Thursday, September 9, 2010

Back to the Future? - How about Forward to the Past!

I just finished watching the first 4 episodes the so-called smackdown on TechCrunch featuring Dave McClure and Dave Hornik pissing at each other about the validity of the Super Angel vs. mainstream VC investment models.  Frankly there isn't much difference and my conclusion is that it was "much ado about nothing."  I think both models can work if they are scaled appropriately for the opportunity space and are well run by thoughtful and skilled professionals.

The mainstream venture model evolved over 40+ years to the point where huge firms investing huge funds became the norm.  The industry is massively overbuilt.  Returns have been negative for 10 years.  There is, and will continue to be, major downsizing.  Most (greater than 50%) of the mainstream firms will go away.  Many of the remaining firms will look to invest overseas.  There will never again be the kind of returns generated in the 90s because the technology industry is more mature, there is less white-space to conquer and paths to market are dominated by large and successful firms who extract a lot of the value.  Mainstream venture capital is a significantly tougher business than it was in the 1990s.  It will probably be 2015 or later before the industry is right-sized and modest positive returns start to reappear across the category.  Conclusion - nothing wrong with the model if it is sized to the opportunity space.

Super-angel funds are, in-fact, nothing of the sort.  Angels are investors invest their own money and, overwhelmingly, they made that money by being successsful entrepreneurs themselves.  Super-angels are really just micro VC funds.  They raise money just like mainstream VCs.  They just raise less money, invest in deals at lower valuations and look for exits in the sub - $100M range.  They also make the claims that they are "seasoned entrepreneurs" and provide special help to their portfolio companies (Hmmm - maybe).  Oddly this model looks EXACTLY like a the mainstream VC funds of the early 1980s.  Duh!!

There is a current opportunity for these funds because the mainstream firms have too much money under management to support small scale investment and small scale exits.  This space is nowhere near as overbuilt as mainstream venture capital so there is less of a supply/demand disequilibrium.   It is also supported by the ecology because the larger technology firms are having trouble innovating and are looking to buy early-stage innovation at early-stage prices.  Early-stage exits are a defeat for mainstream venture firms.  They are a victory for super-angel firms.  Conclusion - probably a better space in the short term for companies, limiteds and investors who are happy playing on a smaller chessboard and not committed to changing the world. 

What both firms have in common is that they exist to buy and sell equities.  They both buy from entrepreneurs and they both sell to acquirers or (very infrequently these days) to public shareholders.  They are, at their very core, traders.  Their job is to buy low and sell high.  This fundamental truth about the venture business informs every action they take whether mainstream or super-angel.  It also informs the culture of the businesses they create.  Everyone is looking for a pot of gold at the end of the rainbow - the life changing - all consuming - EXIT!!  The nature of their business model demands it.  These are close-end funds.  They have to return money - cash - to their investors and they have to do it in a fixed period of time.

In this blog over the next several months I am going to explore another - even more ancient - model for company creation.  This is art and practice of building and running a business for POSITIVE CASH FLOW.  Before there was venture capital and before there were EXITS, people built businesses to make money so they could pay their bills.  I will argue that re-discovering this model drives a corporate culture which is much healthier, more robust and more survivable than the EXIT-focused culture created by the venture capital model.  I will also argue that the cash flow model can engage the employees, the critical human capital asset of every business, to significantly greater efficacy than equity models.  Lastly, I will argue that we can modestly scale this model to the point that it can become a significant factor in new business creation.

We will follow the early success this model has had in a couple of businesses and, with luck, the later success it will have as the effort proceeds.   The first part of this adventure will start next week.

7 comments:

  1. As an entrepreneur, I think that you give too short thrift to the value that micro-VCs and regular VCs add. There are two fundamental differences between VCs and traders that you did not mention. First, 99% of public companies have some intrinsic value, whereas VCs have to decide if a startup can possibly have value at all. Second, VC funding can be positive sum (a funded startup is worth more than the sum of its parts) where equities trading is inherently zero sum.

    Cheers and many thanks for the interesting post!

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  2. This is going to be interesting; I'm looking forward to your articles.

    Has any state considered repealing its Blue Sky laws? Those laws were passed by states eighty years ago with the ostensible purpose of protecting us dumb yokels from making un-wise investments. Now, those same states run advertisements trying to convince us that it's a good idea to buy a state lottery ticket. So much for protecting us from our own foolishness.

    So, if we had some kind of state-based small stock exchanges, run on the internet, then ordinary folks could participate in capitalism at the ground floor. It would be a source of start-up money down at the grassroots level. Oh sure, there's some risks, and a few folks would get swindled, but the odds would be a lot better than the billions being poured into the lotteries. Plus, some companies would succeed and grow and employ people. Kind of like when this country started out . . .

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  3. Response to Mike Weiksner:

    Mike - Good point. Perhaps I should have referred to VCs as value-added traders. The amount of value they add is highly idiosyncratic and dependent of the individual involved but it can often be significant. The point I was trying to make, however, stands independently of the degree of value add. VCs still have to drive to an EXIT and they still focus their efforts on maximizing the share value at the time of the exit and not on conserving cash and making a traditionally healthy business. Hopefully I will expand on and better support this thesis in future posts.

    Bill Stensrud

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  4. In the end Dave McClure is a great marketer and an upstart. This is really a ploy to source the best deals by getting the best entrepreneurs to seek him out. I completely agree this whole debate is really much to do about nothing.

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  5. Great read. Thank you for sharing your thoughts. I look forward to future posts. Btw, no way to get your updates via Twitter? (your account looks lonely)

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