor so-called fiduciary rule becomes law this year remains to be seen. Many in the industry think its passage is nigh. Critics hope for a reprieve, asserting that costs are likely to outweigh benefits.

One oft-repeated concern is that small savers will be harmed if financial service companies decide to jettison accounts that fall below target asset levels. The Securities Industry and Financial Markets Association ("SIFMA") explains "Because they cannot afford a fiduciary investment advisory fee, they will instead be forced to solely rely on a computer algorithm known as a ‘robo-advisor.’"

Financial technology enthusiasts will counter that a more automated approach to retirement planning is a good thing for big and small savers alike. Certainly the topic merits review for at least two reasons.

  • The use of machines has exploded in recent years. In her November 9, 2015 speech about technology, innovation and competition, U.S. Securities and Exchange ("SEC") Commissioner Kara Stein foretells buoyant growth with an expected $2 trillion in assets under management by robotized advisors by 2020.
  • There are central questions about the fiduciary obligations of a company that concentrates on algorithmic advising and money management. Besides seeking to contain model risk, there is a need, at a minimum, for a vendor to regularly review client objectives and constraints. Click here to access a white paper on this topic by National Regulatory Services.

A few weeks ago, a handful of venture capitalists and prominent angels announced a $3.5 million capital round for a financial technology company called Captain401. Its stated goal is to help small businesses streamline the creation and administration of 401(k) plans that the founders argue would be too expensive to offer without automation. A cursory review of the company website makes it impossible to know much about its business model, technology safeguards or compliance infrastructure. Nevertheless, the funding of this and other "Fin Tech" organizations augurs favorably for added growth in this area.

As the global retirement marketplace adapts to regulatory and economic realities, it will be interesting to watch (or perhaps lead) what unfolds in terms of innovation, service provider competitiveness, cost tiers and other outcomes that impact savers and those who have already retired.

No sooner had I penned "Unicorns, Valuation and the Search for Investment Returns" for my compliance blog, I opened the New York Times this morning and discovered an article about so-called unicorns or companies with venture capital ("VC") backing and an estimated valuation of at least one billion dollars. According to the author of "The Hidden Risk of a Billion-Dollar Valuation in Silicon Valley," law school educator and pundit Steven Davidoff Solomon, venture capital firms want to get paid first in the event of a portfolio company sale which is why they negotiate hard to include a liquidation preference before committing capital. He cites a study by law firm Fenwick & West that confirms the prevalence of this downside protection and suggests that it is one reason why VC firms don’t balk about what others may decry as valuations that are "too high." Interested readers can click here to download "The Terms Behind the Unicorn Valuations" by Barry Kramer, Michael Patrick and Nicole Harper (March 31, 2015). Professor Solomon points out that this kind of return insurance is a boon for venture capitalists but could be a disaster for founders who may end up with little or nothing if a liquidity event yields too few dollars. In an attempt to avoid this unhappy outcome, founders with sufficient voting power could nix a potential sale. Should that occur, investors then face greater risks due to less liquidity.

What is missing from the various analyses about unicorns and jumbo valuations of private companies overall is a discussion about the potentially adverse impact on institutional investors. In the event that valuation numbers are truly disconnected from economic reality, a limited partner may well end up paying too much in fees to its venture capital fund manager(s). Moreover, any institutional investor that allocates money to venture capital as part of its grand strategic asset allocation design may well fall short of its goals if valuations are "too high." Failure to realize a target return, satisfy a minimum funding ratio rule and/or diversify its portfolio are a few of the "nasties" that could ensue, thereby putting investment committee members at risk for allegedly breaching fiduciary duties.

One response, proffered by researcher Ashby Monk, is for institutions to invest directly and cut out the middlemen. This tact is likely to appeal to the bigger endowments, retirement plans and sovereign wealth funds that can afford to hire staff and put the requisite due diligence and technology infrastructure in place to vet and then monitor its investments. Even then, there is the peril of improperly relying on imprecise valuations that in turn drive so many other decisions.

As Dame Agatha Christie declared, "Where large sums of money are concerned, it is advisable to trust nobody." Investment fiduciaries need to understand how asset managers come up with the valuations they report to their limited partners and how their valuation numbers are revised over time to reflect changing conditions.

Who says that money and humor can’t mix? Sources inform that the owner of a collection of funny websites and blogs is now $30 million richer. Seattle-based Cheezburger Network, publisher of popular internet destinations such as Fail Blog, I Can Has Cheezburger and The Daily What, adds to its original $2.25 angel monies by partnering with venture capital funds such as the Foundry Group, Madrona Venture Group, Avalon Ventures and Softbank Capital. According to Xconomy.com, collective traffic is large with 16.5 million unique visitors each month, viewing a total of 375 million pages and adding or sharing 500,000 photos and videos.

