As an investor, and especially a venture capital investor, you need to have the ability to predict the future within an acceptable degree of accuracy. And that is precisely a skill many venture capitalists (VCs) miss out on and generate such mediocre returns. The value of the innovation they select is not meaningful enough.
Venture Capital differs fundamentally from (other forms of) Private Equity in that it requires an extraordinary level of foresight and prescience. After all, one needs to believe in something that does not already exist, and little proof exists it ever will – or is there?
It is impossible to predict what technology will prevail
VCs today are still too focused on technology, even though many proclaim to understand markets (more on that later). The reality is that rarely any business without a technology demo gets funded these days. Popular technology flavors frequently change (every three years or so), and betting on technology is a foolish game. We should know by now.
Driven by the urge to produce results within ten-year vintages and complicated by the (we claim, self-induced) lack of IPOs and M&A, the majority of VCs have retracted to a short-term investment focus, massive diversification, and fragmentation of investment dollars. Quite the opposite of what should have happened to the venture business.
But how do you tell someone to step into the circus ring to tame a tiger without having had the confidence and prior experience to do so. It is just not going to happen. Change in the venture business needs to come from the top.
Limited Partners who do not refresh their VC commitments and requirements now are bound to lose big-time on venture pipelines stuffed with sub-prime investments with no place to go.
It is easy to predict what macroeconomics will prevail
Warren Buffett said it right in a recent interview with Charlie Rose in that the future long-term is a lot easier to predict than the short-term. Or the way I tell my wife, I don’t know where I’ll be during the day, but you can count on me coming home for dinner.
The long-term value does not discount the need for short-term planning in business, but the short-term without long-term (or macro) is a losing gambit. Here are some examples of the lack of macroeconomics and its failures :
– The venture ecosystem
Venture is macro-economically broken—the reason why we provide a solution for Limited Partners here. The venture capital ecosystem consists of ten(!) layers of diversification before the dollars from Limited Partner land into the bank account of an entrepreneur’s company. No matter your views on the venture business, anyone who has attended business school should know that this kind of over-diversification leads to a morass of accountability and in-transparency of results. Without a fundamental change to how venture works today, venture is poised to become more mediocre.
– The VC intake model
Most venture capitalists sit impatiently through an entrepreneur pitch, checking their blackberry until the product demo. Not only does this communicate the VC has no empathy for the macroeconomics, but it also demonstrates that technology risk is the only risk they think they can assess. Per the previous analogy, those VCs are the wives who call their husbands twenty times per day to know where they are. They demonstrate a lack of understanding and faith in macroeconomics and an incorrect investment risk assessment.
– Entrepreneur pitches
Perhaps dumbed down by the only pitch process that leads to getting money from (sub-prime) VCs, many entrepreneurs pitch technology without understanding the macroeconomic forces at work that prevent a pure technology play (albeit perhaps better) from having access to paying customers. When a large incumbent owns access to most customers through perception, a proprietary business model, or otherwise, technology innovation without major business model disruption is worth very little. Entrepreneurs need to think about business and include macroeconomics.
– Marketing experts
Yep, I said it (and yes, I have worked in “marketing” too). Markets do not exist. They don’t. Market definitions are stale and artificially extrapolate people who once exhibited a common purchasing decision into individuals who behave the same way in the future.
We all know instinctively that every individual is different (even when that individual represents a company), that none of us like to be put in a box, and that our reason for purchasing is different and more than merely price/performance ratios. Also, we participate in multiple competitive and complementary marketplaces in whatever order we deem appropriate. And any attempt to put marketplace participants in a fixed market bracket is therefore hopelessly self-serving.
Markets do not exist, but marketplaces do. The impetus to participate is exceptionally complex to quantify, yet not complex to qualify — a simple need for improved relevance and better value – based on individual needs and objectives. Marketplaces are no longer one-to-many but have become many-to-many, with social networks emphasizing and echoing those particular requirements. The long tail of supply is met with a long tail of demand.
So, macro-economically the basis of marketing is flawed. Product success is not driven by marketing but rather by how true the product is to its promise. And that means marketers who make product decisions based on market numbers are wrong, and so are the investment decisions derived from market analyses.
Get ready for the swing test
Macroeconomics matters as it defines whether you have a chance of making it big, but not without careful micro-economic fulfillment. As an entrepreneur “dating” the right investor, you need to be prepared for the swing test that goes roughly as follows:
Explain the vision, explain the product experience, explain the business model, explain the technology, explain the scalability, explain the product requirements, etc., going back and forth between macro and micro until the swing comes to a halt with no unanswered questions. Now, investors and entrepreneurs have a common understanding of the risks involved in the road ahead.
A new investment focus
The real question is whether the application of technology makes acute macro sense. As experienced technologists, we know we have many technology options to support a macroeconomic need, and technology development is the least of our risks. And surprisingly enough and again in agreement with Buffett, macro-economically, we are not much different from a hundred years ago.
Do we like to play music, iTunes anyone? Do we like to stay connected, Facebook anyone? Do we enjoy free trade, eBay anyone? Many other macro-economic desires remain unfulfilled with technology. Opportunity abounds.
Fulfilling support for that macroeconomic need is what Venture Capital should be all about. And it will happen again when we, as Limited Partners, tell the referees (the VCs) that the rules for investing have changed. Our expectations for VC are to chase macroeconomic impact rather than allow the mindless technology herding to continue.
Endless opportunity for great returns
Supporting existing macroeconomics with a more meaningful technology experience that meets the needs of 5/6th of the world’s population still does not use a useful internet application for a fantastic and highly scalable investment thesis. One that we should allocate more-not-less money to as Limited Partners.
But we need to change our tune, now, before it all comes crashing down on us.
