The Wall Street Journal recently published an article entitled “Is Silicon Valley Funding the Wrong Stuff?” The piece suggests that VCs may be encouraging entrepreneurs to work only on silly ideas that seem appealing to young, techie denizens of the Bay Area rather than “the kind of basic research and development that transforms lives, in fields such as energy, medicine or food safety.”
Of course, when you use a word like “wrong,” you need to have a clear idea as to the basis for making that judgment. A temperance advocate might think that investing in Brown-Forman, maker of Jack Daniels and other spirits, is “wrong” — but an investor who thinks that the stock is undervalued might think such an investment is “right”. (Full disclosure: I’ve owned a few shares of Brown-Forman for over a decade. That’s a story for another post.) In this case, the article questions whether investors are making investments that are likely to offer strong financial returns. If investors are attracted to gimmicky, faddish products, they may incentivize entrepreneurs to create start-ups that are likely to fail — which will result in poor returns for those same investors.
As an investor, I certainly don’t want to invest in flash-in-the-pan junk. But, how much basic R&D do I want to fund? And, as an entrepreneur, just how “innovative do” I want to be? Am I the sort of person who wants to make a fundamental break-through, or the kind of person who wants to make an incremental improvement?
If building a business were a video game, would I want to beat the game in the easiest mode — or, would I play in the mode where you have only one life, the bad guys have weapons that kill you with a single shot, and there are no power-ups? Especially if I knew that winning the game in the hardest mode unlocks special bonus levels?
My friend (and former colleague) Brad Dixon recently remarked that a lot of the companies of interest to me as an investor were, in his words, “a little bit pedestrian.” I think Brad’s right. As a scientist, and I’m impressed by scientific break-throughs. As a business-person, I’m impressed by break-through companies. But, as an investor, I have a hard time investing in companies that need revolutionary break-throughs to succeed.
I probably wouldn’t have made an early-stage investment in Tesla Motors, the first financially successful electric car company. I don’t think I’d want to invest in Planetary Resources, an asteroid-mining company funded by some very smart and successful people, even though successful exploitation of resources available on asteroids could provide truly massive returns. Nor would I be likely to invest in D-Wave Systems (makers of quantum computers), even though quantum computers could revolutionize computing. I haven’t had the opportunity to invest in Planetary Resources or D-Wave, but I did recently see a pitch from a company trying to do long-distance wireless power distribution, which is a similarly revolutionary idea. Each of these companies is attempting to drive massive change through massive innovation, and I wish them the best of luck, but I just don’t feel like I can make a reasonable judgment about the likelihood of success. And if I can’t guess whether they have a 10% chance, a 1% chance, or a 0.01% chance of success, how can I rationally make an investment?
As the WSJ article suggests, I find the valuations of some private companies, both early in their life-cycle and as they approach IPO, perplexing. I certainly get nervous when an entrepreneur tells me that he or she doesn’t yet have a proposed business model, or clear target market — but that there will be users and the dollars will follow the users. And when I heard recently that the value in yet-another targeted marketplace was really the social network being built on that marketplace, I became very skeptical very quickly. On the other hand, I do think that Silicon Valley is innovating in meaningful ways, even if some of the companies receiving funding are not meritorious.
In the past few weeks, I’ve seen new medical devices that might save lives and lower costs, new materials that might make 3D printers more useful, and an interesting approach to long-distance shipping. Uber’s technology isn’t revolutionary, but applying the “sharing economy” business model to transportation has shaken the taxi industry. Dropbox’s technology isn’t revolutionary either, but making it extremely easy to share files required some challenging user-interface design. Square is just another point-of-sale device — except that anyone with a phone can use it because the technology and business model are so simple. Those are all valuable innovations. And I like to think that I would have seen that Uber, Dropbox, or Square were doing innovative and disruptive things likely to lead to significant profits. I’m not claiming that these companies are or are not good investments at their current valuations. I’m only saying that early-stage investors could rationally have invested in them without having to assume incredible break-throughs would occur.
As an investor, I prefer a moderate level of innovation. I want your start-up to have to do hard things to succeed; otherwise, everyone else would be doing the same thing you are. But, I don’t want you to have to make multiple huge break-throughs at once. If you have an idea that seems like it makes good commercial sense, but which needs presently unavailable technology, that’s fine — as long as developing that technology doesn’t seem like it ought to take thousands of person-years. If you have a new technology, but you’re not sure if people want it, that’s fine too — as long as we can start doing some experiments reasonably soon. If there’s an industry that might be disrupted by your new business model, that’s fine — as long as it won’t take $1B to build enough infrastructure before the disruption begins.
As an entrepreneur, I think just like I do as an investor. My largest investment will certainly be in my own business. Regardless of the amount of capital I invest, I can only start one business at a time. And starting a successful company will deliver far greater returns than I’ll be able to obtain through investing, given the level of capital I have for investment. So, I think about starting my own business in the same way that I think about investing in someone else’s business. Any startup worthy of the name faces significant risks, and I’m entirely comfortable with that. But, I’m not likely to develop a teleportation device, cure cancer, or create an AI system that will automatically identify your perfect mate.
In other words, if starting a business were a game of Doom, I’d happily play in “Ultra-Violence” mode. But, I’d leave the glory of “Nightmare!” to others.