Invest in the venture system, not venture capitalists.February 27th, 2009 View Comments |
A Forgotten Past, Dying Present and (No) Future | Orla, Texas | Feb 2009
Tom Friedman raised a few feathers with his article Start Up the Risk-Takers and the ideas about redirecting part of the US financial stimulus package to venture capital investors to invest in startups.
The basic idea about creating jobs and economic activity through supporting startups and new businesses is a concept that many in the venture industry have voiced previously. But this article stirred up a little debate as Fred Wilson, Roger Ehrenberg, Alan Patrick, Don Dodge, Brad Feld, Tom Evslin and others (including many, many insightful commenters) entered the scene with a range of opinions.
I’ll summarize and throw in a couple points along the way…
In a perfect world, “more money for entrepreneurs” would mean more businesses would get created. But it doesn’t work that way.
The title of Friedman’s article might be the most insightful part: “Start Up the Risk-Takers”.
That does not mean “start up the venture capitalists”: entrepreneurs are the true risk-takers in the venture industry.
Helping entrepreneurs create businesses in order to jump start the USA’s economy is a good idea: but simply giving money to existing venture capitalists is not the way to execute it.
Hopefully we’ve learned what happens when we give money to companies: they spend it how they see fit, not how we want them to.
The history of the government directly investing in startups is spotty at best, with In-Q-Tel as one of the possible success stories. But it’s unlikely that the USA government bureaucracy would be the most effective organization to invest in startups, and not surprisingly, few commentators advocate that approach.
That said, I would be curious to hear more about the examples of government-supported entrepreneurship in other countries. Examples? Thoughts?
But even more telling, more money doesn’t necessarily mean more (or better) businesses even if venture capitalists are the ones placing the bets.
Why?
The fundamental math behind venture capital works against:
- Early-stage investing. Roger has written about the subject of early-stage investing before, and Matt explained it particularly well in Roger’s post about the debate.
- Service-based businesses. As Don explained, “Service based companies create lots of jobs, but don’t get VC funding.”
Fred also pointed out a role for government programs (using the example of current programs like SBA and SBIC as examples) to fund businesses that don’t fit the traditional VC economic model.
Incentives guide behavior; and the current venture capital models simply don’t create the incentive structures to invest in the early stages of new ventures, especially service-based businesses.
If you’ve read some of my past posts, none of this should be a surprise.
If “more money” is the path, where should it be directed?
Where are the needs?
- Traditional seed-stage, $200K to $1 M. We’ve developed effective ways to test ideas, but we’ve created a funding gap between “testing ideas” and “building businesses”
Given Marc Andresson’s plans to start a venture fund and his thoughts on the industry from a recent interview with Charlie Rose, Marc might agree.
- Government programs or new private funds to “incubate lives”, focusing on service-based and “lifestyle” businesses. These companies won’t create big-hit investment returns, but they can generate cash flow and create jobs. The SBA and its programs are a start, but without other structural changes they are not the ultimate answer.
Should we focus or direct money towards specific industries, technologies or geographical regions? I’m open to thoughts, but I still believe the market, not the government, should decide which deals to fund. The big win is to focus on strategies instead of tactics, the system instead of the specifics.
The current needs will not always be needs; instead of plugging the gaps, let’s address what created the gaps.
Everyone is focused on pumping more money into the venture ecosystem. But why don’t we think more about removing costs?
Thank you. Dumping more money into the same structures, the same incentive systems, the same uses, is not the answer.
Instead, how about streamlining the legal processes behind creating businesses? Or reducing other transaction costs to starting new ventures?
Why don’t we invest in the underlying venture ecosystem by removing transaction costs and streamlining the processes in starting, funding and growing business?
A number of commentators touched on the issue:
- Fred explicitly noted the opportunity in investing in education; others added in thoughts about funding basic and applied research and development.
- Dan pointed out the opportunity to use existing structures like the SBA to increase the funding of the SBIC and SBIR programs.
- Brad pointed out the Seed Capital Tax Credit, a way for the government to incent seed stage investments. Chris Schultz mentioned similar programs in Louisiana specifically aimed at igniting post-Katrina economic growth when I met him in December.
But it’s not enough.
How can we invest in streamlining the system?
- Create easier and quicker processes for researching, applying for and accessing government funding (SBA, SBIC, SBIR, research grants, etc.)
- Reduce transaction costs, including legal requirements, taxation policies, accounting rules and government regulation. How can we make it cheaper, quicker and easier for companies to start?
