Some say that the venture capital is broken. The argument usually contains reference to (a) lower costs of starting a technology-based business, (b) the growth in VC/PE capital committed in US funds and (c) asymmetrical risks of VCs compared to entrepreneurs, (d) increased opportunities for small to mid-range sized acquisitions of start-ups rather than big IPOs, and (e) improved sophistication of angel groups and funds.
Recent VC return data seems to drive this point home.
(found on Redeye VC from a Kaufmann report written by Paul Kedrosky).
The conclusion often drawn is that there should be less money invested in start-ups. Or that VC funds will die off and/or reduced in size. While I agree the dynamics are changing and if investors do not innovate some will go the way of the buggy whip, I think these arguments miss a bigger picture.
I see it differently.
We don’t have too much VC money. Rather it could be used better.
First, on the amount: a little internet research reveals that something like $25 billion a year has been invested by VCs into companies the. R&D budgets for large companies have declined in many cases. “From 1980-2005, firms less than five years old accounted for all net job growth in the United States” (from Kaufmann research). Many established companies recognize how hard it is to innovative within a given organization structure and have largely outsourced their R&D to start-ups (see Cisco for example, briefly the world’s most valuable company.) To put that all together that’s about 0.19% of US annual GDP used for investment in creating the opportunities, technology and jobs of tomorrow. I don’t think that is too much.
Second, on the use of investment capital, let’s get innovative. We shouldn’t take money out of the VC and startup sector, instead we should improve it.
- Focused Too Narrowly. We have tremendous challenges that face us and the rate of change seems to be increasing. How do we address global warming and generate the energy of tomorrow? How do we meet the needs and desires of the next billion people joining the middle class or the 4 billion people at the bottom of the pyramid? How do we improve happiness and health which can take a hit with affluence? How do we govern ourselves in a connected and real-time world? The number of opportunities is awe-inspiring and should challenge us to tackle them. Too many VCs focus narrowly on existing developed world markets, competing with each other for the same deals.
- Better Business Model. Many VCs funds run on a 1970s model. Could you get away with that in your industry? I’m talking about things like insisting on warm intros, evaluating people by gut, talking about the importance of people and systematically focusing on financial models, etc. There have been some changes to this system like VCs opening up their process by blogging and accepting cold intros. Websites like TheFunded are a way for entrepreneurs to rate and understand investors and for them to be held accountable. Also, founders funds where entrepreneurs swap stock to share risk after getting VC funding are good innovations although there aren’t enough of them. I wonder is there an opportunity for passive ETF or index style system that does not rely on active management? There has got to be room for a lot more innovation.
- Too Few Entrepreneurs? Maybe it’s too strong to say their aren’t enough entrepreneurs. Yet, my personal experience is that too few people who have an interest take the leap. With better mentoring or training infrastructure, we could have more entrepreneurs. We’ve been working on this at YES and YEI. I know there is more opportunity here.