Selling to the Crazies

From Jim Flowers, director of business acceleration center VT KnowledgeWorks, and author of the blog So you want to launch a business…

It really is a shame that it takes a major economic disaster to show Web 2.0 investors and managers that they were risking too much money on questionable opportunities.  They should have known much earlier like before they bloated companies dependent on transient social behavior patterns rather than on compelling end-user needs.  Apparently the first Internet bubble has been forgotten. 

Please consider these unfair generalizations:

  • Venture capitalists are not investors.  They are speculators.  Do the math.  As a group, they readily admit that they expect roughly half their portfolio companies to fail.  That means that a coin flip would probably do as well at “picking winners.”  They further admit/report that their overall profits are derived from fewer than 10% of their portfolio companies.   The few winners win so big that their success covers all the bad picks – but only in a crazy stock market that overvalues unique visitors to the tune of triple digit earnings multiples.  For every Google, there are literally hundreds of venture-funded failures.
  • Venture capitalist are lazy.  Aren’t we all?  They would rather invest $5 million than $500,000, even if the company does not need $5 million.  Why?  Because they have so much money to invest that at $500,000 a pop, they would never get the portfolio completed before the fund partnership’s life was over.  And because it takes just as much work to oversee a $500,000 investment as a $5,000,000 investment.  Oops.  Did I say investment?  Sorry, I didn’t mean investment.  I meant bet.
  • What’s worse?  They are betting other people’s money.  The general partners in venture funds typically provide only a tiny fraction of the at-risk capital.  For this they get a 2% annual management fee (that’s 2% of the total invested capital) plus 20% of all the profits.
  • So – we have had lazy people betting someone else’s money in a market segment that is not firmly supported by fundamental personal or business needs.  Now many of these companies have to retrench or go broke.  Is anyone shocked here?

I have a Doonesbury cartoon framed and prominently displayed in the lobby at business acceleration center VT KnowledgeWorks.  Mike’s investor friend, Bernie, has just abandoned his foray into “leading-edge applications for wireless handhelds” and has shifted his investment emphasis.  Into what, you ask?

“Boring stuff that people actually need.” 

The publication date of that cartoon was March 25, 2001.

Remember the San Francisco gold rush?   It is now widely understood that the people who got rich were those who sold supplies to the poor slobs who were sinking their lives into the 1849 equivalent of lottery tickets.  What has changed?

Companies that last don’t hunt for gold.  They make and sell picks and shovels, and clothes, and food.  And the innovators sell machines that replace picks and shovels, and tougher jeans, and free-trade, organic food.

Look at TechCrunch, the company that started keeping count and is now tracking the Web 2.0 layoffs.  They are selling stuff to the crazies.  Now that is smart – as long as they remember that the crazies will eventually go away, just like the 49ers.

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Business acceleration center VT KnowledgeWorks is located in the Virginia Tech Corporate Research Center, a technology park, a research park, and a science park on the Virginia Tech campus in Blacksburg, Virginia.  The research park provides high-technology companies access to university faculty, university facilities, university equipment, and business-related support services.  The Virginia Tech Corporate Research Center fosters commercialization and technology transfer of university research for both high-tech start-up companies and established technology businesses.

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Comments

  1. Very interesting juxtapostion of your assessment of VC investment strategies with this analysis from SBANC: Venture Capitalists’ Investment Criteria: 40 Years of Research.

    Here’s a quote: “In addition, we focus on the ongoing debate that can be traced in the literature as to whether management characteristics or product/market attributes play the most prominent role in impacting VCs’ decision to invest.”

    http://sbaer.uca.edu/research/sbi/2008SBIPROCEEDS/20.pdf

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