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Venture capital is best used to accelerate success

image 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.

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  • http://twitter.com/L1AD LIAD

    I'm not sure why VC's feel duty-bound to explain the value they bring to start-ups.
    VC's are financial investors, their goal is to provide returns to their stakeholders.
    Good VC's obviously bring more than just money to the table, but I'm not sure that innovation is or needs to be one of those things
    It's a nice added bonus – but not something which should be expected and thus not something that the VC industry should need to apologise for.

  • http://www.theequitykicker.com brisbourne

    Hi Liad – we are in the business of selling ourselves as well as our money so we can win deals on criteria other than price!

  • http://en-gb.facebook.com/joodoo9 Giles Palmer

    Hey Nick
    I agree with the trust of your post. I guess the issue that 'outsiders' have is really tied up in the name. 'Venture' implies taking more risk/getting involved a lot earlier than most VCs are comfortable with. But I agree that you guys can add the high octane juice to early stage fires.

    see you soon no doubt

    giles
    http://www.brandwatch.net

  • http://twitter.com/L1AD LIAD

    These value-added options obviously act as differentiators from an
    entrepreneurs perspective but I dont feel that of all the things an
    entrepreneur hopes a VC will bring to the table apart from Cash, innovation
    itself is overly important

    2009/9/21 Disqus <>

  • http://www.theequitykicker.com brisbourne

    I agree.

  • http://www.broadstuff.com/ alan p

    Good post Nic, I think many people confuse often VC with early day funding. The argument that the “V” bit of VC is culturally missing more in Europe is a different issue.

  • http://lmframework.com/blog/about David Semeria

    The assumption is that a startup can get to market with limited capital – which, admittedly, is increasingly true for many (not all) web startups.

    But what happens if you need significant capital just to get off the ground? Who do you go to?

  • http://twitter.com/davidsmuts David Smuts

    Hi Nic, To be fair to VCs this is what they've been telling people all along! VC funding is acceleration funding, not innovation funding. As entrepreneurs we give VCs a lot of stick for being risk-averse, not innovative enough and being generally absent from the seed stage= all true in my view, but as you rightly point out this is not what VC money is for, so why should we complain so much!

    Our problem (and I mean this collectively as an ecomony and a society) is the equity gap for fostering innovation. We have in this country limited funding available for seed stage. We just don't have a large enough network of “professional” Angel investors. Compare the NESTA figures of about 6,000 Angels in the UK with the US with over 350,000. OK I know the US is a larger market (5 times our population) but if we use comparative pop stats the UK should have nearly 70,000 Angels. OK I know we have Seedcamp, but lets be honest here- an investment of 30-50K Euros is not going to get a start up very far!

    Nic you're spot on about VC funding contributing to Google, Facebok, Twitter acceleration. But heres the irony…, tech companies no longer require the $10-20M for acceleration which they did back in 2004-2007, they can get by with much less, both in part due to lower technology costs but also lower costs in talent and infrastructures as a result of the downturn in the economy. This means instead of $20M for accelerating growth they can probably rely on about $5-10M and if they have the traction in the market that VCs require for their funding, then they have numerous alternatives to VC funding. I won't go into that here…, but if tech companies are requiring less acceleration growth then VCs are going to be faced with more competition from PE funding growth. And when you compare VC terms against PEfund terms the choice for any CEO is pretty simple.

  • edahan

    Entrepreneurs innovate and create.

    VCs fund growth.

    Simple and straightforward.

    VCs provide the mortgage loan once a house is built – once an entrepreneur has built a product or service with “traction”. No one is really sure what the ultimate value of the “house” will be, but you can get housing values from appraisers and get startup appraisals from competitive products/services, potential market size, etc.

    Construction loans are given based on plans for the house, size of the house, neighborhood, etc. Construction loans are given to “builders” and their reputation, trustworthiness, ability to build a real good house, current market for real estate, etc.

    Startups are funded by friends&family, entrepreneurs and their credit cards, angels and sometimes validation partners.

    The only exception to this rule is funding Famous Guys.

    I'm sure if the Larry Pages or the Sergey Brins or the . . . . of the world had a new idea they could get a whole bunch of money by simply letting the VC world know that they are thinking of starting something. The latest example of this would be Asana.

    The question is not whether VCs create or innovate.

    The question is how do we level the playing field when an entrepreneur goes for VC funding ?

    Money is Global. Technology is Global. Entrepreneurs are Global. Validation Partners are Global.

    The answer is in building an Early Stage Collaboration Community –

    A Global Collaborative Community that brings together the mutual interests of: Sponsored Companies, Sponsoring Organizations, Validation Partners, Funders and Support Resources for Mutual Benefit

    And it brings these elements of the Early Stage Community together in a global, efficient, secure and highly focused way –

  • http://www.globalizationresearch.com/ Vivek Wadhwa

    Nic, I don't disagree that VC can be used to fuel success. But you have ignored almost every point I made. I was reacting to the misleading statistics which the NVCA published and their unfounded claims about VC's creating entire industries, 12 million jobs — 81% of those in software, contributing to 21% of GDP, etc. etc.

