Venture capital firms are run by cowards, who get their money from other cowards
Sarah Lacy points out that risk aversion and short term thinking are overwhelming the tech industry:
I think there’s also a mindset problem when it comes to venture capital. Investors and many entrepreneurs are no longer focused on building companies and taking real risk. Paul and I did another clip yesterday about Facebook, where he argued it doesn’t make sense for Facebook to stay a stand alone company anymore because the ad markets are going to be locked up for 24 months.
I love P-Ked, but what the hell does a 24 month contraction have to do with building a company? Especially a company that’s still private, growing like mad, has loads of money in the bank and is essentially break even? We’ve got to break ourselves from this quick-fix, quarter-to-quarter mentality of Wall Street– and increasingly Silicon Valley– if any next great tech companies are going to be formed. The very reason great companies are typically started during downturns is they’re started by people who aren’t obsessed with timing a market. They’re started by real entrepreneurs.
In her BusinessWeek column, she also points out that it’s been a bad decade for tech focused venture capital:
But check your calendar. We’re closing in on 2009. And even if the financial system on which VCs depend for returns averts collapse, it’s still in for a few years of serious wound-licking and stepped-up government regulation. Ask anyone in Silicon Valley whether Sarbanes-Oxley had a chill on IPOs.
This realization hit me like a ton of bricks during a recent trip to Boston, coincidentally the same day Lehman Brothers (LEHMQ) filed for Chapter 11. I was sitting down with Tom Crotty, of the venerable Battery Ventures, which had a unique approach to the tech meltdown. Battery, full as it is with more financial gurus than Valley-style engineers, responded by diversifying from traditional startup investments into so-called Private Investments in Public Stocks (PIPEs). Battery also capitalized on the consolidation of cash-rich but fragmented industries.
Crotty hopes the atypical investment approach will insulate Battery, but he nonetheless sees a reckoning coming—specifically toward the end of 2010. He points to 2000 as the “last really good year” for venture capital. Looking back, “the one-year, three-year, and five-year indexes are all going to be terrible,” Crotty says. “And once 1999 and 2000 fall off, the 10-year will be, too. It’s going to be painful.”
But she also points out that there are new markets out there waiting for investment:
That won’t be such a bad thing. After a painful period of forced reckoning with bad past decisions, VC will emerge stronger. Entrepreneurs and the larger U.S. economy will still need venture capital. Some venture capitalists will engineer a new way to make venture-style returns, like Battery Ventures did eight years ago. Many will turn to emerging markets such as India and China. There will be even fewer Google-like (GOOG) home runs. Then again, a leaner, smarter industry may not need as many.
She puts needed qualifiers around the idea that downturns are good for innovation:
To those of you who say platitudes like: “Downturns are GREAT times for innovation!” yes, that’s true, but you are missing the point. This isn’t just the cause of a downturn. This is a structural change in the industry that needs to occur and has been building for nearly a decade. There is far too much money, tech is maturing, and clean tech isn’t mature enough.
Real innovation can not be done in 90 days. Real innovation does not conform to quarterly profit reports. Real innovation comes from those people who can see a potential business when it is still way out on the horizon, and then find ways to reduce the risk of getting from here to there:
People think entrepreneurs are risk-loving. Really what you find is successful entrepreneurs hate risk, because the founding of the enterprise is already so risky that what they do is take their early resources, the small amounts of capital that they have, whatever assets they have, and they deploy those resources systematically, eliminating the largest risk first, the second-largest risk, and so on, and so on.
In the title of this post I used the word “coward”. That is a strong accusation. It is deserved by those who feel the normal risk minimization of entrepreneurs is no longer enough to allow a business to be trusted with money. It is deserved by those who now only place sure bets, and only short term ones, too.
The tech industry, especially the web portion of it, has been infected with speculative excess. During the South Sea Bubble of 1720 financial manipulators raised money for “a company for carrying out an undertaking of great advantage, but nobody to know what it is” and today we have similar ill dealings: “The company will ‘let its purpose and presence be known’ as soon as they reach their goal of raising a Series A capital round of $10 million”.
For the true entrepreneur, the goal is always MR4MR: minimum risk for maximum reward. But they have bold goals that demand big risks be taken — they then set out to find the least risky way of achieving that goal. This applies to many fields. Shakespeare, Napoleon, Thomas Edison and Bill Gates had this common: they were all successful at minimizing the risks they had to run to achieve their goals, yet their goals were so ambitious that even the least risky path still entailed big gambles. The NASA team that first sent men to the moon was fanatic about reducing risk, yet still the mission was among the riskiest endeavors ever undertaken by the human race.
The driving force of the digital revolution were two fold: the increasing power of computer chips, and the dramatic fall in the price of communications, due to breakthroughs in multiplexing. The pulse of change for both has grown slower. Wal-Mart, Fed-Ex, Google and Twitter were all instances of a creative soul finding that the digital revolution allowed a new way to organize human activity. Such surprising alterations to the existing scene will continue as long as there is still growth in computing power and communicative capacity, though the appearance of such novel businesses can be expected to slow as innovation in the underlying technology does.
We should not allow the term “innovation” to be killed by its over-association with the industries that grew during the last few booms. There are other fields desperate for the intervention of the entrepreneur: green energy, green transport, recycling, lower impact production methods, the education of adults, the teaching of children, child care, environmental clean up. We will soon see a new wave of change in the oldest industry, I mentioned community supported agriculture in the post where I made predictions, in some sense no economic activity is more important than how the human race feeds itself. And at some point in the next 50 years we will see considerable breakthroughs in the way the human race relates to living things on earth, as our understanding of the underlying rules of DNA come into focus.
Downturns are a great time for innovation, but the invitation is only there for those who are thinking long term.