There’s an interesting thread going on between Doc Searls and Rick Segal about the need for innovation in the VC industry. I wrote a somewhat snarky comment arguing that it’s silly for VCs to try to innovate around the notion that entrepreneurs are their customers. They should recognize the entrepreneurs are their raw materials and innovate from that perspective. Doc had a follow up question. I tried posting a reply to his comment but kept getting a server error, so I’m putting it here. Doc wrote:
Seems to me you’re saying A) innovation in venture capital can only benefit VCs and cannot benefit the companies they invest in, and B) blogging by VCs and a general increase in transparency is the one good thing to come about in the VC business in the last 25 years. That right?
Close. To carry the Wal-Mart example a little further: though their customers have gotten the most benefit in terms of lower prices, their suppliers have benefited somewhat thanks to, for example, their awesome ability to predict demand. Net-net, the cost to deliver a product to a customer is lower, and those savings disproportionally accrue to 1) the customers (in aggregate) and 2) Wal-Mart. Suppliers save money or make money too, but they’re further downstream in the value chain.
There were discount stores before Wal-Mart, of course, but they changed the game so radically that many of them are now gone or have reinvented themselves as niche player.
If you apply this same experience to venture capital, the analogous outcome is not that VCs become more efficent and pass on those savings or growth to entrepreneurs. Rather, it’s that they get removed from the equation altogether.
This assumes your goal is to increase the number of successful companies and their products. If your goal is to increase the profits of VCs, then yes, you probably want to innovate within the current VC framework.
And I stand by the notion that “the biggest benefits of innovation flow to buyers, not sellers.” They have to in order for capitalist economics to work. Yes, the web has increased distribution and the number of sellers, but it’s also driven down profit margins and introduced more foreign competition. To be sure, it’s not a zero sum game. Otherwise Bill Gates wouldn’t be so rich and hundreds of millions of people wouldn’t have immense computing power on their desktop.
Also, blogging by VCs isn’t the one good thing to come about in the industry over the last 25 years, but it’s in the top five. I went shopping for VC money 10 years ago, when a $4 million deal was very big and the typical VC fund was less than $100 million. It was awfully hard to get an introduction and even harder to learn the mechanics of dealmaking. In other words, VC in 1996 was much closer to the way things were in 1976 than they are now in 2006. (Though the wheels were in motion after Netscape’s IPO in 1995.)
Nowadays you can introduce yourself to and impress a VC remotely by putting up a smart blog and/or product that’s available over the web, VC funds of more than $1 billion are common, and it’s really easy to take a crash course in everything from term sheet negotiations to how your PowerPoint should look. The last 10 years have seen far greater change than the previous 20.
Which is not to say I don’t like VCs or the VC paradigm. As the something goes, some of my best friends are VCs. But, you know, it’s best to call a spade a spade. If there’s going to be a major innovation in small company finance, I suspect it will look more like mutual funds (aggregation of “the little guy’s” assets into the hands of a professional) or day trading (direct investing by “amateurs” at the expense of the professional) than the current model.
Which is really to say, I don’t think there ever will be a major innovation that dislodges or marginalizes VCs.
(As an aside, I first started learning about VC from a book called Risk and Reward by Thomas Doerflinger and Jack Rivkin. Unfortunately it’s now out of print and isn’t even listed on Amazon. It’s an excellent history of private capital that starts in the age of railroads and carries through to the PC revolution. They explain how private capital got its start, how it’s changed and the role of bubbles in its development. Even thought he book was published in 1987, the information is still very relevant.)