According to its website, the Foundry Group that led this deal has some demonstrated winners in its portfolio, including the mammoth game maker Zynga and StockTwits.com, a popular social network for trading strategies. Softbank Capital invested in the Huffington Post and, until it was sold to NewsCorp, the religion powerhouse website known as Beliefnet, Inc. Madrona lists Amazon.com as a prior investment. Avalon has a stake in the aforementioned Zynga which boasts "10 percent of the world’s internet population (approximately 215 million monthly users)" as having played one of their games.

Another fun-oriented firm that has raised venture capital money is JibJab.com. In early 2009, it was reported that this popular creator of satirical videos took in $7.5 million in a Series C round from Sony Pictures Entertainment, Overbrook Entertainment and Polaris Venture Partners.

As pension funds add to their venture capital allocations, imagine the due diligence conversations that focus on monetizing funny cat and dog photos or growing virtual crops.

Of course venture capital investing as limited partners means that pensions, endowments and foundations must have a comfort level with how the general partners manage risks and value their portfolio companies. For ERISA plans, an expanded definition of fiduciary, if approved, could materially change the relationship between institutions and fund managers for this alternative investment class. For government plans with a stated goal of revving up the local economy, achieving full diversification may be a challenge.

Editor’s Note: Links to related items are shown below.

For those in need of help, click to access the "Troubleshooter’s Guide to Filing the ERISA Annual Report" (U.S. Department of Labor, October 2010). This 70-page publication includes a handy reference chart that relates to the Form 5500 and Form 5500-SF (for small firms), along with related attachments. Another helpful resource is "FAQs About The 2009 Form 5500 Schedule C."

School’s still out regarding the extent to which plan sponsors will be able to comply with new rules. So far, Schedule C seems to be a sticking point with numerous questions being asked about how to properly report "indirect" versus "direct" compensation to service providers.

As more pension plans allocate monies to mutual funds, hedge funds, private equity funds and funds of funds, they will need to report details about fees paid to these organizations as they too are now deemed service providers.

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this final question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about limited partners and lawsuits involving venture capital "VC" fund managers. Click here to read Mr. Levensohn’s impressive bio.

SUSAN:  Ive read that some general partners ("GP"s) are suing LPs for not making capital calls. The LPs claim that they are cash constrained and/or the VC fund has not performed. Do you see a trend in the making?

PASCAL: First, it would appear that the reports of numerous limited partner ("LP") defaults exceed the reality. Based upon discussions with industry participants, most institutional LPs have, in fact, met their  obligations to make capital calls. Second,  the decision of a GP to sue an LP over a default is most often the absolute last resort. The GPs are not in business to institute litigation. This is a distraction for the GP and added publicity that neither GPs nor LPs desire. When the LP Agreement is executed, all of the parties enter into a contract with the expectation that both LPs and GPs will honor their respective commitments. The GPs have committed their time. They have built an organization  to implement an investment strategy and program for the VC fund. They should be  entitled to rely on the contractual obligations of those sophisticated  investors who agreed to support this program over the long  term.

Editor’s Note: Our heartfelt thanks to Mr. Pascal Levensohn for taking time to talk to Investment Governance, Inc. on behalf of subscribers to www.FiduciaryX.com. The topic of venture capital fund investing is an important one indeed. Readers may want to check out "A Simple Guide To The Basic Responsibilities of VC-Backed Company Directors" (Working Group on Director Accountability and Board Effectiveness, National Venture Capital Association, October 2007).

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this ninth question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about IPOs and whether institutional investors should allocate monies to venture capital ("VC") funds right now. Click here to read Mr. Levensohn’s impressive bio.

SUSAN: Does an anemic initial public offering ("IPO") market will remain a deterrent to VC investing?

PASCAL: Yes I do. I believe that an entire generation of American innovation is at risk as a result of the lack of IPO’s. The statistics are overwhelming in support of my position, starting with the fact that over 90% of jobs created by VC-backed companies occur AFTER their IPO – and this has been the case for 40 years. What concerns me the most about the IPO vacuum is that it is systemic and is the result of a “one size fits all mentality” when it comes to regulation of the securities industry.  A relatively unknown emerging growth public company with a $500 million market cap has different needs for research and trading support to provide liquidity for investors than IBM. I remain surprised that this seems to be difficult for our policy makers to understand, but I am encouraged that the U.S. Securities and Exchange Commission ("SEC") has recently invited public comments for a 90 day period to address structural problems with the U.S. equity markets.

