Entrepreneurs, not venture capitalists, drive innovation. Scientists and engineers, not venture capitalists, start technology companies, and for the most part venture capitalists go where they take us. In the 1980s it was mostly all manner of health care-related ventures. In the 1990s it was mostly information technology and telecommunications. At the moment it is mostly Web 2.0, clean energy and biotech.
My counterpart laments the hordes of "me-too" companies out there today. For sure there are legions of copycats, as there are always many more followers than leaders. Way back in the 1970s the launch of a high profile, blockbuster Winchester disk drive company spawned 50 more virtually overnight. Today one finds the phenomenon still healthy with respect to solar cell technology and social networking companies. Buyer beware.
My counterpart’s April, 2005, IEEE Spectrum article, "How Venture Capital Thwarts Innovation," closed by stating, "Perhaps there’s just too much money chasing too little innovation," to which I say. "Bingo!"
Here is an excerpt from a February, 1988 editorial written by then-Venture Capital Journal editor Jane Morris:
"In December, 1972, Business Week published an article, `More Venture Capital Than Venture Deals?,’ and since that time about every five years this question resurfaces. With a record amount of new capital garnered by the industry in 1987, industry participants and observers may once again be wondering if there are too many dollars chasing too few deals. The venture capital industry has increased its annual rate of investment from $400 million 10 years ago to over $3 billion today."
How totally fascinating. Here was Jane writing (in 1988 – 20 years ago) about a then 26-year phenomenon with industry disbursements "blistering" along, concernedly, at a $3 billion-per-year rate. In 2000, a mere dozen years later, that number was over $94 billion. Of course that bubble-bloated, record number has been tailing off since, but 2007’s investment pace still totaled $29.9 billion.
Four hundred million to 29.9 billion in 45 years? That is a compound increase of just over 10 percent. What do you think the odds are that the number of quality companies in which to invest has increased more than 10 percent a year for 45 years as well?
I don’t think so. Let me now turn to my counterpart’s four postulates regarding how venture capital thwarts innovation.
1. A venture fund has a life cycle. True enough, but there are many funds, including ours, that have held onto portfolio positions for more than a decade, and if an entrepreneur is looking for fund managers with patience, the research required to find them is an afternoon’s job. Our first fund, a standard 10-year limited partnership, did not fully liquidate until 17 years later – and we returned over seven times our capital base.
2. VCs act like business people, even when they have a technical background. My counterpart states, "Engineers who work with VCs for any length of time are inevitably frustrated by what they see as the VCs limited ability to understand revolutionary technology. It would be difficult to argue that VCs are ignorant of engineering and other technical areas," to which I say, "Guilty as charged, but so what?!"
The very oldest industry bromide is that the three most important elements of any venture capital investment decision are "management, management, management" (not technology). All four of the partners in our firm are liberal arts graduates, yet we have been successfully making seed stage, technology-based investments for over 20 years. When an entrepreneur approached us with an idea for a line of meaningfully-beyond-the-state-of-the-art broadband communications test equipment, we first noted that he had been recognized by his peers as the premier engineer in his field a couple of years earlier.
Then when we talked to some customer prospects and they told us essentially that they would figuratively kill to get their hands on instruments which featured the prospective line’s specifications, we cut a check – no rocket science necessary, thank you. Nine years later we jointly delivered the company over to Hewlett-Packard.
3. VCs can’t distinguish between smart and lucky. My counterpart states that "no one likes to invest in anything that seems daring." For sure, most investment opportunities do not feature daring technology, as there is a whole lot more in the world that is more evolutionary than revolutionary. I cannot think of a single example, however, of a credentialed team of scientists and engineers with a well-rounded, accomplished management team which failed to secure funding because its planned technology was too daring. Venture capitalists love an "unfair," protectable technological advantage.
4. VCs sync investments to business cycles. Whether one believes that the average investment cycle for a seed fund is five years (as many at least state) or eight years (as we believe), there is simply no way that anyone can prognosticate medium-term business cycles. Will the economy be strong and the IPO market robust in 2013 or 2016? Heck if I know. Last year VCs put $29 billion to work, a record amount, post-bubble. While much of it may turn out to have been ill-invested, it will not be because VCs are afraid to take technological risks.
Call me Shorty or call me forty, but don’t call me thwarty.
Beste is CEO of Mid-Atlantic Venture Funds, a 23-year-old family of four partnerships totaling just under $200 million in capital. He has 40 years of early-stage venture capital investing experience with institutional investors in Washington, D.C., Kentucky, and Pennsylvania. He received his bachelor’s degree in economics from Stetson University in 1968 and grew up in Baltimore County, Maryland.