Uncle Sam Takes Over the VC Business
Last week I had yet another lunch with yet another former venture capitalist from yet another imploding VC firm. Like a slow motion train wreck, the business of backing and building startups with private risk capital continues its decline. As the last of the money raised during the glory years gets carefully doled out to those start-ups fortunate enough to survive the triage process dominating the venture business these days, it pays to pause and ponder what the future might hold for the innovators that drive progress.
Like all professionals associated with the finance industry, venture capitalists have come in for their share of criticism. Disappointed investors whose dreams of double digit returns went poof and slathering press hounds gleefully shooting the wounded are egging the public on to demand that Congress prevent fill-in-the-blank from every happening again. Any target will do; if you made money when times were good then, ipso facto, you are guilty of driving the economy over a cliff.
Was there folly along the way? Of course there was. Making risky investments in unproven startups run by visionary entrepreneurs always looks like folly when it doesn't work. Eliminate all prospect of folly and you can be sure to take genius down with it.
Was too much money chasing too few good ideas resulting in too many bad ideas getting funded? Of course. When has this ever not happened when our country went on an innovation binge?
Do these misallocations of capital usually work themselves out once the innovation market recovers from its hangover, goes on a diet, and starts laying the foundation for the next wave of progress? It always has, in a cyclic process that propelled this nation forward for over 200 years.
But it may not this time. That's because a new player has emerged determined to dominate the business of financing innovation.
This player doesn't have to raise capital from skeptical investors; he just takes what he wants from whomever he pleases. This player will never be measured by his rate of return but will only be judged by the goodness of his intentions. This player is not only exempt from any rule he chooses but gets to make up rules his competitors must obey. This player doesn't fret over how to serve markets, he deigns to create them. This player doesn't carefully scrutinize the projected gross margins of the companies he funds because profits are not his goal. This player rarely does due diligence, never sits on boards of directors, spends no time guiding young companies through their growth pains, and barely keeps track of what happens to the money he dispenses. Yet the size of the checks he is writing threatens to dwarf the capital dispensed by the rapidly shrinking ranks of venture investment professionals.
Say hello to Uncle Sam, VC.
Pursuing a murky mix of industrial policies guided by politics, ideology and the relentless pursuit of campaign cash, the Federal Government is showering grants, loans, tax credits, earmarks, subsidies, and mandates on unproven technologies at such an unprecedented rate that it's roiling the entire entrepreneurial community. This is being reinforced by a Greek Chorus of academics at our top technical universities who are herding their most talented students en masse into the politically favored fields of Energy and Cleantech.
Sure, Uncle Sam has financed Big Science ever since the Second World War. But selecting which science is ready to be turned into technology to power what new products, and which of these products are ready to be produced at scale to support what emerging market, has always been the job of private industry. Under the rubric of "crisis," be it climate change or energy independence or green job creation, this painstaking trial and error process is being replaced by technology czarism.
Technologies that are a decade away from feasibility are being rushed directly into production. The discipline of venture financing and the winnowing process of early stage failure are being skipped as politically favored projects go directly to large scale project financing. New constituencies whose survival depends on the uninterrupted flow of federal largess are sprouting up like weeds, funneling a percentage of that money back to the Congressmen who keep the whole thing going. The antiquated theory that in order for a business or industry to be sustainable it must create more wealth than it consumes is being discarded in favor of the belief that if you fervently hope for something good to come true, then it will.
Rather than measuring technologies, business plans, and product roadmaps by the yardsticks of positive gross margins and net operating profit, new measures of value like "carbon footprint" dominate the decision process. Headcount is going from a private cost to be minimized to a public benefit to be maximized. Supply chains that normally take years to develop since they can only be sustained if the weakest link is profitable are being replaced by webs of vendors connected by links labeled "and then magic happens."
Thanks, again, to educational institutions that are driving a politically correct blend of entrepreneurship mixed with a call to social service, this new mentality is becoming pervasive. Ask a young cleantech entrepreneur how his business is going to make money after the subsidies go away - as they inevitably will once Uncle Sam maxes out his ability to print or borrow another trillion dollars - and they look at you like you have two heads. They're not in it for the money. They're out to save the world.