I (Michael Arrington) recently had a conversation with venture capitalist and tech pundit Paul Kedrosky about all the criticism being heaped on venture capitalists these days (much of it here on TechCrunch). He has a slightly different view than some others on what VCs are supposed to be doing, and how well they’re doing it. And frankly I tend to agree with him. VCs supply much of the capital that drives the entire startup ecosystem. The world would be a much less interesting place without them.
You can follow Kedrosky on his Infectious Greed blog, or get the cliff notes version on twitter at @pkedrosky.
Hating venture capitalists is profoundly satisfying. After all, they are slack-jawed, monied, oily, know-nothings who carom off innovation, fire capable founders, squash angel investors, and exist mostly to make commercial bankers look smart and interesting.
Or at least that’s the story we like to tell. By “we,” of course, I mean all of us who lovingly poke venture capitalists in the eye with sticks now and then. They are such easy targets, what with making up numbers about how many jobs they create, missing great investments, delivering awful ten-year returns to investors, having higher failure rates among companies they fund than among the ones they don’t, and generally being so self-important and irony-unaware.
But that doesn’t mean VCs are quacks. Or that what they do isn’t hard. Or that it’s unimportant. Because it is important, and the good ones are smart, and what they do is very, very hard.
Creating a successful startup is among the hardest things you can do in a capitalist economy. Entrepreneurs must successfully navigate a sea of multi-dimensional uncertainty, from technology (will it work?), to people (do I have the right employees?), to market (will anyone care?), to financial (can I finance doing this, and can I then sell the product or service for more than it costs?) At big companies you can fail at launching a product, fail at hiring people, fail at making money on a product, and fail at figuring out whether something will work. Your big company will probably be unaffected, and you may even get promoted. Do any of those things wrong at a startup and, in all likelihood, you’re dead. You are wandering a maze of dark and twisty passages — most of which are paved with trapdoors to hell.
The idea that anyone at all would build a business around funding startups is the remarkable thing. No revenues, no sure market ahead, no collateral, no liquidity, and doe-eyed founders who were in high school when Enron blew up. It all adds up to more ways to break down than an old Winnebago. Far from wondering why so few companies get venture capital, we should perhaps wonder why any do, and how venture capitalists remain so damn optimistic. To borrow an industry adage, the best venture capitalists retain the capacity to fall in love despite having had their heart broken over and over again.
And the opportunities for heartbreak are legion. Even if the mortality numbers you usually hear are wrong, failures rates are high for startups. Across all sectors, about one-quarter of startups die off in the first year, while half-ish make it to the five-year mark. The numbers are different, however, for venture capital-backed companies. Failure rates among venture-backed firms are lower in the first few years, but higher later on.
Does that sound nasty and mean-spirited? I don’t think so. Matter of fact, it sounds like VCs are being precisely the sorts of patient investors that people say they aren’t. They are giving risky companies a chance to experiment and find something that works, which is crucial, given that most successful startups don’t end up doing what they started out trying. It is a luxury that markets don’t afford other companies.
Another favorite club with which to whack venture capitalists is their supposed inability to create innovative new companies. Just look at Bessemer’s well-known anti-portfolio, with them turning down Google and Apple and Federal Express (seven frickin’ times!).
Imagine if those innovative companies had actually been funded and…oh wait, they were. The companies still happened, and succeeded, even if some venture capitalists said no. Given how often the average VC must say no in a given year – a bazillion times, give or take – it should come as no surprise that they sometimes say no when it turns out they should have said yes (and vice-versa).
The “VCs as innovators” problem wouldn’t be so bad, of course, were it not for the scene-stealing entrepreneurs. Those bastards keep creating risky startups and getting all the glory. Damn you Sergey Brin and Jeff Bezos and Steve Jobs. Just in case you needed a reminder, it’s not VCs who create companies, it’s entrepreneurs. Blaming venture capitalists for their capital not changing the world is like blaming Pfizer’s treasury department for Viagra not saving your marriage. Yo, you have bigger problems, so to speak.
Wouldn’t it be nice if venture capitalist drove more innovation? Of course it would. But that’s like saying “Wouldn’t it be nice if supermodels followed you home?” Of course it would, but it’s fanciful. Innovation is one input into the startup business, not its main output. For startups or VCs to pretend otherwise is a speedy path to going bust. Venture capital investing is hard enough without turning it into a Disney-style dream factory for self-styled social engineers.
Here is what we should want from venture capitalists. They should be trying to find and help early-stage companies at rising above the muck and dirt and crushing difficulties of being a startup. At the same time they must produce hefty profits in a timely way for their own impatient investors. That VCs can’t do the preceding, while simultaneously satisfying their critics by making no funding mistakes and changing the world with every deal, is a feature, not a bug.
