Where is the Venture Capital industry headed?
Venture Capitalists (VCs) used to be trusted aides of founders exploring the unknown. They complemented the founders’ enthusiasm and vision with capital and experience. Unfortunately, those days are long gone. Most modern VCs believe in forcing founders to chase their goal which is growth and valuation rather than harbouring innovation.
One of my close friends doesn't believe Venture Capital is mandatory for businesses to succeed. She opines, "The best business book I have read in recent times is Shoe Dog by Phil Knight – founder of Nike. It is an inspiring book, and every entrepreneur can learn something from Phil Knight. But what caught my eye is Phil Knight built his billion-dollar enterprise without any venture capital. His business was bootstrapped."
I dare say she is correct, at least partially correct. Mr Knight didn't receive any help from Venture Capitalists because the Venture Capital industry didn't exist in his time. But on the bootstrapping part, Mr Knight did receive some outside capital. As he writes in his wonderful book, he built his business using "float" from his bank. It wasn't easy but he did it. No wonder Nike's motto is Just Do It.
How did the Venture Capital industry develop?
VC model, when it arrived, came to encourage innovation. Most founders don't have the capital to start their companies. But they have ideas that have the potential to transform the world. Banks don't lend to such businesses, and these businesses are too small to access public markets. VCs fulfil this critical gap. They invest in innovative companies that don't have access to other forms of capital. And they hope that some of these companies will pay back their investment manifold either through public markets or through acquisitions.
Modern Venture Capitalists
But this simple VC model of taking small bets on innovative companies has changed over the years. The VC funds have become bigger, and investors are comfortable staying invested and putting much larger chunks of capital for longer periods. IPOs are not even an objective for many companies. These companies want to remain private because it means fewer regulations and disclosures.
In the current model, an early-stage VC invests with the hope that late-stage VCs will acquire their investment at a higher valuation. IPO or acquisition used to be the exit for late-stage VCs under the traditional model. But we are seeing a new trend where big VCs like SoftBank are comfortable holding cash guzzling massive companies for years. And the "apparent" success of this new age investing model has lead to traditional VCs like Sequoia and Tiger raising large funds. These bigger than ever VCs believe in growth at any cost. They want to create global behemoths with monopolistic powers. And to achieve that result, they continue investing capital in companies who under the traditional VC model would have either gone bust or public.
What about the internet and related tech?
But the jury is still out on the success of this model. We don't know if these companies will ever become profitable. Most of them don't know any other way to grow except by burning cash. The public market response to such companies has been tepid. Uber is a prime example. Its stock price halved within six months of its IPO but has risen since. It took more than seven months to go back to its IPO price. Without additional "growth" capital, most of these "global startups" will struggle to maintain their existing market share. That would spell doom for their global domination ambitions. And when this experiment of growth at all costs and creating global monopolies ends, we will go back to the traditional venture capital model where investors created companies that changed the world – not through size but innovation. And that, in my opinion, won't be a bad thing.