The VC Trap
Paul Kedrosky is easily my favorite blogger. The topics -- VC, investing, skeptical optimism and the internet -- are my favorites.
His posts and material are provocative, insightful and clever.
And he's always looking at things from a new angle.
Today's no exception with this post on The VC Trap, Part II:
A reader (thanks Brian!) sent in the following as an email, and he has nicely agreed to allow me to repurpose it as a post:After reading your blog post on why VCs seem to desire only startups with proven teams, tech, biz models, etc., I realized why the bubble happened and why the crash was inevitable despite the valid projections on where the Internet/Web would be right about now (b/c of broadband, wireless, faster chips, increased storage, et al).
Since my theory only touches upon consumer-facing startups it may or may not pertain to infrastructure and enterprise plays and despite my generalization, there are exceptions to every rule.
To follow upon your conversation with the startup CEO you spoke to, this is my outline of why things happened the way they did and will continue to happen in the same manner.
The first entrepreneur, call him Radical Joe, has a newfangled idea about a technology or business model. Radical Joe, not in step with conventional thinking, may lack the presumptive network, pedigree, or attitude of a VC's ideal entrepreneur, so when he pitches his idea to investors he is turned down flat. Despite the rejection, Radical Joe bootstraps his startup with F&F money. Lo and behold, the idea takes off and the business becomes a genuine hit. Now Radical Joe is celebrated in the press and lands on the cover of Business 2.0, if not Time.
VCs, cursing themselves for not funding Radical Joe, plot their revenge. If a nobody like Radical Joe could succeed, they rationalize, how much better could a startup do staffed with A-level talent and stuffed with a boatload of cash? So, they recruit the usual suspects (big tech ex-managers/retired CEOs/I-Bankers/entrepreneurs-in-residence) to run me-too startups into a now "proven" market (because of Radical Joe's perseverance). The startups are invariably overcapitalized and spend money like drunken sailors; though the rational is always justified as a need to steal market share away from Radical Joe's breakthrough (but then-unloved) idea. While consumers often benefit from this tremendous competition with goods and services often given away for free (but made up in advertising), it wrecks company balance sheets, including Radical Joe's; wiping out late-to-the-party investors when the bubble inevitably bursts.
Newly formed VCs who invested just as the punch bowl was taken away from the party get hammered in the downturn. They bemoan about how all this money poured into risky copycat startups created brutal competition which left few winners standing with their investments among the losers. To placate their angry LPs VCs say they'll be more disciplined as a way to better insulate their risk the next time (if they're still around). That usually means, as you guessed it, funding only perfected technologies with superior management staffing the startups in a "proven" growth market.
Can you say deja vu?
Nice work, Paul!