As an entrepreneur that has been through two successful liquidation events I can tell you that there are some good vc’s and some profoundly useless vc’s. The founder must figure this out before taking the money. The quality and reputation of the firm is one filter but not entirely helpful. You can find perfectly useless vc’s at great firms.
The worst kind of vc. One that never actually ran a company but seems to have all the right answers and is insistent about his knowledge. It’s really hard for a serious CEO to take someone like this seriously, especially when the decision is very important.
Pick a vc with real operating experience. Pick a vc with a congenial personality. It’s hard to find both traits in one person but it can be done and, for your sanity, must be done.
I had a VC contact me recently based off of a buzz. I really was anti-VC for years only because I felt it was a generic method to starting a business. But in reality I can honestly say my ignorance towards VC was only because I wasn’t in the position where I could see needing one. Now that’s changed and I do see the value of a good VC as it can be the “make” or “break” component of a successful business plan.
I loved this article thanks guys.
HI Paul – really enjoy your blog but perplexed why you’re guest authoring here with a kiss ass post on VC’s most of which don’t add any real value these days for the management fees ( funny you did not mention ) they charge. As you well know for most software startups today ( may be different in other sectors ) there is little difference between most VC’s and plain ole dumb money
As far as I can tell you didn’t back up your main theses for this piece. Are VC’s quacks? Ok forget that one. What they do isn’t hard – address that please. Or the idea that only the few with the best connections or best record see the best deals (self-perpetuating cycle). Also a little more quantification on which VCs have ongoing long-term decent returns (not including any fund started between 95-99). But back to how hard it is to be a VC – which seems to be the main point of your segment (or should be based on your intro). PLEASE be much more specific about what exactly is hard about what VCs do. I am not arguing that their job is not hard but others have apparently and I would love to hear you explain why it’s not just a question of either having been a successful entrepreneur who is selected to be a partner at a ‘good’ VC or just knowing the right people. That in and of itself is hard one could argue – but that’s not being a VC – that’s getting the job… Please give more details and less blather. Thank you.
what is with these huge comments?
> what is with these huge comments?
Yeah critical thinking is rare to see these days since most people appear to react with superficial comments like wow great post in 140 characters
I agree that this is a superficial comment. Whoever posted this should have come up with something more clever. You start first, km4,…
Have followed Paul through his blog and Twitter account for a while and always enjoy his insight and the breadth and depth of his analysis. Keep ‘em coming.
BTW @km4, if you’re going to slam the guy with some half-assed comment why don’t you man-up and identify yourself?
let’s keep it real. this was a rant.
best piece of reading is @spotrunnerhelp comment. spot on!
What did the venture capitalist say to the mob boss? « Bobservations http://bit.ly/10AyJB
hah.
It’s a shame that 99% of VCs give the other 1% a bad name.
This is like a post saying “Hey guys, AT&T isn’t so bad, they let you make phone calls!” in the early 80s.
The fact is, like AT&T, big VCs are good at some things (e.g. funding capital intensive, medium risk projects like biotech or pharma), and really bad at others (funding very early stage web/mobile/software companies with low capital requirements).
This is a great post, but as all posts on the “problem” with the VC industry it misses the mark…it’s never been the entrepreneurs or the VCs…it’s the LP’s.
VC is a limited capacity equity strategy (not an asset class, btw) and as long as there are LPs to pay eggregious fees there will be VCs to provide access (more than the strategy can accommodate) and as long as there are VCs flush with cash, there will be entrepreneurs to get paid to scratch lottery tickets.
Take a look at who’s making money at the end of the day and tell me who are quacks in the equation! If there’s a problem in the industy, it’s a supply side problem…and yet how convenient is it that ther are no articles about that…lest the industry bites the hand that feeds it!
“VCs supply much of the capital that drives the entire startup ecosystem.”
Without startups there would be no VC’s. Without VC’s there would still be plenty of startups. I don’t disagree that VC’s are useful, but the world definitely isn’t going to stop innovating if suddenly there aren’t any VC’s. I think the world would still be plenty interesting without them.
Why I love Venture Capital(ists) Too:
http://parand.c...apitalists-too/
nice post
+1
The inclusion of the quotes about France and NSF funding were really good.
VCs know all of this too. But they don’t care, and why should they? Like Paul said, they’re easy targets, but it doesn’t matter to them what you say. Innovation will happen with or without them, and they know it. They just hope to get their pound of flesh along the way.
But the reality is, their capital has absolutely accelerated the pace of innovation. To compete in today’s global economy, every second counts.
VC is not broken – Anymore: http://bit.ly/2yJXgA
This is a good post but I think it sidesteps most of the issue that in the 2.0 world I think creates a lot of friction with VCs and VC bashing:
“At the same time they must produce hefty profits in a timely way for their own impatient investors.”
The tension with many 2.0 companies is they may be successful, but not reach $100m in revenues, and not need $100m in financing.
The problem is this produces inherent tensions with VCs who need huge returns for their investors. In the 1.0 days it didn’t matter b/c every idea needed $30m to get off the ground. Today, not so much.
