Has Venture Capital Failed America?

I’m at the Kauffman economic bloggers forum in Kansas City (you can view it on a live webcast if you want). One of the great joys of this forum is that it gives me a chance to meet people I otherwise would not come across, including Robert Cringeley, who is best known for his technology writings, but who also writes interesting stuff about finance. Here’s what he recently wrote on venture capital:

…let’s take a look at how venture capital has failed America….

The big VC hangover today was caused by this simple misunderstanding.  Firms thought they could scale-up their businesses and make even more money as a result.  If your $100 million venture fund is replaced by a $1 billion fund, why not just make every deal 10 times as big?  Because it doesn’t work that way.  Companies are over-capitalized.  Good deals are passed-over because they can’t absorb enough cash.  Money is wasted.  Founders are inevitably discarded and  alienated.  The rusted hulks of failed and over-funded startups are often forced to merge just to hide the real carnage.  Everybody ends of hating everybody else and that’s where we are today.

I think the venture capital industry  has been hit by the innovation shortfall.  Over the past ten years, the VCs put a lot of money into start-ups  that they thought was going to work.  Big bets in areas like biotech, MEMs and a variety of other cutting edge assets.

Unfortunately, the number of  big innovative wins over the past decade has been comparatively low, and the successful IPOs comparatively few.  To some unknown degree, there is a shared responsibility–a combination of government regulation that suppressed useful innovations; problems in the VC industry that led to funding the wrong companies; and bad coin flips on the technology, which meant that some things that we thought were going to work, didn’t–at least not yet.

Comments

  1. What specific govt regulation did you have in mind? They always point at Sarbanes-Oxley but the truth is they didn’t have startups making enough money to IPO for SOX to kick in. The real issue is a deep and fundamental economic stupidity, the biggest manifestation of which is a fantasy that one can “scale” up huge advertising-supported businesses and avoid having to charge your customers. As for VC specifically, I think the big problem is that you had a bunch of semiconductor VCs that somehow got repurposed to invest in dot.coms then biotech then cleantech. It’s questionable if they were ever very good at vetting semiconductor investments, they’ve done abysmally in the other fields. So one big part of the problem is the broken process that limited partners have used to choose their VCs. As for bad coin flips, that’s just a consequence of the aforementioned fundamentals: if it were really just luck, you might as well have monkeys do it. Actually, they’d probably do better. ;)

  2. There is a lot of innovation that probably doesn’t get the “innovation” label because it doesn’t harness previously unused principles of physics etc. to achieve new effects, i.e. it doesn’t have that leaps-and-bounds or “mad scientist” quality; or the innovation is in an area that is not very sexy and telegenic. On the latter note, it seems the public focus in the US has shifted away from the (non-computer?) sci/tech that was considered cool before computers became mainstream.

    But perhaps I’m missing the topic and the topic is innovation that nets big visible ROIs.

    In the field of software, and particularly internet based services, that Ajay is alluding to one set of “problems” seems to be a combination of a high discretionality of the offerings and relatively low barriers to entry leading to easy substitution.

    Then there is the other type of innovation where substantial upfront and/or sustained investment is needed to push the envelope further where the bar is already raised. Some classes of innovations may be so costly/risky, or require such a scale, or require a market arranged by the government, that the private sector will not attempt them (unlike military tech where said market is being arranged). And for government to make substantial investment like let’s say between WW2 and the 80’s seems to be impossible because of ideological bias.

  3. We can decry the lack of meaningful research to validate hypotheses about innovation, but we can still generate new hypotheses, so here’s one.

    In the venture capital arena, the disparity in knowledge between those with the money and those proposing to make good returns with it has grown too great. The big payoff in technology innovation is already so far in the past that it does not spawn and smartly fund new technology innovators. Some of the more technically innovative companies of the past slipped under the control of management that did not actually revere technology; some still have lots of cash and enough failed experience trying to incubate that they would rather turn the cash over to financiers. Financial innovators and those who’ve benefited enough to actively seek new opportunities for their money are a hodge podge collection hardly capable of judging and guiding anything from any angle other than the financial one, which is pretty difficult at the proposal and early returns stage, especially where science and technology are concerned.

    In agreement with cm above, I sense that sci/tech has lost its coolness to the public at large. I’m full of unprovable opinions about the evidence of it and why that came to be, but I’ll spare you.

