21 September 2010

do VC's make the world go 'round ?

I've often wondered how much value VC's really create. Not for the few that are allowed in, but for society as a whole. Are they the innovation engines as advertised, or merely savvy investors that realize above average returns ? Day traders or world changers?

First, I am surprised at how young the industry is. The first VC's started in 1972 with the founding of 2 of the marquee names even today, Kleiner Perkins and Sequoia Capital. Institutional funding didn't come in until the late 70's. The first home runs were with Apple and Genentech's IPOs in 1980. So we're really talking only 30 or so years. The 80s were a bust for VC's, so now we're down to 20 years.

The industrial revolution brought America to dominance with the byproduct being new industries and jobs. Let's assume for a moment that the VC/internet era (ie. the last 20 years) has had that same kind of impact. The internet has changed everything everywhere and created a better way of life for most. More importantly, it kept us ahead of the competitiveness curve (many US jobs created out of the internet revolution). One would think that VC's played a significant part in that correct?

The goal of VCs is to bring new ideas, technologies and innovation to the masses (and get paid handsomely to do it). They partner with entrepreneurs (sometimes with only an idea in hand), take a significant equity stake, and help them grow towards an IPO or sale five years later. They only look for visionary companies because they have to pay for the 9 other investments in their fund that went bust and still yield a 25% return to their limited partners after fees. Most of us remember the mayhem of the Netscape IPO in 1995; almost every household tech company you can think of (google, amazon, ebay,etc..) have VC fingerprints all over them. At the surface, it seems like they've been the thought leaders they're supposed to be.

But are they? An article written by 2 insiders argues that VC funding actually thwarts innovation. They point to, among many factors, the short life cycle of funds (usually 5 years), aversion to unproven companies, and the fact that there are more MBA's (64%) than there are Master-level engineers (29%) at the top funds. Not the usual source of technological breakthroughs (present company excluded of course).

Just think about it. Ebay was not the first auction website, just the first successful one. Google came out of Stanford's lab, the internet roots were from the US military (and Al Gore). VC's didn't only invest in Google and Yahoo, they invested in 100s of search engines (don't get me started on my infoseek investment). How many biotech companies are they now investing in? How many will even survive much less cure diseases? They tend to invest in clusters; a sign of "me too" investing, not extreme innovation.

But they've monetized it. Have they ever. Sequoia turned $12M into almost $5B with Google. Not too bad, eh? But lets face it, without VC's, these emerging companies would not have reached the masses as quickly and deeply as they have. Google, and the many others, have brought information and commerce to the masses and completely changed the world for the better.

So mad scientists they are not. Mad capitalists they are. It's just too bad that my address is not on sand hill road.


  1. Very interesting diatribe and some facts on the history that i really had never known. I struggle with the value of VC's and dislike their short-term perspective (except when it has benefitted me financially)as i don't see the real "people" value created as we know that mergers and sales lead to losses of jobs and creativity to make that firm better. However, many good ideas would never come to fruition without them as they fund both great ideas like Google and shitty ideas like PeaPod.

  2. What is their other option? Individual funding? There's 2 sides to everything, even "good" things ;) Definetly don't agree with the creativity invested in MBAs rather than Masters level engineers, I believe it has to be a perfect blend of the two (kind of like our marriage ;) ). I propose to you the challange of dreaming up a new idea to fund these artists!!

  3. Agree. Despite the early stage nature, the mindset seems to be very short-term focused.

    By the way, peapod is still around. I dont know how thats possible.

  4. I do not think that VCs thwart innovation. Yes, many companies they invest in strike out, but eventually one makes it. I would imagine that the one that does has some technological advancement that the others did not have (i.e. it is not just that the management team was better). Not all new trends flow through VCs, but it is truly hard to get one to market since it is difficult to find the kind of money VCs bring to the table from any other source. It is my opinion, then, that VCs are and will remain a vital component to enable companies to change the world.

  5. I agree to some point. I think they are more business enablers rather than tecnology innovators. Most of the companies you see being funded are in industries that are already existing, rather than brand new ones.