Paul Kedrosky: Why I Love Venture Capitalists

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I (Michael Arrington) recently had a conversation with venture capitalist and tech pundit Paul Kedrosky about all the criticism being heaped on venture capitalists these days (much of it here on TechCrunch). He has a slightly different view than some others on what VCs are supposed to be doing, and how well they’re doing it. And frankly I tend to agree with him. VCs supply much of the capital that drives the entire startup ecosystem. The world would be a much less interesting place without them.

You can follow Kedrosky on his Infectious Greed blog, or get the cliff notes version on twitter at @pkedrosky.

Hating venture capitalists is profoundly satisfying. After all, they are slack-jawed, monied, oily, know-nothings who carom off innovation, fire capable founders, squash angel investors, and exist mostly to make commercial bankers look smart and interesting.

Or at least that’s the story we like to tell. By “we,” of course, I mean all of us who lovingly poke venture capitalists in the eye with sticks now and then. They are such easy targets, what with making up numbers about how many jobs they create, missing great investments, delivering awful ten-year returns to investors, having higher failure rates among companies they fund than among the ones they don’t, and generally being so self-important and irony-unaware.

But that doesn’t mean VCs are quacks. Or that what they do isn’t hard. Or that it’s unimportant. Because it is important, and the good ones are smart, and what they do is very, very hard.

Creating a successful startup is among the hardest things you can do in a capitalist economy. Entrepreneurs must successfully navigate a sea of multi-dimensional uncertainty, from technology (will it work?), to people (do I have the right employees?), to market (will anyone care?), to financial (can I finance doing this, and can I then sell the product or service for more than it costs?) At big companies you can fail at launching a product, fail at hiring people, fail at making money on a product, and fail at figuring out whether something will work. Your big company will probably be unaffected, and you may even get promoted. Do any of those things wrong at a startup and, in all likelihood, you’re dead. You are wandering a maze of dark and twisty passages — most of which are paved with trapdoors to hell.

The idea that anyone at all would build a business around funding startups is the remarkable thing. No revenues, no sure market ahead, no collateral, no liquidity, and doe-eyed founders who were in high school when Enron blew up. It all adds up to more ways to break down than an old Winnebago. Far from wondering why so few companies get venture capital, we should perhaps wonder why any do, and how venture capitalists remain so damn optimistic. To borrow an industry adage, the best venture capitalists retain the capacity to fall in love despite having had their heart broken over and over again.

And the opportunities for heartbreak are legion. Even if the mortality numbers you usually hear are wrong, failures rates are high for startups. Across all sectors, about one-quarter of startups die off in the first year, while half-ish make it to the five-year mark. The numbers are different, however, for venture capital-backed companies. Failure rates among venture-backed firms are lower in the first few years, but higher later on.

Does that sound nasty and mean-spirited? I don’t think so. Matter of fact, it sounds like VCs are being precisely the sorts of patient investors that people say they aren’t. They are giving risky companies a chance to experiment and find something that works, which is crucial, given that most successful startups don’t end up doing what they started out trying. It is a luxury that markets don’t afford other companies.

Another favorite club with which to whack venture capitalists is their supposed inability to create innovative new companies. Just look at Bessemer’s well-known anti-portfolio, with them turning down Google and Apple and Federal Express (seven frickin’ times!).
Imagine if those innovative companies had actually been funded and…oh wait, they were. The companies still happened, and succeeded, even if some venture capitalists said no. Given how often the average VC must say no in a given year – a bazillion times, give or take – it should come as no surprise that they sometimes say no when it turns out they should have said yes (and vice-versa).

The “VCs as innovators” problem wouldn’t be so bad, of course, were it not for the scene-stealing entrepreneurs. Those bastards keep creating risky startups and getting all the glory. Damn you Sergey Brin and Jeff Bezos and Steve Jobs. Just in case you needed a reminder, it’s not VCs who create companies, it’s entrepreneurs. Blaming venture capitalists for their capital not changing the world is like blaming Pfizer’s treasury department for Viagra not saving your marriage. Yo, you have bigger problems, so to speak.

Wouldn’t it be nice if venture capitalist drove more innovation? Of course it would. But that’s like saying “Wouldn’t it be nice if supermodels followed you home?” Of course it would, but it’s fanciful. Innovation is one input into the startup business, not its main output. For startups or VCs to pretend otherwise is a speedy path to going bust. Venture capital investing is hard enough without turning it into a Disney-style dream factory for self-styled social engineers.

Here is what we should want from venture capitalists. They should be trying to find and help early-stage companies at rising above the muck and dirt and crushing difficulties of being a startup. At the same time they must produce hefty profits in a timely way for their own impatient investors. That VCs can’t do the preceding, while simultaneously satisfying their critics by making no funding mistakes and changing the world with every deal, is a feature, not a bug.

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