    Financial innovation shifts talent and money away from whole industries, while offering little to nothing that any individual could build upon and put before a venture capitalist.

    Health care cries out for process efficiency innovation, but for some reason that probably relates to the ability to pass on cost increases, those insiders who should be proposing the great ideas aren’t.

    Finally and probably needless to say, outsized housing and health care inflation in the context of stagnant wages have conspired to decrease the public’s discretionary dollars available to provide the returns that innovators need. Innovation that is so mundane as to skip the need for venture capitalists to take a cut is more the order of the day — Craig’s List, for example.

  4. Incomes haven’t been rising for most people. That means discretionary income is flat or falling. You can’t get an ROI if there’s no one to buy your products.. Also, flat incomes mean cheaper labor, and that means less need for innovation. There’s no return on the investment or the consumer side. It’s a double whammy. Throw in the lack of government industrial policy, like that of the 50s through 70s, and it’s no wonder finance is just bubble after bubble with investors looking for returns.

    • This fits in with your next post about how private sector employees are underpaid when compared with public sector employees.

  5. cm, given how every minor web startup is hailed as some great new innovation, I don’t see that the innovation label is being given out too rarely, if anything it’s the opposite. Yes, public focus has shifted to computing, as that’s precisely where we are making and can make the most gains today, your point is? High discretionality? Not sure what you mean by that but as for easy substitution, that’s a fact of life for almost all business nowadays, with globalization and online services. It’s nice that you continue to fantasize about these hypothetical breakthrough sectors that require giant govt investment in order to start up, particularly given the trillions floating around world markets today looking for places to be invested, but that’s easily shot down by asking for an example, of which you provide none.

    LAO, I’m not going to bother trying to parse the mishmash of thoughts you’ve put down except for the last bit about “housing and health care inflation.” Housing prices rose because consumers bid them up, there was nothing stopping them from moving farther away or renting: they chose to spend that money on housing as opposed to the latest gadgets, implying they preferred housing. As for health care inflation, those same consumers chose to continue the current horrible third-party medical payment system by voting for Obama, when McCain clearly wanted to move the system towards non-employer insurance and health savings accounts, which Obama demagogued with his “it will kill the current employer-based system” comments during their debate. As long as consumers continue to make such idiotic decisions, they will keep paying the price for their stupidity.

    Kaleberg, your comments are so ignorant, I can’t even start to whack away at them. I suggest you actually read some economics before you attempt such analysis or worse, start making policy suggestions.

    • Ajay, you seem to be incapable of or utterly disinterested in civil discourse. There is no point to respond to you on any subject matter.

      • cm, I don’t think you understand what civil discourse means, you seem to think it means that everybody must always agree with you. There’s nothing uncivil about pointing out that you’re peddling a fantasy of extremely expensive govt-funded breakthroughs. As usual, you make silly and unfounded assertions that have no connection to reality.

  6. The Fifth Horseman says:

    It is not VC that has failed America.

    It is America (Washington) that has failed VC.

    SarBox made IPOs harder.
    The US has a Capital Gains tax MUCH, MUCH higher than India or China.
    The US makes it very hard for highly skilled immigrants to settle here (6-12 year process of getting US citizenship).

    Washington has failed the innovation economy, not the other way around.

  7. Maybe it is a stretch to connect “too big to fail” institutions to venture capital behavior, but at least regarding the innovation shortfall, the Fed Kansas City president, Thomas Hoenig, in an address to the U.S. Chamber of Commerce, seems to have decided that he knows the reason:

    “When the markets are no longer competitive, firms become a monopoly or an oligopoly and it matters more who you know than what you know. Then, the economy loses its ability to innovate and succeed. When the market perceives an unfair advantage of some over others, the very foundation of the economic system is compromised.”

    The Chamber of Commerce is an odd place to make these points. I am fond of pointing out that Wal-Mart is too big to fail. If economic or monetary policy suddenly upset its grip on low prices based on massive importation, then a significant tier of society would be in desperate trouble, so Wal-Mart can pretty much be assured that nothing is going to change. The same could be said of some other national chains. That sets the standard for any innovator aiming to divert consumer dollars in a big way. Meanwhile, U.S. corporations are sitting on more than $900 billion in cash that they apparently find more profitable to hold than to risk on innovation.

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