I used to not get why a good company would need a VC, but “bootstrapping” my own start up in March I am not starting to see. As I learn more about how it all works I can see why they are needed. Sometimes the general public needs to have something shoved down their throats a little to see why it’s a great idea. People are afraid of tech, but if some VC money helps a start up explain things, they can be the next twitter, facebook, or who knows what else.
VC’s can be great, take huge risks, fund important new things. I think their bad rap comes more from those (maybe more like investment bankers) who speculate in ‘fictitious capital,’ as Karl Marx put it. They create speculative money from speculative money and produce little if anything of value.
A while back Barron’s did a piece on Commodore Vanderbilt. He started with nothing and built a fleet of steamships, then controlled the railroads. He never bought insurance on his steamships because he paid his people well and kept the ships in shape. And never lost one. After he got a monopoly in railroads he – get ready for this – *dropped* prices so more would use them.
When he died, Barron’s said, he was a hero to the common man and they had parades in his honor. Not much chance of that happening today with capitalists, they noted.
Wouldn’t it be nice if that did happen. Like with a VC who funded a company that, say, made algae biofuel commercially viable. Not only would he be honored, he could change the planet.
Could happen. Hope it does.
And I think to myself…. what a woOonderfuul wooOOrld
Both good things and bad things are happening to both VCs and enterpreneurs. Just as many enterpreneurs are fighting for their companies now, many VCs are fighting for their jobs.
I am not bashing the VCs, because I might myself become a VC soon, but whomever to blame, for a money-losing enterpreneur to chase a VC is like a poor young girl to chase an old rich man — he would strip many of the gals down and tell them they are not his type. VCs are just as picky, naughty, and foolish as you and me.
So, in order to make it easy to attract VCs, you’d better be a rich woman first (like Paris) and then hook around. Many of the VCs will fall down on you and ironically, you may not necessarily need them at that time.
This is truer in difficult times. A great, genuine VC is him who invests when a company is not profitable or in difficult times.
From Bessemer’s anti-portfolio (linked above):
“Cowan’s college friend rented her garage to Sergey and Larry for their first year [of college]. In 1999 and 2000 she tried to introduce Cowan to “these two really smart Stanford students writing a search engine”. Students? A new search engine? In the most important moment ever for Bessemer’s anti-portfolio, Cowan asked her, “How can I get out of this house without going anywhere near your garage?””
Funniest thing I’ve read in ages
This is why I hate VC’s
http://www.meta...ital-Subtitles/
Great article and memorable.
Nice post, Paul. As a card-carrying VC (and former entrepreneur), I appreciate your sympathy for our plight!
At Flybridge, we like to say the entrepreneurs are the rock stars and we are the groupies. No purely rational human being would become an entrepreneur for the personal expected Net Present Value they can generate. Follow your passion, have fun, work with great people, and hopefully the money will follow.
Having founded YouSendIt I have some really bad things to say about my investors with names in particular.
$34M in the funding.
Unfortunately if I do that, they will send their $600/hour lawyers after me for defamation.
This is VC.
We built a web site with over 5M users/month and profitable. They got lots of funding, hired lots of people and lose about $400k per month.
Ask yourself, this: Why did you seek and take VC money if you were “over 5M users/month and profitable”?
This is exactly why I don’t want to take VC. We have VC scale ideas that we are actively implementing, but have a very successful underlying business. I don’t want the underlying business to die in the name of creating a 10x exit that has a small likelihood of happening. Just too much risk….
I’ll take this with a grain of salt if this Khalid Shaikh is the same guy that Apple recently banned for spamming the App Store with useless iPhone applications:
http://www.mobi...ific-developer/
Chances are he was less the victim here than he claims to be.
Great post Paul,
Would love to see a follow up on “What makes a great VC” (or more sarcastically “What makes VCs suck less”)
I’m sure from our many conversations that you could do this topic a lot of justice.
-Austin
No, we love VCs…
Mostly well done and spicy
The value that VC brings to start-up should not be underestimated in the world where cash is gold.
Could there be more value thou? I would say, absolutely. Cash and expertise are priceless assets.
What a typical venture fund is missing now is a the set of tools and a framework to accelerate the growth of emerging companies.
I keep wondering, how come? I have been pushing certain ideas along with solutions in the venture world for last couple years… I would give it 5 more years if the VC industry is still there…
The change is inevitable…
The VC model is broken, just ask anyone, except perhaps a VC or people who make their living by billing them (lawyers, accountants, landlords, restaurateurs, escorts, etc. This Google search for “vc model is broken” returns over 3 million results: http://www.goog...earch&hl=en
Like General Motors is it not time VC got a new name ?
Most VCs love to boast in how many “start-ups” they have invested in . I’d love to know how many of the start-ups become finish-ups – meaning they were a success and the VC had a return ?