Forget Ponzi Schemes: Try Venture Capital!
I was at a party in Northern California last weekend. It was a very good party. These folks are expert drinkers. They bend to the task year-in, year-out, weekend after weekend, regardless of the season. Fortunately, they're merry drunks and like each other's company. They've gone through it all together. Marriages. Divorces. Triumphs and troubles with kids. And most of all, the inflations and explosions of the various tech bubbles that have swept their world over the last 20 years or so.
Although you wouldn't know it from all the good-natured laughter and noise, on Saturday night, at least 25% of the room is now unemployed. Some are journalists who have been laid off from their newspapers or magazines. Others were technology officers of companies that have expired in the current red tide. A pretty fair number were entrepreneurs who have been crunched by the temporary fall of venture capitalism.
Which brings me to a conclusion I've reached in this post MySpace, post YouTube, pre-Facebook and Twitter transactional universe. Forget the occasional Ponzi scheme. Venture capitalism may be the greatest scam going.
Not long ago I asked an investment banking friend of mine how many VC deals he knew of in the tech sector over the last ten years or so. A thousand, he said. And how many are still around and doing business? I inquired. Three? he replied. This may be just Darwin at work. But I don't think so. It's something baked into the DNA of the venture capitalism game. Look at the model:
-- I have money, which I give to you to pursue your little idea.
-- You develop your idea to the point where it can be sold to somebody who has none.
-- During that time, I can do whatever I want with you to grow your bulb into a tulip I can sell.
-- I then sell your pretty flower, take all my money back and then some. The guys who grew the thing get a little taste, but are for the most part left holding the bag.
-- The tiny, wafer-thin notion wilts inside the big hothouse that acquired it, generating the requirement for a massive write-down.
-- I'm still rich even though nobody else involved in this is.
This brings me to Matt, my pal who threw the party. He's an entrepreneur. His business partner was there, too. They're both unemployed. They had a very good little business going for a while, though. Something about brokering space to companies that require it. Whatever. Classic tasty concept. VCs came along. Snapped them up. They were rich for a while, on paper. But they had to work and couldn't really monetize their supposed "wealth."
After a while, of course, the inevitable happened. The VCs sold their company to a nice corporation that wanted to pair what they do with some software applications that they had also just acquired. Their VC walked away with the money. My friend stayed on. It was, in his mind at least, still his baby.
"The problem was that the software they made us use wasn't scaleable," he told me sadly over his sixteenth beer. To be fair, there was that pound of paella we each consumed to soak it up. "We had to use it... but it wasn't... scaleable," he repeatedly sadly. "And the whole thing just... stopped working. Ah, well."
I don't have to tell you the only one who walked away with all the dough from that sad story. Whatever its current difficulties, let it never be said that capitalism is bad business for the guys holding the checkbook.
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Name names. We are trying to get the big picture.
A few decades ago I did a study of Venture Capital for a unit of the Department of Commerce. In those days if a VC invested in ten companies; one would typically go public or be sold to a larger firm. One would go bankrupt. The other eight would become what they called among themselves "the living dead". These were firms that survived and generated products and jobs, but they were not glamorous or profitable enough to do more than repay bank debt. It was that scenario that resulted in VCs taking a very large bite of the equity in any firm they financed. Since it was that one in ten that gave them their return.
We need a new way to finance enterprise that does not depend on the big winners, but opens the door to management help and bank debt liquidity in return for a modest equity bite. Bank risk can be insured. SBA tries to do this but is not staffed by entrepreneurial individuals.
The current economic crisis is lighting up the weak points in our economy and some might be strengthened in the aftermath. But, there is a huge hole where the financing of enterprise is concerned.
A bank entrepreneur who initially funded our Company developed a possible new approach. However, he passed away before it was possible to try it. Perhaps one day in the future it will take root.
Thanks for this post.
Why do the Viet Cong still continue to get the blame?
Viet Cong, Venture Capitalists - both destroy everything they touch..
In the world of entrepreneurs, angels, and venture capitalists, money ALWAYS does the talking.
The money men take the risk and make it happen.
One of the biggest mistakes entrepreneurs make is to become too attached to their own deals. As you say, your friend held on to "his baby."
'The money men take the risk and make it happen.'
Unwittingly, you may have coined the emptiest phrase of the decade.
"One of the biggest mistakes entrepreneurs make is to become too attached to their own deals."
Think about the illogic of that for a moment.
By necessity an entrepreneur is likely the inventor. (I'll use singular pronouns, but usually it's a team of people). The inventor identifies a problem, works for years on a solution, and envisions a unique future. They do this on their own dime until they can convince investors of the potential to actually build the device and a company.
After all of this insight, inspiration, problem-solving, effort, sacrifice and sweat, by definition the entrepreneurs are attached to their "deal." It's literally the same as saying a mother is attached to her baby.
To be sure, we could choose to create the next Pet Rock or farting iPhone application. We could sell "medicinal marijuana" or perhaps sell heroin to the bored rich children of VCs. Swapping one such deal for another is no big deal.
