I have talked and written for a while now (5 years or so) about the impending demise of Venture Capital (not innovation) before the numbers proved the same, and recently with plenty of “hard” trailing evidence (with VC even producing negative returns according to Thomson Reuters) that finally makes the economists who serve the Limited Partners pay attention, the need for me to reiterate those points is starting to subside.
Another way of saying the same is that at age 47, I don’t want to spend too much of my time waddling in negativity unless I am tickled.
Letting go of the old
Barring, of course, any blatant nonsense Venture Capitalists keep spreading to affirm their protectionist stance while raising another fund from Limited Partners who still don’t get that the problems in Venture are full attributable to its self-induced dysfunctional arbitrage. I have and may continue to refute some of the VC arguments to ensure not too many entrepreneurs get trapped in their unholy “religion.”
Ringing in the new
So based on that timing, I have decided from now on to focus a majority of my writings (my thinking switched a long time ago) on a solutions-driven approach to Venture and leave the participants of the existing Venture ecosystem alone with their “self-induced indigestion.”
Already more than one year ago, I devised a systemic solution to Venture, with a prelude that covers in detail why the current Venture model is dead and can never be reborn the way it functions today. Not even an improvement in the economy will systemically improve scalable Venture performance. The prelude to my fix to Venture has been available publicly since January the 1st of this year called “The State of Venture Capital” (and viewed 8,000+ times) for those Limited Partners looking for good reasons to get out of Venture.
And without giving away all the secrets that form “unique access to scalable returns built by groundbreaking innovation” for Limited Partners, I will now focus more of my writings on conveying why the future in Venture is bright and which Limited Partners should get back into Venture, yet with a new economic model at its foundation and more appropriate and disciplined deployment of risk.
With my writings, I will be dancing around my cohesive solution to Venture to reel Limited Partners into the fold, while at the same time providing entrepreneurs and venture capitalists with new standards and metrics they are going to be measured against.
So, please strap in for the continuum of a great ride, a gradual transition of tone greased with more foundational revelations of my plan to improve performance in Venture systemically.
A habitat for innovation
Innovation comes from a culture that rewards the best (outlier) ideas, no matter where they come from. And for innovation to flourish, it needs to lie “in a bed,” a habitat, in which the idea is married with top-notch execution, so monetization and realization of that idea in the real world happens at a pace compatible with the investment thesis of the financial system that funds it.
Reread that last paragraph until you get it. It is loaded with “goodies.” And ask questions in the comment section below if the following explanation does not clarify things.
The term “innovation” is currently liberally and fashionably applied to any advance in technology evolution. But when funded by Venture money, the term “innovation” should be attached only to those advances that create significant socio-economic value. Not because I say so but because of the considerable deployment of capital that requires even more significant returns. In other words, innovation only has relevance when the popularization of its implementation reaches public markets and public investors and induces a trigger to buy the product and stock (and can, therefore, be lured away by the favorable terms of M&A).
> Silicon Valley score: F
With the rise of subprime Venture Capital in the last twenty years, the quality of the investment thesis has systemically eroded and ignored the selection of companies that are considered to provide meaningful innovation and has significantly eroded the trust of the public. We lied to the public about the value of technology companies and are now dealing with those lies’ reciprocity.
Stuffed to the gills with “after-market innovation,” Venture Capitalists should not be surprised that their “capital-efficient companies” become quickly obliterated by fewer so-called “market-makers” who favored the pursuit of upside over the protection of downside.
The realization of an idea is the timely mapping of innovation to existing macroeconomic behavior, a concept we described in previous blogs. So, the recognition of an idea is only as good as its actual attachment to consumers’ macroeconomic behavior. Meaning, if an idea has theoretical merit but lacks practical relevance to the public, it is worth nothing (yet). Stronger put, technology does not create “markets”; it merely serves them. Technology can serve markets so efficiently and aggressively that it can serve as the new and dominant distribution for that macroeconomic behavior.
> Silicon Valley score: C
Entrepreneurs usually ignore the need to attach to existing behavior (which is the source for real capital efficiency) and overestimate their ability to create new behaviors. As a result, the idea is unlikely to produce healthy realization and, even though deemed worthy by investors, often entirely ignored by the public.
Startups are not the place where you learn how to run a business; startups are where people gather who know how to run or guide one. The unique culture of risk is what defines the propensity to recognize the right kind of innovation. Meaning, the pyramid consisting of Limited Partners, Venture Capitalists, and Entrepreneurs need to have an aligned understanding of what constitutes risk associated with creating groundbreaking innovation and how to invest, deploy and execute on the funds made available.
