Do VCs Thwart Innovation?

I’ve often wondered how much value VC’s really create. Not for the few that are allowed in, but for society as a whole. Are they the innovation engines as advertised, or merely savvy investors that realise above average returns? Day traders or world changers?

First, I am surprised at how young the industry is. The first VC’s started in 1972 with the founding of two of the marquee names even today, Kleiner Perkins and Sequoia Capital. Institutional funding didn’t come in until the late 70’s. The first home runs were with Apple and Genentech’s IPOs in 1980. So we’re really talking only 30 or so years. The 80s were a bust for VC’s, so now we’re down to 20 years.

The industrial revolution brought America to dominance with the byproduct being new industries and jobs. Let’s assume for a moment that the VC/internet era (ie. the last 20 years) has had that same kind of impact. The internet has changed everything everywhere and created a better way of life for most. More importantly, it kept us ahead of the competitiveness curve (many US jobs created out of the internet revolution). One would think that VC’s played a significant part in that correct?

The goal of VCs is to bring new ideas, technologies and innovation to the masses (and get paid handsomely to do it). They partner with entrepreneurs (sometimes with only an idea in hand), take a significant equity stake, and help them grow towards an IPO or sale five years later. They only look for visionary companies because they have to pay for the 9 other investments in their fund that went bust and still yield a 25% return to their limited partners after fees. Most of us remember the mayhem of the Netscape IPO in 1995; almost every household tech company you can think of (google, amazon, ebay,etc..) have VC fingerprints all over them. At the surface, it seems like they’ve been the thought leaders they’re supposed to be.

But are they? An article written by two insiders argues that VC funding actually thwarts innovation. They point to, among many factors, the short life cycle of funds (usually 5 years), aversion to unproven companies, and the fact that there are more MBA’s (64%) than there are Master-level engineers (29%) at the top funds. Not the usual source of technological breakthroughs (present company excluded of course).

Just think about it. Ebay was not the first auction website, just the first successful one. Google came out of Stanford’s lab, the internet roots were from the US military (and Al Gore). VC’s didn’t only invest in Google and Yahoo, they invested in 100s of search engines (don’t get me started on my infoseek investment). How many biotech companies are they now investing in? How many will even survive much less cure diseases? They tend to invest in clusters; a sign of “me too” investing, not extreme innovation.

But they’ve monetized it. Have they ever. Sequoia turned $12M into almost $5B with Google. Not too bad, eh? But lets face it, without VC’s, these emerging companies would not have reached the masses as quickly and deeply as they have. Google, and the many others, have brought information and commerce to the masses and completely changed the world for the better.

So mad scientists they are not. Mad capitalists they are. It’s just too bad that my address is not on sand hill road.