3 Grievances on the VC Industry

The VC conference that I attended earlier this week gave me a very different view of venture capital. I was expecting to hear a lot more from the fund managers regarding their investing strategies. There were a few things that really got to me, and made me wonder whether some of the people in the room actually knew what they were talking about. Here is a list of grievance that I have regarding the VC industry:

1. No Real Investment Strategy. Quite a few VCs in the room were asked the question "What kind of companies do you normally fund?" The answer that a lot of them gave was that they were looking for 'anything and everything', as long as they were 'disruptive technologies.' Now, there are A LOT of VC-backed companies out there that do not even mildly look disruptive. Flash video technology was disruptive- it affected the movie and music industries and created a revolution in personal expression in the internet sphere. The IPhone is being disruptive- Apple single-handedly changed the idea of what a phone should be and is on the way to beating RIM and other competitors into the ground. A social network twist that allows you to share musical ideas is NOT going to disrupt anything! Yet VCs keep putting money into these start-ups, which in turn fuels more non-disruptive start-ups to emerge (no wonder there is too much money chasing too few good deals!) This shows that either a) they don't have an investment strategy or b) they are not following their investment strategy. This conclusion got me thinking and I arrived at my second grievance.
2. They are essentially gambling. If you set out at the start to get a success rate of 10-20% something is seriously wrong. If your investment strategy is to make picks and get that low a rate I equate it to gambling (even a random toss of the die gives you a 16% chance of success.) Now, I understand that the model has been proven to work, people have made money, etc. etc. Yet I can't help but wonder how anyone could possibly think that this current model is the right one to use going forward. Just because this has been the typical result historically doesn't justify it being a future goal. This thought led me to yet another realization and, indeed, another grievance.
3. Misalignment of interests. The objective of the fund is to make money in x years (typically 6). This time constraint and the large funds that are raised forces VCs to make investments no matter what to make sure they get a large return for their investors (even if they haven't come across the next disruptive wonder) I believe that this is a misalignment of interests, as VCs are pushed to use their money unwisely, resulting in the ridiculous 1/10 success rate. Again, this system just doesn't seem right.
   

Now let's get back to the infamous complaint of there being 'too much money chasing too few good deals'. The first reaction that I had to this statement was that not enough innovation must be happening- after all, given the billions of dollars out thee one would expect innovation to increase. Yet in retrospect I wonder whether this excess money is playing some role in stifling innovation by encouraging people to create moderate innovations in an effort to make a quick buck. If this is true, it suggests that VCs are actually doing damage to themselves because of the aforementioned grievances. Then what are some possible solutions to these problems?

1. Give VCs less money. If they have less cash they will have to make every dollar count. No more of this 1/10 success rate business. Investment strategies will have to be clearly defined and followed to the letter. With this much scrutiny, entrepreneurs will be pushed to create true breakthroughs
2. Make VCs set higher targets... if VCs attain higher success rates because they are no longer swimming in cash then losses should go down and expected returns should go up. This means that LPs should demand higher returns on their capital and push the VC partners to invest their money better.
   

No VC at the conference really addressed these questions completely (admittedly, I only confronted 2 people on the topic) so I'd be interested in hearing peoples' thoughts on this.

My Two Favorite Web Generators

Over the past couple weeks of looking around the blogosphere, watching videos and talking to entrepreneurs I came across two great website that I wanted to share:

1. The Dot-o-mator: I published a post a while back about the importance of naming your company early on. After not having followed my own advice for the past two weeks (and after suffering one of the pitfalls I'd predicted at a VC conference) I decided to get it over with. Enter the Dot-o-mator. This is a fantastic web-app that helps you generate a list of names and then automatically check for domain name availability. The programmer let's you specify the prefix/suffix and then lets you merge this with prefixes/suffixes from selected categories. So for example, if you are creating a sports website an want a 'Tech' name, you get results like soccercast, soccerfeed, soccerwire, etc. etc. etc. The author did a great job in thinking up all of the popular suffixes that are out there and then categorizing them. A lot of fun, very easy, give it a shot.
2. Dilbert Mission Statement Generator: I get the feeling that I'm one of the few people in the world who hadn't seen this before, but in case there are more of me out there this is a must-see web app. Guy Kawasaki referred to this as a way to 'save $25,000', making fun of how inane corporate mission statements are. I think it's really clever and amusing. Enjoy.
   

