Sunday, September 20, 2009

VCs Are Useless? That's Bullshit.

Vivek Wadhwa has a guest post up on TechCrunch, "What Have VCs Really Done For Innovation?" It's obviously meant to court controversy. Mission accomplished.

This post is my refutation. Wadhwa's post claims:

1) VCs have little to no impact on startup success, and in fact, may have a negative impact

2) Venture capital slows the innovation process

This is one of the most dangerous and wrong-headed posts that I have read all year. And I’m flabbergasted by the lack of critical thinking displayed in the comments section.

There is definite truth to some of what Vivek has to say. The NVCA’s estimates are bogus, because they equate investing in a company with being responsible for its success. This is an egregiously egotistical assumption.

It may very well be true that the venture industry as a whole trails index investing. It’s hard to pick winners. But so does the entire actively managed mutual fund industry.

But the statement that “VCs at best have little to no impact on these companies and at worst have a negative impact” is absurd.

First, there is a major survivorship bias problem with the data. By interviewing successful companies, the study fails to prove whether VC makes success more or less likely. All it says is that the majority of successful new businesses in the US do not rely on VC.

A number of commentators seem to be of the impression that VCs make easy money by investing in companies after all the risk has been removed by the entrepreneur. This is talking out of both sides of one’s mouth. If the VCs aren’t taking risks, then how can they be delivering sub-par returns? By definition, they must be taking risks.

Venture capital plays an important role in the startup ecosystem. It provides high-risk equity capital to startup companies. Not every company can be a bootstrapped consumer Internet company. Many important businesses (semiconductors, hardware, biotech) require significant up-front capital. If VCs went away, would there be enough funding for these business? Do you seriously think banks would start lending to these companies?

I also wager that most of the commentators pooh-poohing VC would be glad to accept funding for their startups.

This is not to say that I support a VC bailout. Screw bailouts. All bailouts do is support the weak and incompetent. There are plenty of VCs who are doing just fine.

On the other hand, having the government hand money over to startups is stark, raving mad. If you think VCs are incompetent at allocating capital, just wait until you start a government program to do so! While in principle, a tax break for entrepreneurs sounds good, the net result will be like cash for clunkers--a disastrous transfer of wealth to people gaming the system.

The three most important companies in Silicon Valley are Cisco, Apple, and Google. All were funded with venture capital before they became going concerns. Keep that in mind before you begin to discard the VC model.

6 comments:

Anonymous said...

"If the VCs aren’t taking risks, then how can they be delivering sub-par returns? By definition, they must be taking risks."

--
I call BS on this. Let's stipulate that high returns can only be made while taking high risk. That statement does not in any way explain sub-par returns (whether it is low risk, low return or high-risk-gone-bad).

You can make sub-par returns in a variety of ways. For example, VCs could be paying too much for "proven" (i.e assumed to be low risk) entrepreneurs.

Chris said...

Just to be more clear:

If VCs do not take risks, and they take advantage of entrepreneurs (presumably by undervaluing their companies), then how can they possibly deliver sub-par returns.

If in fact VCs don't take risks, but deliver sub-par returns because they overpay entrepreneurs, why would those entrepreneurs complain?

Foobarista said...

Having been a "startup lifer", I've come to the conclusion that VC money can be useful and can also be deadly. At my current company, they're useful: our management knows how to use VC money and has a product and market that is favorable to VC timescales and growth demands.

In my previous company, it was clear to us that we had a product that would reliably make about $20M/year with little additional investment. This wasn't interesting to traditional VC firms, who are trying to find the "next Google". Our mistake was in going after VC money early on instead of doing the heavy lifting to get to organic profitability.

The VCs then tried to get us to grow too fast, hiring a bunch of sales and marketing guys who ate money and didn't help much. We did successfully become a "market leader", but the market was too small to sustain 100 expensive people.

$25M/year wouldn't interest most VCs, but would make a darn good living for awhile for a small group of founding partners.

After a long, slow decline, we ended up selling the IP and our Japan office to a Japanese company as most of our customers were in Japan.

Anonymous said...

@Foobarista: Was this company by chance the one behind the Curl RIA technology stack? (aka: curl.com)

Foobarista said...

Anon: no, it was a company selling embedded products, which was another kiss o'death. You can't do SaaS or other "hosted" approaches if your software has to be burned into a ROM inside an Acura - and has to be carefully ported onto the chipset/FS/RTOS.

Even though it didn't fly, it's still cool seeing cars every day with my code running inside them...

Chris said...

Foo:

As the old saying goes, you don't have to be wrong, you just have to be early.

Creating value and capturing it are two very different things altogether.