On the other hand we could invent a life-saving breast cancer surgery technology or significantly reduce hospitalization for the 125 million Americans with chronic diseases. I think you'd be attached to those deals, wouldn't you?
I'm pretty motivated by money, but the Big Why do we get up every day is to create something profound AND make money AND then do it again. Not everyone can be a Dean Kamen, but I'd sure like to try.
AHHHH! Most of you don't even know what you are talking about. I guess people who risk their capital should not be rewarded for their risk. VC plays an important role in building jobs, wealth, and keeping our economy running. They won't touch a company unless they believe in it, and if they continue to bet on loser companies they will be out of business because they will lose all their investors.
Somebody earlier mentioned Romney because he is so evil for making money with Bain Capital. Maybe we should compare apples to apples. Romney responsible for 1000's of jobs through the companies he built and helped grow "IndieBlue" 0. It's funny how Romney is brought up in the discussion of evil VC but Al Gore never was. Al Gore net worth has grown an to an estimated 100 million from 2 million in 2000 because of his involvement in the over exaggerated Global Warming.
http://gatewaypundit.blogspot.com/2009/04/it-pays-to-go-green-al-gores-net-worth.html
I only tell you this because most of his money has come through working with and for the evil VC firms. http://www.msnbc.msn.com/id/21756222/
If VC was so bad why did Al Gore join one http://www.msnbc.msn.com/id/21756222/
I guess it's okay to become rich off of something that YOU believe in.
And I guess people who contribute their ideas, intelligence, and hard work should be equally rewarded to those who provide capital. And quite frankly that is true whatever Al Gore might think.
if you want to be rewarded for your hard work and intelligence, STOP taking partners or anyone else having a stake in your business.
GROW it to be whatever size you want and cash it out. sell it and whatever you get it in the market is your prize for your effort.
just dont tag along investors for the ride :) but then you wanna get big dont cha. get along some investors to contribute money to your enterprise.
well guess what? cant have it both ways
does comparing apples to apples require in particular to compare reality to forecast - as opposed to comparing dreams to marketing slogans to fictions to ideologies?
just asking.
Of course there should be VC. The question is: how to do it and how to contain the abuse.
try some apple to apple comparisons. It'll help.
Hard work? All they do is supply cash, often someone else's cash, and take the rewards for other peoples work. They act as if throwing money at someone else's scheme takes some kind of specialized skill. They did such a great job in the e-bust in starting companies that had no hope of ever generating a dollar in income.
But don't worry, the big firms get their cut up front and on the back end. They were usually the only ones to make money in these deals. They are no different than the private investment firms or leveraged buyout firms who are only concerned with maximizing their cash, not caring whether the company survives or not.
Really, it is all pretty simple. Make your product work before you go get money.
I mean, really work. Yes, take no salary, be your own VC, until your product works and then, when you do take the cash, don't do it for 10% ownership stake. Let them buy in for a 10% ownership stake.
It takes longer, but well worth it.
good sensible post. !!
if you want your own reward, NO INVESTORS. do it all on your own and then cash out by selling it in the market. no body will be asking for a slice of the pie (or most of the pie).
A noble concept and good advice, especially about making it work.
Easy if you're doing software but pretty close to impossible with medical devices that have to clear clinical trials, even with NIH grants.
BTW: Any experienced VC is going to demand about 40% of the company in the first round. Which also means you want to make sure you have a big valuation before taking a penny from them.
Late reply...yep, very true about the software vs. medical device aspect.
As for the 40%, that is typical, though their are some smaller players that will go lower (or higher)...but their valuations suck....
Treat the guy who delivers your pizza graciously. Before 9/15/08, he promoted VC firms.
I always enjoy Mr. Bing's articles, but on this one, I have kindofa dumb question:
If someone has a business/technology idea they want to develop, and are not fortunate enough be to wealthy themselves, or to have rich friends of family . . . where can they go?
Oh, I have another dumb question:
Of all of these startups, how many were just simply bad ideas that should never have been funded in the first place (i.e., they were only fund due to hi-tech hysteria), and how many were potentially good (i.e., profitable) ideas that got messed up by the VCs, or by the companies to which the VCs sold the startups?
It's neither about the business model itself - which is perfectly fine and dandy - nor about the losers who are trying to abuse it - who are going nowhere fast anyway.
It's about the sad fact that the implementation of the (initially uplifting) idea leads to so much nonsense.
Lendall, never be afraid to ask questions, a dumb question is one that's never asked.
Realistically, it takes a team of people of very diverse skills to develop an invention/idea into a company. There is more FREE information available today than ever. If someone wants you to pay money for this information, run the other way! It's a lot easier if you're in Silicon Valley where every day of the week there are free or almost free (pay for the food) events for networking and learning. The best ones are at top universities where you can crash an event, schmooze and eat for free. What's the worst they're going to do - throw you out? Be polite, listen, network, pose interesting questions, and you, too, can be transformed.
