Your Thoughts on "How to Fix Venture Capital"
I've been reading responses to my how to fix venture capital post with interest. Let me take a few minutes to speak to some of the themes that have surfaced.
In a very interesting response well worth reading, Paul Graham says: Google did very much want to sell out, it just didn’t get a high enough offer. Yes, Google did shop what was essentially PageRank around in 1998/99, for terms in the low millions.
But we’re concerned with Google’s strategic behaviour after it had done something economically revolutionary – not just simply technologically interesting. When there was a meaningful, potentially revolutionary business on the line, what happened? Did Google sell out its new value chain design, built around AdWords – or not?
Let’s look at some numbers. Google was offered between $3-$5bn in 2002, if the press was accurate. That’s a (very) generous valuation, given Google's 2002 revenues – and Google didn’t take it.
Paul, perhaps, misses the strategic richness of the story: Google didn’t sell out even when it did get a much higher offer.
Perhaps no one could have offered Google enough to compel it to sell out. Conversely: Google had greater expectations for itself than others did – the beginnings of a purpose.
Let’s summarize some more of the themes.
The real problem is that very little seed stage capital is available – again, by Paul, who reiterates many of the themes we discussed previously. Yes, of course, there’s an equity gap; because of the way funds are organized and managed, it's hard to put small sums to productive use. But why have venture guys not been able to renew their DNA for more than half a decade? Because venture is ridden by structural inertia and risk aversion: exactly the point of my first post. Think about that: absurdly, it takes behemoths like Wal-Mart less time to respond to sweeping new market needs than it does for lean, mean venture investors.
Google was due to a perfect storm of exogenous factors – growing interaction, etc, by Ashkan. That's a good point. But it doesn't help us explain why there aren’t more successful venture companies, for two reasons. First, the economy is undergoing even more severe shocks today than in 2001. Second, it assumes that the firm is simply a victim of its environment – a perspective I think is limiting, and ignores the reality that firms influence and shape their environments.
Dude, the IPO window’s been closed, by Smoothspan. The IPO window’s been closed…during the biggest financial boom in recent memory? Every security under the sun (even ninja loans) could find a market – but not venture equity? Perhaps the causality goes the other way: the IPO window remained closed because venture guys weren’t investing seriously in meaningful new business models and markets – just in features and add-ons.
The public markets have criteria that 2.0 players can’t (ever) fulfill, again by Smoothspan. These are things like stable earnings, and a floor of >$100m in revenues. Let me point out that there’s an existence proof that’s not the case. Perhaps my two of my favourite revolutionaries, Mixi and Megastudy, are publicly traded 2.0 plays – just not in the States. The deeper point is, again, causality: it takes revolutionary new business models to fulfill those criteria: new business models which Mixi and Megastudy are pioneering, but their American and European counterparts aren’t.
Dude, it was obvious that Google was, well, special - a general refrain. I think it was far from obvious: in 2002, Yahoo’s revenues were more than double those of Google. Google’s hypergrowth was dependent on the continuing success of AdWords, etc – and though it seems certain to us today, the very real story is that Google took massive risks to make AdWords truly revolutionary – while Yahoo evaded risk, and continued to buy and sell media exactly as it been bought and sold for the last century.
Finally, the deeper point: uhh…what’s with this purpose stuff? We’re here to do business, not have a love-in. Purpose might sound soft. But it’s a razor sharp way to think strategically in a world where coercing others in the name of near-term shareholder returns is becoming as obsolete as a gas-guzzling SUV. Yes, purpose is difficult – because we have to question our assumptions about why and how we manage firms the way we do.
Thanks to everyone for the comments and posts - I wish I had time to respond to all of them.
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Umair Haque is Director of the Havas Media Lab, a new kind of strategic advisor that helps investors, entrepreneurs, and firms experiment with, craft, and drive radical management, business model, and strategic innovation.