Let’s be clear: this is not about “propping up startups”. I’m not advocating creating more structures to help entrepreneurs, but instead removing the need for those support structures in the first place. Investing in creating better structures would mean less distractions, less costs and more productivity, right?
Entrepreneurs face the problem of navigating government bureaucracies all around the world: take Singapore as an example in the difficulty (and opportunity) in figuring out government funding programs.
At the end of the day, this is just the latest round of a debate over the future of the venture capital industry.
It’s all about money: who, what, when, where, why and how, and the traditional answers to those questions may not be the right ones for the current situation.
More money does not mean more businesses, better businesses or more jobs.
Blindly pumping more money into the existing system will exacerbate, not fix, the venture industry’s structural issues.
All industries go through cycles of creative destruction and resurrection: why would venture capital be any different?
February 28th, 2009 at 14:51
There is a way to do better than the VC model to invest in Startups, and Entrepreneur Commons (http://www.entrepreneurcommons.org) is offering such an option, resolving the typical issues:
- the funding gap comes from the lack of scalability of the VC model. So many partners, and so much money, they cannot to invest less than a certain amount without wasting their time. Entrepreneur Commons scales because the investment decisions are coming from entrepreneurs themselves through a cooptation process. – the current selection process is biased towards high risk high returns companies, which leaves out a lot of very good companies that create jobs but do not bring a 3x or 10x return to the investor. With Entrepreneur Commons, we are talking about loans with a fixed rate with a stock incentive, so that you know what you will get, and you may get more if the company turns out to be the next Google. As long as the rate is good you do not need to stick to high risk high returns, and you can focus more on the businesses that can bring good cash and will be able to pay off the loan. Note that despite the hype and the well advertised returns from a few top VC firms, the average return to investors from VC investments is S&P minus 3% (after the VCs have taken their fees – from a study of about 1300 VC firms worldwide), so it is actually not that hard to offer rates that can match VC investment.
Such a model is not new, and governments in Europe are involved in similar models through Mutual Guarantee Funds. They are sustainable (you do not need to keep pouring cash into it), with very good returns.
The government should offer to match investment is such a fund as a way to create a real incentive to try something different to help startups.
February 28th, 2009 at 14:51
There is a way to do better than the VC model to invest in Startups, and Entrepreneur Commons (http://www.entrepreneurcommons.org) is offering such an option, resolving the typical issues:
- the funding gap comes from the lack of scalability of the VC model. So many partners, and so much money, they cannot to invest less than a certain amount without wasting their time. Entrepreneur Commons scales because the investment decisions are coming from entrepreneurs themselves through a cooptation process. – the current selection process is biased towards high risk high returns companies, which leaves out a lot of very good companies that create jobs but do not bring a 3x or 10x return to the investor. With Entrepreneur Commons, we are talking about loans with a fixed rate with a stock incentive, so that you know what you will get, and you may get more if the company turns out to be the next Google. As long as the rate is good you do not need to stick to high risk high returns, and you can focus more on the businesses that can bring good cash and will be able to pay off the loan. Note that despite the hype and the well advertised returns from a few top VC firms, the average return to investors from VC investments is S&P minus 3% (after the VCs have taken their fees – from a study of about 1300 VC firms worldwide), so it is actually not that hard to offer rates that can match VC investment.
Such a model is not new, and governments in Europe are involved in similar models through Mutual Guarantee Funds. They are sustainable (you do not need to keep pouring cash into it), with very good returns.
The government should offer to match investment is such a fund as a way to create a real incentive to try something different to help startups.
February 28th, 2009 at 19:24
RT @mdangear Invest in the venture system, not venture capitalists http://bit.ly/nsfcX
March 1st, 2009 at 02:20
>> Entrepreneurs face the problem of navigating government bureaucracies all around the world: take Singapore as an example in the difficulty (and opportunity) in figuring out government funding programs.
The Singapore government is trying hard to inculcate entrepreneurship among the young adults, especially in the technology area. Several million dollars of funds were setup, and many events were organized every month with topics such as “Turning your ideas into business”.
Although there is nothing wrong with this, they failed to recognize that true entrepreneurship comes from within. Constant inspirational talks or indirect persuasions only produce superficial startups that give up when the reality sets in.
March 1st, 2009 at 02:20
>> Entrepreneurs face the problem of navigating government bureaucracies all around the world: take Singapore as an example in the difficulty (and opportunity) in figuring out government funding programs.
The Singapore government is trying hard to inculcate entrepreneurship among the young adults, especially in the technology area. Several million dollars of funds were setup, and many events were organized every month with topics such as “Turning your ideas into business”.