    Rather than taking one of the examples I used and building your case on that, I would like to see you respond to the points I made and the evidence which I presented. Just like I challenged the NVCA to prove causality, I challenge you. How do you know that if VC wasn't available, that Google wouldn't have been able to raise alternative forms of financing?

    I stand behind my statement that it isn't the VC's who make innovation happen, it is the entrepreneurs. To fuel economic growth, we need to nurture entrepreneurship. We are not going to make the right policy decisions unless we have our basic facts straight.

    I am not trying to be anti-VC or build anti-VC sentiment, but get down to cold, hard facts.

    Regards,

    Vivek Wadhwa
    Duke/Harvard/UC-Berkeley

  • http://www.theequitykicker.com brisbourne

    Hi Vivek – thanks for the comment. Rather than challenge your post I was attempting to make a positive statement of what venture capital is good for. I think we agree that VC is not about creating innovation but about helping it flourish.

    NVCA stats are produced as part of a lobbying effort, and if they are anything like the British Venture Capital Society over here then the purpose of that effort will be to benefit VCs and then entrepreneurs indirecty. As such I think they contribute positively to the ecosystem. That said I accept your point that in reaching for headline grabbing numbers it is possible they overstate the influence of VCs (please forgive the caution in my words).

    Finally, establishing the demonstration of causality you seek is impossible, as I suspect you know. What I can say for sure though is that a number of the successful businesses DFJ Esprit has been invested in say we played an important role in helping them scale the heights.

  • http://www.theequitykicker.com brisbourne

    I agree – more angel funding would really help.

  • http://www.theequitykicker.com brisbourne

    Go for it! More collaboration amongst startups would help everyone.

  • edahan

    Nic – please send me your email address. BTW – I knew John Taysom when he was investing for Reuters and I was investing for Microsoft.

    Thanks,

    Elliott Dahan
    elliott(a)thegrowthgroup.com

  • http://twitter.com/davidsmuts David Smuts

    What a great posting Vivek and Nic- I love it when I see some “real” intelligent debate on these blogs (seldom happens).

    NVCA and BVCS are lobbying groups on behalf of one industry (VC). I don't trust much of anything any lobby group spouts out about its industry which is one of the reasons why I'm working to set up a transatlantic forum of luminaries across the Innovation Spectrum (Entrepreneurs, Angels, VC, Government, Academia, Communities, LPs and Legal).

    Vivek- you're right VC funding does not create innovation. You're also right about the propaganda espoused by VC lobby groups. But VC funding has “accelerated innovation” beyond a doubt. Look at the countries where there is a healthy source of VC funding (US, UK, Israel) and there you find numerous examples of these countries being ahead in the innovation of new technologies. Personally, I think the cost of capital of VC funding is too high compared to alternative PE funding but this is generally something beyond the expertise of most CEOs leading emerging companies- they go straight for VC without even looking at the alternatives.

  • http://www.globalizationresearch.com/ Vivek Wadhwa

    Ok, Nic…no issues.

    Let me know when you're in Berkeley, CA.

    Regards,

    Vivek
    wadhwa at Duke.edu

  • http://twitter.com/davidsmuts David Smuts

    What a great posting Vivek and Nic- I love it when I see some “real” intelligent debate on these blogs (seldom happens).

    NVCA and BVCS are lobbying groups on behalf of one industry (VC). I don't trust much of anything any lobby group spouts out about its industry which is one of the reasons why I'm working to set up a transatlantic forum of luminaries across the Innovation Spectrum (Entrepreneurs, Angels, VC, Government, Academia, Communities, LPs and Legal).

    Vivek- you're right VC funding does not create innovation. You're also right about the propaganda espoused by VC lobby groups. But VC funding has “accelerated innovation” beyond a doubt. Look at the countries where there is a healthy source of VC funding (US, UK, Israel) and there you find numerous examples of these countries being ahead in the innovation of new technologies. Personally, I think the cost of capital of VC funding is too high compared to alternative PE funding but this is generally something beyond the expertise of most CEOs leading emerging companies- they go straight for VC without even looking at the alternatives.

  • http://twitter.com/davidsmuts David Smuts

    What a great posting Vivek and Nic- I love it when I see some “real” intelligent debate on these blogs (seldom happens).

    NVCA and BVCS are lobbying groups on behalf of one industry (VC). I don't trust much of anything any lobby group spouts out about its industry which is one of the reasons why I'm working to set up a transatlantic forum of luminaries across the Innovation Spectrum (Entrepreneurs, Angels, VC, Government, Academia, Communities, LPs and Legal).

    Vivek- you're right VC funding does not create innovation. You're also right about the propaganda espoused by VC lobby groups. But VC funding has “accelerated innovation” beyond a doubt. Look at the countries where there is a healthy source of VC funding (US, UK, Israel) and there you find numerous examples of these countries being ahead in the innovation of new technologies. Personally, I think the cost of capital of VC funding is too high compared to alternative PE funding but this is generally something beyond the expertise of most CEOs leading emerging companies- they go straight for VC without even looking at the alternatives.

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