Why Venture Capital Kills Compounding
- Aki Kakko
- 6 hours ago
- 4 min read
In the previous articles, we dismantled the VC selection process (The Map is Not the Territory), exposed the psychological barriers (Fear of Looking Stupid), and revealed the misalignment of incentives in fundraising (Why VCs Make "Bad" Bets on Purpose). But even if a VC firm gets everything else right—if they use data to find the outlier, ignore the herd to buy at the right price, and avoid the ego trap—they still face a structural wall that prevents them from capturing the true magnitude of the Power Law.
That wall is the Closed-End Fund Structure.
The standard Venture Capital vehicle is a relic of the 1970s: a 10-year legal agreement.
Years 1–5: Deployment (Finding and buying).
Years 6–10: Harvesting (Pressuring and selling).
This is no longer just false; it is destructive. The 10-year clock is the silent killer of compounding. It forces investors to interrupt the miracle of exponential growth right when the curve is starting to go vertical.
The Oak Tree and the Firewood
Imagine planting an oak tree. You water it, protect it, and watch it grow. By year 7, it is a sturdy sapling. By year 30, it is a magnificent giant. Now imagine you have a contract that forces you to "liquidate the forest" in Year 10. You cannot wait for the giant to mature. You are forced to chop down the sapling and sell it as firewood to show a return to your investors. This is modern Venture Capital.
If you invested in Amazon, Nvidia, or Tesla at the seed stage, the vast majority of the returns—the wealth that actually changes the world—occurred after year 10.
The standard VC model effectively creates a cap on the Power Law. It captures the "venture" phase but misses the "empire" phase.
Because Limited Partners (LPs) operate on their own internal clocks, they demand DPI (Distributions to Paid-In Capital). They don't want paper gains; they want cash. This creates a toxic incentive known as "forcing the liquidity event."As a fund approaches Year 8 or 9, partners become desperate to show cash returns to raise their next fund. This leads to:
Premature M&A: Pushing a founder to sell to Google or Salesforce for $500M when they could have been a $50B independent company.
The Secondary Shuffle: Selling the stake to a Private Equity firm or a "Growth Fund."
This is a game of "Hot Potato." The early-stage VC sells the asset just as it's becoming de-risked and profitable. They are trading "unbounded future compounding" for "immediate internal rate of return (IRR)."It looks good on a spreadsheet today, but it is a strategic error of the highest order.
The Solution: Permanent Capital (The "Berkshire" of Tech)
The only way to align with the true math of the Power Law is to break the 10-year clock. We are moving away from the "Fund" model (dated money) toward the Permanent Capital model (evergreen money).In a Permanent Capital structure:
There is no expiration date. We are not forced to sell.
We hold winners "indefinitely". If a company is compounding at 30% year-over-year, the correct holding period is "forever."
We recycle capital. Dividends or partial liquidations from one investment are immediately deployed into the next generation of founders, creating a flywheel of innovation.
This is the model Warren Buffett used to build Berkshire Hathaway.
In a Permanent Capital model, we do not need to bully founders into selling their companies to incumbents. We can afford to wait for the IPO. The VC industry has become terrified of the public markets. They treat the IPO as an "exit" (the end). We treat the IPO as a "graduation" (the beginning of liquidity). By holding permanent capital, we can take companies public and keep holding them.
The IPO provides liquidity for the founders and employees (who need to buy houses).
The IPO provides a liquid mark-to-market for our balance sheet.
But it does not force us to sever the relationship.
This aligns us perfectly with the founder. We are not looking for a "quick flip" to a strategic acquirer. We are building for the public markets, where the company can remain independent and endure.
The Arbitrage of Time
The greatest arbitrage in finance today is not information; it is Time Horizon.
Most of the market (Hedge Funds, High-Frequency Traders) competes on milliseconds. Traditional VCs compete on 5–7 year cycles. By adopting a Permanent Capital structure, we compete on a 20–30 year horizon. There is almost no competition here. While other VCs are screaming at founders to "hit the metrics" so they can dump the stock in a secondary sale, we are offering founders the one thing they cannot buy: Patience.
The future of VC is not just about automated data (The Ghost in the Deal). It is about patient money (The Shell). We are not building a fund that expires in 2036. We are building an institution that compounds alongside the companies it backs.
The math of the Power Law requires time. We intend to give it the room to breathe.
The "Power Law" Trilogy:
Second chapter: Why the Smartest Money in VC Looks the Stupidest
