I am responding to an article written by Dan Primack at Reuters PEHub (where some of my pieces are syndicated), pondering the question as to how to radically reinvent Venture Capital. To start offering a solution, we should look at the original promise of Venture Capital (VC).
But it is not such a big surprise. Subprime VC attracts subprime entrepreneurs ready to cash in on the hype, and hence an overwhelming amount of noise the stampede for money produces drowns out the music, leaving many investors without a strong compass overwhelmed, numb and unable to separate fiction from reality and creating a massive cloud of false positives and false negatives. And now, most of those VCs are debating whether a new VC firm structure or deal mechanics can fundamentally change the outcome of the game. It will not.
Since the beginning of 2000, VC performance is underwater and that hurts. But just like un-inspirational politicians who can’t get legitimate voters to vote for them, un-inspirational VCs waiving an old rule-book around cannot attract great entrepreneurs. But don’t for a moment, think the American entrepreneurial spirit is dead. It is not.
1/ Invest in macroeconomics
Rather than invest in mindless technology classifications, certain macroeconomic behaviors ingrained in society for hundreds of years can be harvested with technology. Think premium “market” and free-market models. Each has great potential depending on which product or service is being sold. The cyclical behavior of adoption can prohibit the success of either, no matter how good the technology. Studying the model and the reason for its receptiveness will be the first clue towards a fundable business.
2/ Invest in inefficient supply and demand
Regardless of technology, many technology segments that we discard off-hand as too difficult have not even reached maturity or dominance by a single player (achieving over 30% “market” share). Even the well-publicized Personal Computer segment consists of over 40% fragmented ownership, let alone an untapped opportunity of roughly 5B people on this planet which don’t use a computer today. But fragmentation is the ultimate indicator of under-served potential; it merely means the current capability is ineffective, opening new opportunities for a new solution (iPhone anyone?). So, get your facts straight.
3/ Invest in the application of technology
Many new lines of businesses can benefit from the infusion of technology innovation. If the use of technology yields dramatic bottom-line impact and provides a sustainable roadmap, then how it is built (with what flavor of technology) at the moment of entry merely indicates the cost to improve the upward trajectory further. So, stop investing in technology, but invest in the application of technology.
Those three points alone require an entirely different assessment of the risk factors associated with innovation than the one I see Silicon Valley VCs apply today. Most investors have become risk-averse and invest based on cost rather than on opportunity.
So, to reinvent venture capital, we need to reinvent the people behind it. The mechanics and size of government are irrelevant if they do not affect the behavior of politicians that inspires people to vote. Similarly, the effectiveness of VC will not improve by changing fund size, deal staging, etc. (or escaping to a green-tech “bull” market, for that matter) unless the investors change their behavior that inspires the right people to innovate.
We need to bottom-up VC. Investors need to become genuinely complimentary to great entrepreneurs and practice similar ethics, transparency, and perseverance traits to become valuable contributors to the innovative process that allows them to reap the rewards. Teams that can consistently yield a path to trustworthy IPOs will be charmed into even more lucrative acquisitions along the way.
It is a “buyer’s market” only for those investors who buy mediocre innovation. And mediocre innovation will not produce great fund returns. So, in the end, innovation remains a “seller’s market” – or no market at all.