Comments
purpose, intention, motivation, the "whys" underlying all enterprise structures or advertising campaigns, i believe are felt or intuited qualities, they intrinsically accompanying all products and services .... they cannot yet be quantified, because they are qualitative, but they are there.
boldness of vision is synonymous with increased sensitivity, and where "professional" once implied "impersonal", exactly the opposite is true in the new marketplace.
the difficult task is the examination of one's personal and institutional motivation, the switch from might makes right to, right makes might, is underway.
it will turn out to be easier to change than to avoid it
- Posted by gregory
April 16, 2008 3:23 PM
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- Posted by Martin Kamerman
April 17, 2008 2:27 PM
1. Risk: Yes, VCs refrain from REAL risk taking. Most people are. Daniel Kahneman et al. got a Nobel prize couple of years ago for saying pretty much that. At the end of the day, that's what makes top-tier VCs - they have the confidence to give risky ideas and non-conformal people a chance. I remember one great VC partner sitting in a room full of his peers saying something like: "I don't understand exactly where this is going or what will be the biz model, but it has the potential of changing the web". The problem is, that you usually gain confidence from success and most "successful" partners got mid-size notches on their belt. The really risky deals actually don't succeed 9 out of 10 times. BTW, that partner got my deal the minute he said that sentence.
2. Incentive: "Fixing" the VC system is rather simple, it seems. As always, it's just a matter of aligning the incentives with the required result. If you want a risk taking VC just build it so that the GPs profit emerge only when big deals succeed, i.e. over, say $3-400M, and on the other hand, that their failed deals aren't counted in calculating the profit division. That, and some competitive pressure, will soon cause the emergence of a new kind of VC firms. Naturally, this proposal is as simple as it is improbable, because you need to persuade the limited partners to put their money where the risk is, and they'd refrain from doing so. This is the food chain, and there's little sense in jumping on one link of the food chain asking it to change its evolutionary programmed behavior. You better off going to the Harvard endowment fund et al. and ask them to change their investment policy.
3. Google: Back in the days, before 1856, each sack of corn that would arrive to a store in New York, Los Angeles or Washington DC had the marking of the farm in which it grew and the farmer who grew it. Farmers used to take pride in the quality of their corn. Then in 1856 the Chicago commodities exchange defined the Corn No. 2 standard and commoditized corn for good. That was great for corn consumers. Some may say even too good, given the fact that today almost 25% of the food products in Walmart etc. are corn based.
However, it sent the entire farmer community into a self-perpetuating spiral of lower margins and higher throughput to make ends meet, and feed enough grain to the big grain elevators scattered across Iowa. Similar in spirit, Google has become the great grain elevator of web media, pushing publishers to the lowest margins possible by determining the financial value of a page by a single, very narrow dimension - the keyword.
Publishers are certainly getting the short end of the stick with adsense, and actually, without even knowing what's the length of the stick, in most cases. If Google was really all about good beats evil, why the obscurity? why not tell publishers what they are earning. It's hard to see the "greater good" this opaque strategy aims at. At least in the case of corn, consumers had the benefit of cheaper food, cheaper meat and other "greater good" goals. In the Google case, the only one who really benefits from this is Google itself, and possibly some of its advertisers.
Great writing, keep it up
- Posted by Eran Shir
April 20, 2008 5:39 PM
I think that the problem with venture capital is that everyone is asking for far too much. There is also a matter of economies of scale - I believe that thinking big is a problem - far better to place a ceiling on investments so as to make more seed capital available to smaller concerns- here perhaps greater risks could be taken in accepting projects that require lower capitalisation - a pooled venture insurance would look after those who get unstuck - today if anyone has an idea or project - it really is difficult to see the light of day - all the patent and intellectual property laws and demands of financiers puts an effective break on many small businesses - the idea of putting up one's house as collateral should it fail is absolutely ridiculous. Perhaps again there could be an intermediary company which serves to deal with the patents etc, in-house - thereby taking away the costs of patenting and allowing projects to go through on a fast-track. In short, we should be much more dynamic in providing capital to innovators, reducing the risks to them by the above measures.
- Posted by Stephen Pain
April 24, 2008 6:00 AM