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Venture Capital Loses Spirit of Adventure

Adam Osborne, the hyperbolic computer entrepreneur whose sense of humor frequently outstrips his business sense, loved to ask friends, “What do you get when you cross a lemming with a sheep?”

The answer: A venture capitalist. During the heady, excessive 1980s--when any fast-talking technologist with an MBA or a legible business plan could get venture funding (and did)--that was a pretty good joke. Now it’s out of date.

In the 1990s, a venture capitalist is what you get when you cross a plucked chicken with an invertebrate. Venture Capital has become Wimp Capital.

The industry that helped create Intel, Apple Computer, Genentech, Cetus, Compaq, Lotus Development Corp., Sun Microsystems, Calgene and dozens of other influential, innovative and vital companies has lost its nerve. Instead of seeding start-ups and nurturing them into new industries, most “venture” capitalists have now retreated into the less risky regions of late-round financing.

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Instead of creating value, they’ve degenerated into portfolio managers. “There’s conservative investing in the later rounds,” says David Kelley, a partner in the Onset seed capital venture fund, “but no one’s really investing in start-ups.”

According to the Venture Capital Journal, venture investments are at their lowest level in nearly a decade. Overall funding dropped over 40% from $3.4 billion in 1989 to under $2 billion last year. “It’ll be half of that this year, if that,” asserts Kevin J. Kinsella, managing general partner of Avalon Ventures, a La Jolla-based venture capital firm.

What’s worse, start-ups--totally new ventures--are receiving a shrinking share of this contracting resource. Where start-ups once received about 20% of the venture capital pie, they’re now getting closer to 10%. So at the very time that dramatic technological change accelerates in fields ranging from biotechnology to new materials to software to new computer architectures to medical devices, American venture capital is evaporating.

“The attitude has shifted away from start-ups,” says Richard Schaffer, whose Computer Letter tracks venture capital investments in the silicon world. “People are more aware of the risk than the romance. The venture capitalists who still do start-ups do it because they’re rich enough to afford it.”

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Where venture capital was once a high-octane fuel driving the creation and commercialization of new technologies, it is now more like a lawn sprinkler under water rationing. The impact is more on the margins than at the center.

By any measure, venture capital was essential to launching the semiconductor industry, biotechnology and the personal computer hardware and software industries. It reshaped the global technological landscape of the 1980s. Not only did venture capital bring new technologies and companies to life, those companies and technologies forced existing businesses to transform themselves.

So what happened? “Because of the spectacular successes,” Avalon’s Kinsella says, “venture capital exhibited all the qualities of Gresham’s Law--bad money was chasing out the good. There were a lot of people playing in the game who had no business being there.”

These sheep/lemming venture capitalists funded enterprises such as the 36th disk drive company and the 12th electronic spreadsheet software start-up.

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“Start-up fratricide,” says John Doerr, a partner at Kleiner, Perkins, Caufield & Byers--one of the most successful venture firms. These firms didn’t invest; they binged. So returns to investors shriveled.

Conversely, the truly successful venture capitalists--the people who knew how to nurture companies--raised huge multimillion-dollar megafunds. Venture capital became more institutionalized.

“It takes just as much time to manage a $150,000 seed investment as a $10-million late round investment,” Computer Letter’s Schaffer says. Consequently, investment slid away from the riskier early round financings to the safer haven of later investments.

Worst of all, the culture of venture capital changed. Instead of going out and helping create companies, too many venture capitalists sat back on their haunches and passively examined the “deal flow"--editing business plans, making phone calls and delegating due diligence to MBAs who believed that they could get richer faster in Silicon Valley than on Wall Street.

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“It’s a damn tough business,” says Kinsella, who specializes in start-ups. “You have to work at it. . . . You can’t take August off.

“Most venture capitalists are not combing the halls of MIT, Stanford and Caltech looking for technology,” he adds. “They’re not reading the primary science journals. . . . They’re looking for a nicely packaged, ribboned business plan.”

The truly successful venture capitalists--people such as Arthur Rock (who helped launch Intel and Apple Computer) and the partners at Kleiner, Perkins (the firm that created Genentech and seeded Lotus and Sun Microsystems)--have always appreciated that venture capital means more than money. They’ve understood that the money has to be mixed with insight, operational expertise and the ability to help transform an entrepreneurial team into an organization that can sustain growth.

As Cabot Brown, a partner at Volpe, Welty & Co., a San Francisco-based investment banking firm, points out, the issue isn’t the quantity of money in start-ups--it’s the quality of those start-ups. “It’s better to have fewer, better capitalized and smarter start-ups,” he asserts.

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Perhaps. But you would think that there would be a lot of older and wiser people given all the venture capital investments of the 1980s. You would think that we would have an emerging generation of venture capitalists who could give us both quantity and quality. The numbers suggest otherwise. Sure, there are still a few investments in biotechnology but, by and large, venture capital is likely to be less of a positive force in this decade than it was in the last.

The change isn’t just cyclic; it’s structural. Increasingly, aspiring entrepreneurs are forced to look to foreign investors. For Americans concerned about industrial competitiveness and economic growth, venture capital’s inability to keep pace with technological opportunity offers an excellent reason to worry.


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