Yeah, that is the spirit of a recent statement made by one of Sequoia’s general partners. Let me first debunk the superficiality of those kinds of comments I have heard before, and then explain how investing in technology is not so easy for some and impossible for others.
First, as a well-known critic of venture capital, I smirked at the statement that investing in venture capital would make one humble. As I have yet to hear that same sentiment echoed by any entrepreneur coming out of an investor meeting. Humble is not how one would describe the modus operandi of general partners playing with other people’s money. But that sentiment would work well when the chips are down, and the cyclicality of raising a new fund requires some pre-emptive public relations.
To the unsuspecting laymen, that reflective statement sounds honest, compelling, and deserving of much empathy for venture capital’s plight. Probably a reason why so many walking-dead investment firms are allowed to spawn new venture firms with a different composition of rotating general partners, ready to give the “trading in private company stock” (as I call the risk aversion from the subpriming of venture today) another whirl.
A plight riddled with very inconsistent performance throughout the last twenty years. One that, despite the massive greenfield available to technology, as the seemingly limitless investment asset, leads asset-managers, on the whole, to shun venture, or at best to tippy-toe into venture with no more than a single-digit percent exposure of their total assets under management.
Weird, given the asset of technology with so much worldwide potential and everyone talks about as the best thing since sliced bread, cannot find the proper arbitrage capable of producing consistent returns to become an asset manager’s most wanted and prized allocation, leaving them to favor their 100-year old asset classes still.
Could the problem with technology innovation be its arbitrage? Could it be?
The reality is that venture capital has turned itself over the last 20 years subprime, by the operating-model it deploys – chockfull of collusion, boosted by deal fragmentation combined with excessive syndication, now macro-economically incompatible with finding the outliers of innovation. In simple terms, outlier risk cannot be caught with a fishing-net of uniform risk.
Venture capital is still choking on the fog of its self-induced subpriming. A dense fog of false-positives so vividly on display at the pageantry of the many mindless events I get invited to but never attend.
The nitwits on Sand Hill Road deserve all the credit for making their own lives, in having to wade through that fog, so difficult. As I have written and experienced (as a former part-time venture capitalist) for the last 15 years or so, venture capital, the way it is allowed to operate today (in blatant violation of the most rudimentary free-market principles), is not the right model to pursue outliers of innovation the world truly cares about.
Neither Art Nor Science
That set aside, let me highlight the most critical reason why investing in new technology companies is not quite an art, and indeed not a science. And why and how most venture firms fail from a macroeconomic perspective, as in the first deployment of risk assigned to opportunity, and instead dabble in the pursuit of innovation with the same odds as a gambler in Vegas.
To understand the challenge with finding innovation that breaks the norm requires innovation arbitrage (venture capital) to possess the ability to envision a timely need for the obliteration of the norm. The norm being an implementation of the past from a temporal normalization of truth. A norm that may previously not have included technology, and now with new technology can be significantly enhanced to deliver renewable socioeconomic value and trust.
Hindsight Versus Foresight
The reality is that many general partners, especially not the ones indoctrinated by the education-systems of our renowned business-schools of finance, have no idea how to separate an extrapolation of hindsight (downstream innovation), from a new normalization of truth delivering foresight (upstream innovation).
I saw this prominently on display acting as a judge at a national venture capital competition, where the new kids on the block all showed their commendable prowess in the financial engineering process of assessing valuations of startup companies, yet falling so miserably short on determining their intrinsic value – the stuff that creates returns. I saw the same symptom sitting in on a limited partner meeting where venture capitalists pitched their next fund, and my jaw dropped open in disbelief.
Et Tu Brutus?
My point is that limited partners also must share in the blame for the failure of venture capital’s poor performance on the whole. Besides coming to us for advice, how is a limited partner who allocates money to venture to go to assess whether venture’s general partners can separate hindsight from foresight when those limited partners themselves live in the extrapolation of hindsight?
What brings change and hope to all of this mess is that a closer look at evolution reveals a clear pattern by which we can more closely model our human operating-systems, and yields excellent clues of how to dramatically reduce false-positives and false-negatives of innovation, and thus inherently improve the detection of outliers deserving of evolution’s merit.