What Country is it Easiest to do Business In?

It's not the United States- at least, according to the International Finance Corporation's Doing Business Report.

The report breaks down the process of 'doing business' into several categories, including starting a business, registering property, getting credit, protecting investors, employing workers, trading across borders, etc. What's really interesting is that it also gives the breakdown of each category (for example, for the 'starting a business' category you can see that the metrics are how many procedures it takes to start-up, the average number of days, cost and minimum paid in capital)

It's interesting to see how high China is ranked, both in relation to the developed economies and the emerging markets. Though it ranks quite low in starting a business, acquiring licenses and registering property, it is ranked 3 or higher for getting credit, protecting investors, conducting trade and paying taxes. I commend the IFC for making this information public, as it is a valuable resource for businessmen and policy makers alike.

Venture Capital in the Emerging Markets

I attended a conference called Venture Capital in the Emerging Markets today in Istanbul, hosted by a local VC named Golden Horn Ventures. I was really looking forward to hearing what everyone had to say about the state of VC/innovation in emerging markets outside the BRIC countries. The panels were arranged such that they addressed three viewpoints- Funds of VC Funds, VC funds and entrepreneurs. These were my key takeaways:

• Plenty of opportunity to grow/capture the market for goods and services as emerging economies develop and household incomes rise.
• Legal barriers are still a pressing concern for investors and entrepreneurs. I had no idea how long the list of grievances was before today. VCs were concerned with matters like enforceability of contracts (the IFC rep noted that they had a whole portfolio in Russia because of this) and the infrastructure in place to facilitate investing/exiting. Entrepreneurs complained about the inability to create different classes of stock and create stock options within some emerging markets’ legal systems.
• Exits are difficult. The normal exits come through either IPO or M&A, yet these are much more difficult in emerging markets. In fact, a Turkish PE fund manager noted that a preferred exit for their company was to sell the shares back to the entrepreneurs! However, the possibility of exit through M&A is increasing as a result of multinational firms seeking to expand into emerging markets.
• Private Equity will need to become established before Venture Capital. A panelist noted that the lucrative deals being sourced by Private Equity funds have roughly the same IRR as those of VC deals in some emerging markets. Hence PE is a much more preferable option for investors.
• There is a lack of relevant VC/Entrepreneur experience. One of the panelists referred to this as a ‘chicken and egg’ problem. Nobody wants to invest in regions where VCs/entrepreneurs don’t have prior experience, and yet these regions have a lot of first time entrepreneurs who can’t gain experience without acquiring funding.

• It may take time for a new generation of entrepreneurs to out of these markets. Many attendants noted that cultural norms make it very difficult for entrepreneurs to come out of emerging economies. For example, not all cultures are as accepting of failure as much as the Americans and there is a huge amount of social pressure to stay away from high-risk business ventures.

Overall I was very surprised to see how new the concept of early stage investing was to the local VCs. It was very easy to tell who had worked previously in Europe and America and some investors openly admitted that they were unable to fund the kinds of companies that American companies did since they did not know what risks to take… which makes me wonder what the BRIC countries are doing right, that is facilitating so much VC/PE activity. I’ll give an update here when I find the answer.

Update- Morgan Stanley Internet Trends '08!

I was able to find the '08 version to the Morgan Stanley Internet Trends Report (published just in March) and I've embedded it for your viewing pleasure.

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Some interesting things that catch the eye:

• A quote from Google's CIO saying that consumer software is now better than enterprise software in terms of reliability, security and speed.
  
• 15% of internet traffic belongs to social networking- a category that did not even exist in the report 3 years ago! (Youtube + Facebook have more page views than Google and Yahoo combined)
• Online ad spending per household is still significantly lower than newspaper spending but has grown 26% Y/Y while Newspaper advertising fell 7%.
• Some interesting insights on how Facebook's interface has made it more successful in growing than myspace (slide 15)
• The mobile platform is a growing opportunity, especially outside the western countries where developing landlines have skipped building landlines in favor of wireless services.