Recent economic events are creating an innovation gap in the United States. Early stage Venture Capitalists (VCs) are cutting way back on early stage companies to focus on later state and even already public companies. This exodus from early stage company investment will create an innovation gap that puts the entire US entrepreneur system in jeopardy. This over reaction by VCs to tough economic times reinforces the trend that VCs are neither. Rather, the trends seem to indicate that the traditional VC model of going for the big win (or 10 x return) starting to breakdown and you find more and more VC’s acting like investment managers instead of funders of innovation projects.
The irony of this new trend is that this is the perfect time to invest in early stage and new technology. Labor is widely available, facilities are cheap and several government incentives also sweeten the pot. So, why are the number of new ventures funded down so significantly when this is the optimum time to fund them. The surprising answer is that VCs are having trouble raising funds themselves. Their Limited Partners (LPs) are reluctant to have them draw down on already committed funds because those funds are either tied up in depressed assets or they just don’t have the money.
Solving the innovation gap will take a fundamental change in the way entrepreneur’s are funded. No longer can the focus be on the big wins because while big wins will come, the focus just on creating them saps fundamentally solid companies from expansion and growth. When the focus is only on the big win, resources tend to get pilled on not because of a fundamentally sound business idea but rather because the marketplace is hot and statistically, any bets in a hot market, have a higher probability of the big win. Sacrificing the solid, ongoing concern for the big win focus needs to change if the US wants to remain innovation competitive.
The big win mentality has its roots in the recent past. During the booming 2000’s, Initial Public Offerings (IPOs) were plentiful and the red hot Internet sector provided handsome returns just because of the New Economy that threw fundamentals like profit out the window. Then the bubble burst, those New Economy stocks burst with it and IPOs dried up. The only viable exit left was the merger, which tend to garner a low return, owing to the cold hard fact that profitable companies look at fundamentals more than hype. This new reality still did de-emphasize the big win mantra and investment continued to pour into hot markets that might have already been saturated with yet another better mouse trap.
When the decline of Mergers and Acquisitions (M&A) finally came, exits for venture backed companies dried up and the dilemma of how to get the money out surfaced. This is a real problem since in order for an entrepreneur culture to thrive, there has to be a consistent source of exits so that investors can realize a return. This is fundamental to the capitalists system. This does not mean that an entrepreneurial culture should only maximize the return of investors at the expense of other stakeholders such as society and the environment. Exists need to happen and the best way to maximize them is to build fundamentally solid companies that provide goods and services that garner a profitable return regardless of the marketplace hype while being good stewards to broader stakeholders. Returning to this fundamental company building is the only way that innovation can continue to thrive and investors can realize good returns. The days of maximizing shareholder value will not garner the same returns as the present day reality that maximizing stakeholders value is the only way to build profitable, sustainable companies that last longer than the over hyped market.