Summary
Maybe the traditional venture capital model is broken for Internet-based businesses; but maybe the larger issue is that Internet technology-based businesses no longer need venture capital. Venture capitalists right now are faced with the opportunity to either:
- Create new operational and economic structures to serve and profit from micro-entrepreneurship, or…
- Find new platforms for businesses that fit the traditional venture capital model.
Read on…
Paul Graham, Could VC be a casualty of the recession?
VC funding will probably dry up somewhat during the present recession, like it usually does in bad times. But this time the result may be different. This time the number of new startups may not decrease. And that could be dangerous for VCs.
When VC funding dried up after the Internet Bubble, startups dried up too. There were not a lot of new startups being founded in 2003. But startups aren’t tied to VC the way they were 10 years ago. It’s now possible for VCs and startups to diverge. And if they do, they may not reconverge once the economy gets better.
The reason startups no longer depend so much on VCs is one that everyone in the startup business knows by now: it has gotten much cheaper to start a startup.
Completely agreed; I’ve been writing about the changing environment for entrepreneurs and venture capitalists for most of this year.
Even though most venture capitalists are poorly structured to invest in micro-entrepreneurship and “lifestyle businesses”, the venture capital industry is not going to die; just like any industry undergoing changes, venture capital will adapt to the changing demand and supply and find ways to thrive in the new environment.
Venture capital in its current state emerged to serve a need: fund speculative, emerging businesses looking to create new products and services that require time and money to get the company to a point where cash inflow will cover expenses. In return for that risk, venture capitalists expect an appropriate risk-adjusted return, and given the high failure rate for small businesses, venture capitalists require substantial returns from the companies that do succeed to subsidize the losses from the failures.
Over time, venture capital got big because the companies they invested in required large amounts (millions, tens of millions) of capital to create, scale and prove an idea in the marketplace.
The need to raise large amounts of capital created a gap between the lifestyle entrepreneurs and the “big company entrepreneurs”: in order to get funding you had to had a business that could get big and be sold (to the public or to other companies) within a fairly short timeframe (approximately 7 years) in order to make it a viable investment opportunity.
This is obvious. But what happens if the underlying variables change? What happens if the costs of the factors of production decline drastically? What happens if the amount of risk capital and the time needed to startup companies goes down? What happens if the type and amount of risks change dramatically?
Given these broad changes, the “venture capital is broken” refrain has been popular lately; I have used it a couple times myself.
But perhaps that’s not the issue. Perhaps Internet technology-based businesses no longer need venture capital. While some venture capital funds will restructure themselves to better serve the need of micro-entrepreneurs, perhaps the larger opportunity is for venture capital to invest in businesses based on new emerging platforms.
So, the real question:
What’s the next platform?
The Internet made these changes possible: people have taken advantage of the opportunity to access, use and deliver an increasing range of applications and services over an increasingly ubiquitous, inexpensive and broadly understood platform.
Perhaps the opportunity for venture capitalists and entrepreneurs is less to find a new economic structure to better serve micro-entrepreneurs, but instead to find, develop and base businesses on new, emerging platforms that will require the traditional economic and operating model that venture capitalists are used to serving. Many entrepreneurs and venture capitalists will work on changing the math to fit the new environment, but there is also be an opportunity to find new environments where the old math still works.
What platforms could emerge?
- Energy infrastructure.
Governments and private businesses have invested in basic and applied research in energy for many years now, but the level of interest from the public has changed drastically in the past ten years. While energy infrastructure will be a largely government funded and controlled system for the near future, venture capitalists have begun to actively fund companies developing new technologies to fix the many energy problems our economies face.
What could happen if we had an open energy infrastructure similar to the Internet for communications? What could companies do with an open energy grid? What would consumers want?
What new energy infrastructures are being developed? While we can work to make cars with better gas mileage using better gasoline or electric technologies, what if we developed a new ecosystem for auto transportation? Think that’s impossible? Better Place is doing it.
- Wireless telecommunications.
While mobile is mostly used for entertainment in the USA and Europe, mobile technologies are used for survival in many countries around the world. Throughout Africa, India, China and the rest of Asia companies are developing businesses based upon closed and open wireless platforms.
What could companies do with unlicensed spectrum? What could companies do with open platforms and open access?
- Public services.
What could happen if governmental authorities were able to create more efficient marketplaces for government services? What could happen if government operations became more transparent, open, efficient?
We have already seen a huge increase in private consulting companies operating government services in the USA; but what could entrepreneurs do if the transaction costs of working with the government were drastically lower? What current trends in politics and government could entrepreneurs leverage?
- Personal data management.
What happens if people could own, control and promote their own data?
What happens when people can advertise to companies what they want?
What happens when we can bring relationships into markets?
- Transportation.
The US has a fairly established transportation network, even if major parts of the infrastructure need significant investment. But transportation is a major need for many economies around the world; India desperately needs to improve its transportation infrastructure to continue its economic growth.
Governments around the world have struggled to operate transportation networks efficiently, and privatization has not been the cure-all: just ask Britain, for example. The US is struggling under and inefficient FAA and air traffic routing network, poor airports, inefficient gate allocation procedures, and a security system that has failed to efficiently and effectively new security threats.
Venture capitalists and entrepreneurs have traditionally stayed away from opportunities that require big, inflexible, systemic changes to succeed. The required scale is simply to large, the risks are simply to big, the timeframes too long. But how could the government create a new platform in public transportation for entrepreneurs to leverage? How could entrepreneurs develop businesses based on existing transportation networks?
What opportunities do you see? What platforms do you see emerging in the USA and abroad?