As to bad idea/good idea: Typically there are a few good ideas that EVERYONE tries to pursue because it's easy to raise money. Today it's green tech. Inevitably a lot of people get it very wrong, but a few make some big money and even fewer transform the world. Go back in time and there was Web 2.0, dot com, interactive television, interactive CD-ROMs, personal computers, microprocessors, RAM, integrated circuits....to name a few.
Back in the eighties when I first got out of grad school I went to work for a large high tech corporation of the "we do everything variety". Everything from war machines to elevators (hint for the cognoscenti) was our business. I worked in the robotics laboratory with a guy who was really anxious to start his own company but he didn't want to use venture capitalists. He wanted what was called "angel financing" where a single investor would make an arrangement to support the business until it could support itself. Presumably with a better split for the entrepreneur/inventor. This guy always summed up his distaste for venture capitalists with a joke:
Q: "How many venture capitalists does it take to screw in a light bulb?"
A: "None. Venture capitalists don't screw light bulbs, they screw engineers".
This was back in the very early 80s. Same today.
Yeah, Damn VCs. Always holding guns to entrepeneuer's heads to force them to take their 'dirty' money. How dare we allow VCs to keep up this racket, funding the dreams of entrepreneuers! Enabling the development of new technology and ideas!
Horrible people.
And the poor teachers/unions/public pension funds that have dared to put 10% in this 'high risk' investment - good golly, despite getting 20% returns during the good years...they've actually had some bad ones too! Oh my gosh, how dare they allocate a small % of their funds into a high risk category! Its called INVESTING. There is some risk, but VCs can provide huge rewards.
Wow. I'm not sure what the arguments here are...would people prefer that VCs not exist? No one, and I mean no one is EVER forced to take VC money...they just allow small companies to grow much faster than they could without $$$. Yeah, strings are attached, but I personally know many entrepreneuers who are quite wealthy because of, not despite, VCs. Its part of the american dream.
I had a friend who started a compny with VC funds.
Things grew, and eventually, the VCs organized the sale of the company to a larger one.
Sale price $1 Million dollars. Consulting fee charged by VCs to larger company $10 Million dollars.
My friend's 20% was enough to get him through buisness school afterwords, but that still does not sound like a fair deal to me.
Normally, the first deal is the buy into the club. After you let them take you like that, you are supposed to arrange a deal working for them for 2-3 years, so you can do the same things to other people in the space.
Depends, if you like playing financial games, VC is the way to go. If you like making products and companies, stick to running a company.
Somehow, I don't think that story is going to find it's way into a Romney 2012 campaign add.
excellent as usual
Allow me to further describe how the scam works and why it is so dangerous. Where do the VC's get the money to carry out the scam? The money to fund these worthless money laundering start-ups? Certainly they don't risk their own money.
Of course not, they risk the retirements of school teachers, auto workers, janitors, cops and firefighters. The vast majority of VC funding comes from pension funds. Public, private, and union pension funds have given VC's hundreds of billions of dollars over recent years, by allocating 10% or more, of their members retirement money into the highest risk investments possible.
http://www.iplanretirement.com/retirementblog/pension-fund-buys-yacht/
VC's also risk the money of college students and professors. Many private college and university endowments were, and still are, heavily invested in Venture capital funds. It is a big scam. A scam that endangers the retirements and education of millions of unknowing Americans.
VC's don't "get" the money from pension fund and endowments. They are GIVEN these funds by the trustees of these institutions.
In return, they profit handsomely during the good times. In the bad times, they lose, just like everyone else who put their money at RISK.
It's only a scam if a) the government forces you into it or b) the VC's lie about the nature of the risk.
If it's the latter, they go to jail. If it's the former, well, the Democrats will call you "patriotic".
Thank god I never bought a color TV. You just taught me the sublime truth that the world is black-and-white.
Thank you so much.
You're even more naive than RetireGreen.
VCs STILL get paid in bad times, they don't lose anything other than opportunity cost nor are they at risk if all they're doing is managing someone else's money.
VCs are compensated in two ways. 1) They generally are paid 2% "management fee" for all funds under management. Crony capitalism results in partners making half a million a year in management fees and making ZERO investments. 2) They get 20% of the profits from a fund called, "The Carry." Until recently the Carry was taxed as long term capital gain even though it wasn't their capital nor their shares at risk.
Entrepreneurs have their shares at risk, but they don't cash out when a company iss old, usually they have to stick around for 1-5 years earn-out period.
Limited Investors, such as retirement funds, have their investments at risk. If the VCs, who are general partners, invest their own money along with the limited partners, then their pro rata share should get long term capital gain taxation.
Regardless, entrepreneurs are in the weakest position.
Can you show me a VC who's gone to jail? Madoff was not a VC.
And yes, I have raised money from angel investors and venture capitalists with two exits to my credit. And I vote Democratic, as does one of the top VCs on the planet.
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