The Venture Chasm
The technology sector is buzzing and we’re hearing more about venture capitalists than any time since the dot-com bubble. With part of your pension and some of your taxes invested in venture capital funds, you may be curious to know how they are doing.
This piece originally appeared in the Sunday Business Post on 7th July 2013
Venture capitalists are the brave souls who attempt to profitably invest in companies so young they don’t know what they are selling or to whom they are selling it. Although it may seem like reckless gambling, the rare win tends to disproportionately pay for the losses, and then some. Given a portfolio of ten startup investments, a seasoned investor will expect three to fail quickly and miserably. Three more become “the living dead”, refusing to to grow while failing to die, consuming precious attention and promising no rewards. The next three will be bought by larger firms, delivering a modest but unexciting cash return. The portfolio’s overall success depends on the single remaining investment. With luck, it will score a homerun, connecting new technology with desperate customers, quickly capturing the market before being bought by an industry giant for an obscene amount of cash. The profits can be large enough to pay for all the other investments several times over.
The search for the elusive homerun is what keeps venture capitalists awake at night. The Kauffman Foundation (a non-profit that promotes innovation) published a damning report in May 2012 based on data from one hundred US venture capital funds over the last twenty years. They found that the average fund failed to pay their investors back their money. However, a small handful of venture capital firms more than tripled their investors’ money. Their success is explained only by the network of personal relationships a few elite venture managers have with entrepreneurs in hubs like Silicon Valley, allowing them to make the best investments before anyone else. The pensions, banks and endowments that back venture funds have taken notice and “superfunds” have emerged, sucking in more than a billion dollars each to invest in emerging startups. The jury is out on whether any one firm can find enough promising startups to profitably invest such a large sum. Meanwhile, the great majority of funds, who weren’t fortunate enough to invest in a nascent Facebook or Google, are struggling to get their phone calls answered.
This Side of the Pond
In Ireland, the situation is less clear. Most of our venture capital funds are heavily backed by public money, motivated by essential innovation policies that aim to create high-value jobs. Public funding partially insulates them from the market forces that are driving all but the most successful of their US counterparts to shutter their businesses. Data on the financial performance of Irish venture capital is hard to find, but data from Nesta shows that UK funds are returning 4% less capital than their US counterparts, probably because there are fewer large firms buying up small companies.
Startups Sail Clear
With storms ahead for the traditional venture capital industry, the future for startups is surprising bright. IT costs have plummeted, and clever usage of Twitter, Facebook and Google has replaced expensive sales and advertising budgets. Like most European capitals, Dublin is now teeming with countless young digital startups, founded by young entrepreneurs with global ambitions and few obstacles in their way.
A gap has opened up between the venture capitalists and the entrepreneurs, who need them less than ever. Many of the best startups are built by experienced founders, who can now personally finance them to a much later stage. If they finally seek venture finance, they do so on their own terms. This is terrible news if you need a homerun for your venture portfolio. Even if you can find such a company, you are less able than ever to buy enough of it to make a difference.
“The Gulf Between the Funds and the Founders”
The smart investors are turning their eyes to the “venture chasm”, the widening gulf between the funds and the founders, where some very interesting developments are afoot. More small funds are appearing, managed by former entrepreneurs who will get their hands dirty and work alongside their investees to help build their companies. There are angel investors joining together to create “accelerator” programmes, through which they invest in a wider spread of companies while maintaining maximum influence. Then there is the rise of the “venture lab”, syndicates of entrepreneurs who pool resources to create portfolios of startups they build from the ground-up.
Led by entrepreneurs for entrepreneurs, these kinds of organisations are a more efficient path to the creation of new business, wealth and employment. Thanks to the foundations laid by traditional venture capital, we have examples of each in Ireland, and more on the way. For the Irish economy, the investment is beginning to pay off.
Sean Blanchfield is CEO of ScaleFront (a venture lab), co-founder of Demonware and organiser of the Techpreneurs community. You can follow him on Twitter @seanblanchfield.