Although there is nothing wrong with this, they failed to recognize that true entrepreneurship comes from within. Constant inspirational talks or indirect persuasions only produce superficial startups that give up when the reality sets in.
March 2nd, 2009 at 13:59
True, but “entrepreneurship” is not a concept that is interpreted ubiquitously among cultures. There is a need for some education about entrepreneurship, the opportunities and the realities in some cultures. The US's model of an “entrepreneur” is not the same everywhere.
I'd be interested in Aaron Chua's thoughts on the subject…
The subject of government intervention in creating industrial hubs, economic development regions and entrepreneurship and startup “alleys” has a lot of history behind it; I would love to dig into the variety of methods, examples, learnings and case studies on the subject, it's a fascinating area.
March 2nd, 2009 at 13:59
True, but “entrepreneurship” is not a concept that is interpreted ubiquitously among cultures. There is a need for some education about entrepreneurship, the opportunities and the realities in some cultures. The US's model of an “entrepreneur” is not the same everywhere.
I'd be interested in Aaron Chua's thoughts on the subject…
The subject of government intervention in creating industrial hubs, economic development regions and entrepreneurship and startup “alleys” has a lot of history behind it; I would love to dig into the variety of methods, examples, learnings and case studies on the subject, it's a fascinating area.
March 2nd, 2009 at 14:28
Yep: the economics of the venture capital industry make it difficult for VC's to invest in many types of businesses. There's nothing wrong with that: but there's no reason to believe that has to be the only model for funding new businesses.
I'd be interested in learning more about the Entrepreneur Commons model and examples from Europe…
March 2nd, 2009 at 14:28
Yep: the economics of the venture capital industry make it difficult for VC's to invest in many types of businesses. There's nothing wrong with that: but there's no reason to believe that has to be the only model for funding new businesses.
I'd be interested in learning more about the Entrepreneur Commons model and examples from Europe…
March 2nd, 2009 at 15:37
When we started the early stage investment programme called i.JAM, our objective was very different from a VC and that became obvious in how the model was set up.
Our objective from day 1 was not about returns, it is about achieving a critical mass of entrepreneurship. That is why we intend to seed 1000 small projects within 5 years. If we assume each project has 3-4 founders, we would have supported 3-4k people learning from at least 1 cycle of true entrepreneurship.
We also set up the investment vehicle to be more like incubators than VCs. In fact, part of our difficulties was to convince the incubators not to act like VCs. We painstaking told them to forego revenue considerations at this stage of investment because it might kill off many projects. What we want to focus on is the innovation aspect of the project, be it technology, business processes, or social innovations.
Beyond funding, we also create an easy way for startups to assess technology and market partners. This will be the main focus on what I am be doing this year.
http://ac-idealog.blogspot.com/2009/02/challeng...
#Alekkus: we understand that entrepreneurship needs to come from within. It is not something that can be forced. However, there is also a bunch of people who have not consider entrepreneurship because (i) they are unaware of the opportunities and (ii) they are not sure how to do it. This is where our programmes have the most impact. Through these programmes, we are reducing the opportunity and transaction costs for this group people to start something.
March 2nd, 2009 at 15:37
When we started the early stage investment programme called i.JAM, our objective was very different from a VC and that became obvious in how the model was set up.
Our objective from day 1 was not about returns, it is about achieving a critical mass of entrepreneurship. That is why we intend to seed 1000 small projects within 5 years. If we assume each project has 3-4 founders, we would have supported 3-4k people learning from at least 1 cycle of true entrepreneurship.
We also set up the investment vehicle to be more like incubators than VCs. In fact, part of our difficulties was to convince the incubators not to act like VCs. We painstaking told them to forego revenue considerations at this stage of investment because it might kill off many projects. What we want to focus on is the innovation aspect of the project, be it technology, business processes, or social innovations.
Beyond funding, we also create an easy way for startups to assess technology and market partners. This will be the main focus on what I am be doing this year.
http://ac-idealog.blogspot.com/2009/02/challeng...
#Alekkus: we understand that entrepreneurship needs to come from within. It is not something that can be forced. However, there is also a bunch of people who have not consider entrepreneurship because (i) they are unaware of the opportunities and (ii) they are not sure how to do it. This is where our programmes have the most impact. Through these programmes, we are reducing the opportunity and transaction costs for this group people to start something.
March 2nd, 2009 at 16:55
Here is where I struggle: investing in entrepreneurs still has to focus on returns; just a different kind, scope and scale of returns than the traditional VC model.