Specifically, the SEC wants to know if anyone from the public has thoughts on "whether the current market structure is fundamentally fair to investors and supports capital raising functions for companies of various sizes, and whether intermarket linkages are adequate to provide a cohesive national market system." The Commissioners expressed particular interest in receiving comments from a wide range of market participants. Comments on the Concept Release are due within 90 days after publication in the Federal Register.

Click to read "SEC Issues Concept Release Seeking Comment on Structure of Equity Markets" (January 13, 2010).

I believe that the U.S. equity capital markets must be structured with the goal of promoting the growth of publicly held small businesses in America. America had this structure in place prior to 1997. We should take a hard look at what has changed to render the small company IPO extinct. (Contrary to popular belief, it first became an endangered species before the technology bubble).

Compounding this problem is the fact that, with no IPO options, the consideration paid for companies in trade sales – acquisition by larger companies – has been declining.  Why should venture capitalists take the risks associated with starting up a new company, working through all of the difficulties with multiple financing rounds and executive changes over a six-to-eight or even ten-year period, only to get backed into a corner by a large multinational that dominates the sales channel and can wait them out?

The biggest problem the VC industry has today is that, absent access to public market capital, there are too few VC-backed companies that are self sustaining cashflow generators.  The biggest problem that the U.S. economy has today is unemployment. You would think that maybe the stewards of the U.S. economy, our legislators, could make some structural changes to our small company capital markets regulations to fuel the greatest job creation engine in America – the entrepreneur driving an emerging growth company. This problem goes way beyond venture capital. Consider that 47% of all IPO’s since 1991 were backed by neither VC’s or private equity firms. This is an American problem.

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this eighth question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about exiting from a venture capital ("VC") fund. Click here to read Mr. Levensohn’s impressive bio.

SUSAN: What happens if a limited partner ("LP") wants to exit a VC fund? What are their rights?

PASCAL: The options here are limited. The LP can try to sell its interest, including the obligation to fund future capital calls, to a fund that acquires secondary interests. The good news is that a robust market exists for such interests in venture capital partnerships today. Alternatively, an LP can default.  If the LP does wish to sell, the general partner ("GP") needs to approve the transfer. The standard partnership agreement language leaves this decision in the "sole discretion" of the GP.  There is no free lunch if you change your mind several years into a 10-year-plus partnership participation. And there shouldn’t be. This means that either the secondary market buyer will take his or her pound of flesh by buying the LP’s interest at a substantial discount or the GP will by offering the interest and its economic value on a discounted basis to the other LPs. It is far less disruptive to the GP and to the GP-LP relationship for the exiting partner to sell to a secondary buyer but these buyers are totally financially driven and are going to get the best deal possible for themselves.

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this seventh question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about how institutional investors can connect with venture capital ("VC") fund managers. Click here to read Mr. Levensohn’s impressive bio.

SUSAN: Should institutional investors directly contact venture capital fund managers or work through traditional investment consultants, assuming that the latter parties have the background to conduct due diligence on the VC funds?

PASCAL: First, nothing beats direct contact with managers.  I think the VC industry conferences in specific industry sectors provide a great forum for institutional investors to meet directly with VC funds. Historically the two largest conferences have been sponsored by IBF and DowJones.  There are also sector specialty conferences, such as the IT Security Entrepreneurs Forum held annually on the Stanford campus that bring out domain experts. I think that it also makes sense for institutional investors who don’t have the resources to do a full search to work with consultants. However, I will say that, in my experience, many consultants become gatherers of statistics and information—meaning paper pushers—and few of them actually bother to have a deep and current understanding of what is really going on in the market. I’ve actually been shocked at how clueless some consultants are about what is really going in the VC industry. I think the evidence supporting this point is in the fact that, because of the long-term nature of the VC business, consultants will choose to back a certain fund and then assume that they can sit back and wait for five or ten years to see if they made the right choice. This is a big mistake and one of the root causes is because there is a low probability that the same analyst or partner in the firm that made the original “commit” decision is still going to be the engagement consultant even four years after the original decision to recommend the fund was made.  So I am suggesting that a lot of the “standard” recommendations by the consultants in VC are stale. A pension, endowment, foundation, etc needs to do research on the consultant’s process as well as directly meet with the venture firms. Any venture firm that won’t meet with you probably doesn’t need your money and won’t give you the kind of respect in a relationship that you should expect, so that’s a great first cut in your process.