That includes an understanding that the real asset holders in Venture are the Limited Partners with money and the entrepreneurs with ideas, with Venture Capital operating as the arbitrage (and derivative) of how to marry the two.
Venture Capital operates as the marketplace arbitrage that should not necessarily be held responsible for companies’ individual performance, but for the returns produced by its portfolio and the investment thesis that their portfolio represents. Limited Partners should hold Venture Capitalists to higher standards and kill first-time funds that do not perform because with plenty of room for diversification of risk, every Venture Capitalist who does not perform stains a hundred times more false negatives than positives.
> Silicon Valley score: C
The culture of technology is omnipresent in Silicon Valley. When I moved to Silicon Valley 15 years ago, I was very impressed to overhear everyone in a local movie theater discuss technology but have since learned that it is generally void of the complementary business skills that allow it to attach to existing macroeconomic behavior (described above). And so the culture that is lacking in Silicon Valley is the skills that will enable technology to attach to reality. Instead, the majority of startup companies in Silicon Valley are step-ups and trials of previous renditions of innovation that, for some reason, failed to take hold, with the public caring less about either.
Monetization of an idea consists of the funding and the revenues earned from the deployment of the concept. Funding an idea requires the proper understanding of risk, as described in the previous realization section.
Attachment to the sizeable macroeconomic behavior is where the investment risk is not in writing lines of code. So, proper monetization requires investors who apply the risk to anything else but writing code and allows the company to pursue upside (rather than to protect downside). If the company can go into revenue mode already, an early adopter market needs to exist with a smooth extrapolation to a broader addressable market that allows the company to become the king of its space with a single product.
> Silicon Valley score: F
With negative returns reported across the Venture business and allegedly no more than 35 out of 790 VC firms producing any consistent returns for Limited Partners, the defunct arbitrage of Silicon Valley VCs is responsible for producing more than one hundred times more false negatives than positives. Lackluster discipline by Limited Partners prolongs and exacerbates the creation of false negatives of innovation. But Silicon Valley is blessed with a willing early adopter market, albeit not always with a smooth transition to the broader U.S. market.
The startup companies that own and embed innovation go through extreme and challenging periods of growth and acceleration. The ability to hire managerial, marketing, sales, support, and engineering skills quickly will significantly influence a company’s ability to define realization, monetization, and execution expeditiously and optimally reach its milestones. The fine-tuning of prospect-to-customer conversion rates determine a company’s ability to outcompete and own its turf.
> Silicon Valley score: F
While Silicon Valley scores high on the availability of quality engineering resources, its ability to source managerial skills to market, sell and support that can match the skills of the marketplace it attaches to is often mediocre. The wrong realization agenda (described above), combined with the massive attraction to technology as the gold-rush of the century yields many “flies” with more significant resumes than accomplishments. Immature products (the result of improperly deployed capital efficiency) too often depend on highly skilled in-market personnel incapable of detecting, correcting and feeding back the requirements of the ultimate user experience and thus turns users off.
Crucial to the pursuit of upside is to find the appropriate investor(s) who can support the runway of funds needed for the company to take off. Realistically, companies with the propensity to generate macroeconomic value require a minimal of $25M in funding. Please show me a company that has produced a $300M exit value for less.
The economics of producing technology innovation have not become less expensive; its maturity and increased competition force our industry to build more robust and more complete user experiences that ignite real appeal. So, rather than less expensive, meaningful differentiation is more costly to achieve. Who entrepreneurs are dating as an investor (relevant experience, vintage, merit, monolithic runway support, etc.) is a direct corollary to the potential upside.
> Silicon Valley score: F
Silicon Valley VCs struggling with the fallout of its self-induced indigestion and with the increasing competition of micro-VCs and Angels who lure entrepreneurs in with easy yet fragmented investment promises and little infusions of money similar to those of loan-sharks, has en-masse resulted into the deployment of the opposite risk that ought to be deployed in Venture.
The emperor has died
The Silicon Valley emperor, the cartel of Venture Capitalists who en-masse defined and deployed his preferred investment thesis and failed, is dead. And as a result, leaves behind, except for readily available technology resources, a graveyard of underperformance that begs new leadership to resurrect it.
But as much as I want Silicon Valley to survive, I often wonder whether it is worth saving, given the ignorance and resistance it puts up, and starting anew elsewhere becomes a very appealing alternative. Starting over where the proper investment risk can be instilled across the board and can take hold, beginning with a fresh new habitat.
Have a great long Labor Day weekend.