Uncertain Health in
an Insecure World – 57
“Cave
Dwellers”
When early man emerged from a cave, and used one bone to
break another bone, that was new information. But innovation didn’t occur until the prior information gap (i.e., what
bone-on-bone could do) was made available to every cave dweller.
The word entrepreneur is derived from the French word for
adventurer. New adventurers emerge from their caves in Berkeley and Palo Alto
every day.
“Making an investment
is like throwing darts in the dark.” – Naval Ravikant, AngelList
co-founder.
In early seed and angel venture capital (VC) investing rounds,
before gaining market access, by and through their vision & passion, “rock star” entrepreneurs retain great
power. In subsequent cycles of market penetration and dissemination, on the
pathway to an idea’s mass distribution (i.e., reaching every cave),
entrepreneur power is diminished and often financially diluted.
The atmospherics surrounding VC treatment of entrepreneurs matter.
Some factors are cosmetic – the reputations of those investing in the fund,
both general and limited partners. Other are geographic – the concentration of key
elements in an innovation cluster.
In truth, VC’s exploit (i.e., enable the success of)
entrepreneurs’ insights, in order to make cold hard cash.
In the 1970’ and 1980’s, the Russ Building on Montgomery
Street in San Francisco (above left) was the Sand Hill Road (above right) for VC wealth creators and private
equity agglomerators. Kleiner Perkins Caufield & Byers (KPCB) and Sequoia
Capital (both established in 1972) represent the founding royalty of VC firms.
They have been at the epicenter of the Silicon Valley innovation cluster since
the first tremor, backing the “dent
makers” through the close scrapes and dark times when bubbles burst and
markets crash.
At the time of idea inception, market receptiveness matters.
In the Silicon Valley, more so than perhaps anywhere else in
the world, innovation is often a technological insight that becomes a useful
guess as to what is possible. In creating
new possibilities, market dislocators move something that works in cave A to cave B. Disruptive innovators (per Harvard Business School’s Clayton Christensen) create a
new paradigm in cave A … let’s call
it A*.
Disruptive innovators are often in conflict with incumbents, who are undercut
by bone breaking.
Participants in the VC process often fundamentally change
the way that a business is done. This change can be foreseen, or unintended. EBAY ended the classified ad business,
and in doing so, destroyed most local community newspapers.
Along this VC trail of new ideas, in fact from its outset,
the structure of how one gets paid (the “deal”)
influences the behaviors that product the final outcomes (the “exit”).
VC fund down cycles are inevitable. Down cycles attract “road warriors”, the experienced true
angels who are unique to the Silicon Valley innovation cluster. Veteran early
phase investors have this shared survival experience.
The impact of stock market malaise in the early to mid-round
VC world is worsened by betting on over-valued tech stocks. Recall that average
VC fund life is now 11-14 years. Apple (AAPL) is a mature stock with a Sept.
15, 2015 P/E ratio of 13.42. This P/E ratio means that it will take 13.42 years
of company operating profits (i.e. earnings) to pay back the present day per share
purchase price.
The average current P/E ratio across the tech sector is
20.47!
When publicly traded stock markets crash, the window for Newco initial public offerings (IPO’s)
slams shut. The critical alignment between entrepreneurial activity & private
equity towards cycles of liquidity quickly breaks down. When Wall Street gets
the flu, the private equity market goes into the ICU. Why is that?
Wall Street now
controls much of private equity VC.
The massing of investment in the existing innovation
ecosystem has become concentrated in the corporate VC funds of 20-25 big
companies. IPO valuations have increased
dramatically between 2005 and 2015, largely due to the influx of corporate VC from
global companies with hefty balance sheets (i.e., General Electric, Siemans,
Intel, J&J, Merck, Novartis, etc.). These funds often invest in later VC rounds
(series C, D, funds of funds), where “growth"
companies are scaling up their commercial products for the mass marketplace. Corporate
VC now exceeds private equity VC money in the tech space.
As the number of emerging cave dwellers grows, the
controlling interests in The Valley are fewer, and much BIGGER.
In the Square, we worry that such market concentration is
disruptive in all the wrong ways.
No comments:
Post a Comment