A government can take a wide view (wide accounting of “returns”) of the full externalities and follow-on impacts from funding entrepreneurs that a privately-funded institution simply cannot afford to take.
Balancing the goals (and investment dollars) between seeding the entrepreneurial environment and making pure investment decisions in companies is difficult: but finding that balance is part of this debate.
March 2nd, 2009 at 16:55
Here is where I struggle: investing in entrepreneurs still has to focus on returns; just a different kind, scope and scale of returns than the traditional VC model.
A government can take a wide view (wide accounting of “returns”) of the full externalities and follow-on impacts from funding entrepreneurs that a privately-funded institution simply cannot afford to take.
Balancing the goals (and investment dollars) between seeding the entrepreneurial environment and making pure investment decisions in companies is difficult: but finding that balance is part of this debate.
March 2nd, 2009 at 23:28
@Aaron
>>However, there is also a bunch of people who have not consider entrepreneurship because (i) they are unaware of the opportunities and (ii) they are not sure how to do it. This is where our programmes have the most impact.
I got your point. We are looking at different intents here. In some way, you help ease the process of getting people to start up their own business.
Do you think providing people with this kind of “shortcut” will actually help them. When I learned about those funding schemes, I started to think “With those money, what can I do?”. But after the rejection of my proposal, I started to think “Now, with no money, what can I do?”. I didn't give up because I've long wanted to be an entrepreneur. To me, the rejection was a blessing in disguise. The shift of thought made me more resourceful and creative, constantly thinking of ways to keep cost low while maximizing my development efforts.
So my point is, kicking off a startup is only one little setback. There are more to come during the life cycle of entrepreneurs. If you make them comfortable at the beginning, will they have the gist to face more setbacks later?
March 2nd, 2009 at 23:28
@Aaron
>>However, there is also a bunch of people who have not consider entrepreneurship because (i) they are unaware of the opportunities and (ii) they are not sure how to do it. This is where our programmes have the most impact.
I got your point. We are looking at different intents here. In some way, you help ease the process of getting people to start up their own business.
Do you think providing people with this kind of “shortcut” will actually help them. When I learned about those funding schemes, I started to think “With those money, what can I do?”. But after the rejection of my proposal, I started to think “Now, with no money, what can I do?”. I didn't give up because I've long wanted to be an entrepreneur. To me, the rejection was a blessing in disguise. The shift of thought made me more resourceful and creative, constantly thinking of ways to keep cost low while maximizing my development efforts.
So my point is, kicking off a startup is only one little setback. There are more to come during the life cycle of entrepreneurs. If you make them comfortable at the beginning, will they have the gist to face more setbacks later?
March 3rd, 2009 at 05:18
As a government institution, funding some “setbacks” can still be a positive thing and can still generate returns for society (if not the specific investors).
And if it got you thinking and excited enough to build a company even without funding, isn't that a success and still part of the goal of fostering and supporting entrepreneurship?
March 3rd, 2009 at 05:18
As a government institution, funding some “setbacks” can still be a positive thing and can still generate returns for society (if not the specific investors).
And if it got you thinking and excited enough to build a company even without funding, isn't that a success and still part of the goal of fostering and supporting entrepreneurship?
March 3rd, 2009 at 06:21
I fully agree that start up is just the first of many challenges.
One major challenge we are tackling now is growth. Specifically, how do we help startups to grow once they have finished their initial incubation stage.
Our attempt is to cluster companies together in a loose network to form the iphone+itune+at&t equivalent that reduces the transaction costs for startup to access markets and technology. We need to do this because there is no natural platforms among our larger companies.
Only by forming networks does the industry has the chance to become globally competitive.
March 3rd, 2009 at 06:21
I fully agree that start up is just the first of many challenges.
One major challenge we are tackling now is growth. Specifically, how do we help startups to grow once they have finished their initial incubation stage.
Our attempt is to cluster companies together in a loose network to form the iphone+itune+at&t equivalent that reduces the transaction costs for startup to access markets and technology. We need to do this because there is no natural platforms among our larger companies.
Only by forming networks does the industry has the chance to become globally competitive.
March 3rd, 2009 at 07:01
Thanks for sharing. That attempt is very rational. It will be very challenging though, given that most established corporates in Singapore are pretty closed up. It's unfortunate that most companies do not see the potential returns in the long run. Even if they do, it's hard to convince the top management to actually doing it.
