According to this Small Business Trends post, only 10% of all VC investment goes into seed and early stage companies. That is up from only about 5% in the mid-2000′s, but well below the 15-25% range that existed between 1980 and 2000. As everyone knows, this means that institutional VC’s have moved up market to become growth stage investors. Some have moved absurdly far up market…like Greylock and Kleiner and Andressen and Battery and others who invested $950 million in GroupOn in January valuing the company at $4.5 billion. Up in the thin air of multi-billion valuations on non-profitable companies, the only hope for financial happiness is an IPO.
And in January, 2011, IPO’s were starting to happen and it briefly appeared as if we were poised for the salvation of the public markets to begin lubricating the great venture capital funding mechanism. VC’s began bidding up the price of privately held companies and a stampede occurred. The greater-fool theory was at work when those big VC names began piling into these companies and a social media bubble was rapidly inflating as the public was soon going to have access to some of the most hyped companies that Silicon Valley could come up with. It looked like it was only going to be 6 months until they were out among the masses. I don’t know how much these investors thought they could get in return, but I’m sure they thought they could get it quick. Heck, the investment they made in January was a mere bridge loan.
If you don’t remember seeing the press release on the GroupOn funding, here is the most hyper-ventilated quote I’ve seen in a while. ”In the last year, Groupon has been called “the fastest growing company ever” by Forbes Magazine and “America’s best website” by one of Groupon’s television commercials. Two things wrong here.
First of all, their press release cited their own commercials to be declared America’s best web site? That’s funny, right?
The other thing wrong here is the focus on fast growth and not on profitability. In one of my June posts, I was explaining that a company with no profit model was not sustainable. This article by Rob Wheeler, though, says it so much better. Among the gems in his article is this: “The best way to manage a fledgling business is for managers to be impatient for profit but patient for growth.” I’m putting that quote on my office whiteboard.
Well, the true colors of this economy were revealed by mid-summer as the market froth flattened and taking a big, but unprofitable company public no longer looked like a good investment. The big VC’s are certainly big enough to miss a couple of IPO windows. But they’ve got to be wondering what those big bets are worth now. If I sound sarcastically pleased by this, I’m not. If I thought the experience would chane the industry, then I would be pleased. But I’m sure this wasn’t a big enough lesson to fix my concern with how the VC industry funds the growth of America.
My biggest concern is that all this cash is now being burned up sending me GroupOn emails that I’ll never see as my spam filter silently completes its mission. Companies that raise too much cash, find ways to spend it and in the social media world, they spend it on getting big instead of profitable. I can’t help but believe that this country of ours would be much better off had that $950 million been spent on 100 or 150 companies instead of one. And, thus, I finally get to my real point.
As the 1980s became the 1990s and became 2000, the percentage of VC money that went into SEED stage companies declined. Several VC’s reaped a huge harvest as the dot.com era ended. And that huge harvest, in my opinion, became an albatross around the neck of American venture investing. “Big fast” instead of “profitable first” became the driver. Big funds got huge and no longer looked at the small deals. Small funds either got big or began to disappear trying to get big. These big funds became the safest place for big LP’s to put their money and as the 2000s wore on, the big stuff crowded out the small stuff. It set in motion all sorts of other maneuvers and politics that began to change the legal and political landscape to support the big stuff at the expense of the little stuff. Patent law in this country is a good example.
The lumber companies learned decades ago that they live in a renewable business. When you cut down big trees, you plant new ones. The new ones are small and need more attention than the big ones. The VC industry needs to get oriented this way. Place your big bets. Harvest the old growth. But don’t tell me that making small investments costs you as much as making big investments. I am quite sure you can find ways to reduce your costs to make 10 $3 million investments instead of a single $30 million investment. I believe the soil is fertile and capable of building companies that are profitable first and big second.
We just need to nurture the seeds.