Most venture capital dollars flow into businesses that are already showing signs of success, and that want to raise money so that they can grow faster. I often liken best use of venture capital to using petrol to fan the flames of a fire. Clearly that is only going to work if the fire is already burning. VCs are sometimes criticised for riding on the coattails of success, and I think that criticism misunderstands the role that VC plays in the ecosystem, which is more to accelerate success than create it.
VCs love to talk about innovation and making true early stage investments, and indeed most VCs do make some seed deals (and some do a lot of seed deals, not least my DFJ partners in Menlo Park), but the financial logic of investing a typically sized venture fund makes it very hard to generate returns unless most of the dollars go into larger rounds which are aimed at accelerating success.
I’m writing this in response to a guest post on Techcrunch yesterday from Vivek Wadhwa which asks What Have VCs Really Done for Innovation? In it he says that Google was already successful before ‘the deep pocketed VC’s arrived to ride Larry and Sergey’s coattails’. This is true in the sense that Google already had a lot of traffic when the VCs invested, but ignores the fact that they didn’t yet have a revenue model and that the investment gave them time and space to grow the service past critical mass before focusing on the P&L. The VCs didn’t create the innovation, but they did play a critical part in helping Google become the huge success it is today.
Similar stories are playing out at Facebook and Twitter right now. A lot of the innovation at both those companies happened before they raised venture capital, but I doubt if either of them would be what they are today if they hadn’t been able to use VC to fund their losses.
None of this is to say that the venture industry couldn’t do more to stimulate innovation, it can and should. Here in Europe a group of VCs have joined with angels and other prominent members of the ecosystem at Seedcamp which has been making very early stage investments for three years now for exactly this reason and it would be great to see more initiatives like this. Nor is it to say that the VC industry shouldn’t improve its game in other areas.
The first draft of this post didn’t have these last two paragraphs, but I added them because I wanted to make sure the central point of VC being best used to accelerate success didn’t get lost in a wave of anti-VC sentiment, like that which can be found in the comments to Vivek’s TC post, and to an extent in the post itself.