March 3rd, 2009 at 07:01
Thanks for sharing. That attempt is very rational. It will be very challenging though, given that most established corporates in Singapore are pretty closed up. It's unfortunate that most companies do not see the potential returns in the long run. Even if they do, it's hard to convince the top management to actually doing it.
March 3rd, 2009 at 07:07
Examples of success, proof of open beats closed, and a Darwinian market will “convince” companies and management of change (or they'll lose out to competition that do), right?
March 3rd, 2009 at 07:07
Examples of success, proof of open beats closed, and a Darwinian market will “convince” companies and management of change (or they'll lose out to competition that do), right?
March 3rd, 2009 at 07:38
Singaporeans are not risk-takers by nature. Even they know they need to change, they would look for ways that gives short-term tangible returns.
I was lucky to have spend my childhood in Japan and went to the UK for my college. Hence, I'm able to see some subtle culture differences.
March 3rd, 2009 at 07:38
Singaporeans are not risk-takers by nature. Even they know they need to change, they would look for ways that gives short-term tangible returns.
I was lucky to have spend my childhood in Japan and went to the UK for my college. Hence, I'm able to see some subtle culture differences.
March 3rd, 2009 at 07:41
Japanese aren't risk-takers either
I grew up in the UK for 4 years prior to university and have traveled / worked throughout the world; it's amazing how some concepts are interpreted differently by different cultures.
March 3rd, 2009 at 07:42
You are right.
In fact, we used this approach when we first set up our network of incubators. Initially, not all incubators we approach wants to join our network. Instead of banging our heads, we quickly rope in all that do and set off. After seeing the initial results, those that rejected us became very interested to be part of the incubator network.
Bottom line: most people still need some success to be convinced.
March 3rd, 2009 at 07:42
You are right.
In fact, we used this approach when we first set up our network of incubators. Initially, not all incubators we approach wants to join our network. Instead of banging our heads, we quickly rope in all that do and set off. After seeing the initial results, those that rejected us became very interested to be part of the incubator network.
Bottom line: most people still need some success to be convinced.
March 3rd, 2009 at 13:18
As a government institution, funding some “setbacks” can still be a positive thing and can still generate returns for society (if not the specific investors).rnrnAnd if it got you thinking and excited enough to build a company even without funding, isn’t that a success and still part of the goal of fostering and supporting entrepreneurship?
March 3rd, 2009 at 14:21
I fully agree that start up is just the first of many challenges. rnrnOne major challenge we are tackling now is growth. Specifically, how do we help startups to grow once they have finished their initial incubation stage.rnrnOur attempt is to cluster companies together in a loose network to form the iphone+itune+at&t equivalent that reduces the transaction costs for startup to access markets and technology. We need to do this because there is no natural platforms among our larger companies. rnrnOnly by forming networks does the industry has the chance to become globally competitive.
March 3rd, 2009 at 15:01
Thanks for sharing. That attempt is very rational. It will be very challenging though, given that most established corporates in Singapore are pretty closed up. It’s unfortunate that most companies do not see the potential returns in the long run. Even if they do, it’s hard to convince the top management to actually doing it. rnrn
March 3rd, 2009 at 15:07
Examples of success, proof of open beats closed, and a Darwinian market will “convince” companies and management of change (or they’ll lose out to competition that do), right?
March 3rd, 2009 at 15:38
Singaporeans are not risk-takers by nature. Even they know they need to change, they would look for ways that gives short-term tangible returns. rnrnI was lucky to have spend my childhood in Japan and went to the UK for my college. Hence, I’m able to see some subtle culture differences.
March 3rd, 2009 at 15:41
Japanese aren’t risk-takers either
rnrnI grew up in the UK for 4 years prior to university and have traveled / worked throughout the world; it’s amazing how some concepts are interpreted differently by different cultures.
March 3rd, 2009 at 15:42
You are right. rnrnIn fact, we used this approach when we first set up our network of incubators. Initially, not all incubators we approach wants to join our network. Instead of banging our heads, we quickly rope in all that do and set off. After seeing the initial results, those that rejected us became very interested to be part of the incubator network.rnrnBottom line: most people still need some success to be convinced.
March 9th, 2009 at 07:16
[...] Continuing the discussion from the last (real) post, Invest in the venture system, not venture capitalists… [...]
February 3rd, 2010 at 06:57
[...] Invest in the venture system, not venture capitalists. In a perfect world, “more money for entrepreneurs” would mean more businesses would get created. But it doesn’t work that way. [...]
February 24th, 2010 at 09:22
[...] if we consider how and why the larger “venture system” invests risk capital into unproven businesses, then it’s easy to see that venture capital, [...]