If we look at the reduced impact of venture funding on startups and the trends towards decentralization of the big company, it would seem that financing and other structural and marketing imperatives are driving convergence to smaller, self-sustaining entities. This is not a new idea. The prediction that the company needs to get smaller to get optimally productive with invested capital has been around for some time (see Thomas Malone). There is a broad range of factors contributing to these trends. Recent quantitative data on venture funding and expected returns suggests that overall funding will be reduced. The inescapable negative value of many venture-funded efforts captures our attention. If we are on this path of small-is-beautiful, are there any questions we can ask to help shape the focus of entrepreneurs planning to make their ideas into companies?
Fred Wilson from Union Square Ventures quotes a variety of sources, who say that venture-funding targets will be reduced from ~$36B in 2007 to ~$16B in 2009. Using a model of expected exits and returns for the funds’ Limited Partners, Fred tries to set a ceiling on investment in this ‘asset class’. Even if this 2009 level of investment is sustained (unlikely, in light of better ROI elsewhere), it will be barely be enough to cover the few sexy ‘mega-bets’ that venture funds fight with each to throw their money at. Fund managers hide behind their thin logic of Portfolio Analysis hoping that, please God, just one of the mega-bets will save the fund. Here is a ‘law of nature’: big ideas must trade money for time to create their market. If you limit their money, you limit their ability to be successful. These companies spend a disproportionate amount of the pie to get bigger faster. Further,there is an expected timeframe to returns from these funds. In my personal experience, after a few years, most venture investors lose patience, despite the best efforts of the founders to confuse the situation by changing the value proposition in order to find additional rounds of funding. Loss of patience is inherent in the short-term focused model. Small ideas built over a longer timeframe are definitely out for the shrinking venture dollar.
Why would the entrepreneur spend huge amounts of time courting venture investors, begging for attention from a group who rarely returns their voice messages in a reasonable amount of time, if at all? Because the investors can help the entrepreneur to sharpen their value proposition? If the entrepreneur cannot themselves find the right value in the right market, then they do not belong in business. Why would the entrepreneur trade significant ownership interest in their start-up company for the ‘benefit’ of the modern, highly-interactive investor, who behaves mainly as a proxy for the all-too-short-term focus of the broader public markets? Because these investors can help them run their businesses? If the team does not have the ability to run the company, then the team must realize themselves that change is needed and do it. Why would private companies, who are laser-focused on their core business, waste many person-years of senior management time to formalize mostly useless processes to satisfy Sarbanes-Oxley in order to go IPO? I’ll stretch a bit to say that IPO exits are dead except for the mega-bet. After all, Fred tries desperately to paint a rosy picture. As he should, since venture exits are why he gets up in the morning. However, we don’t hear much about the rampant disaffection entrepreneurs have with the venture model and rejection of the prospect of becoming a public company. Listen to Seventh Generation, Inc.’s ‘Inspired Protagonist’ President Jeffrey Hollender when he said in a recent interview that he has tried very hard not to take venture money and would never, ever consider becoming a public company. Out of the question.
It seems that smaller, non-venture-backed, bootstrapped initiatives are the only reasonable alternative for most entrepreneurs to productize their ideas and build a company. What does this mean for the ‘size’ and shape of the problem being addressed (at least initially)? For the markets being addressed? How can we possibly expect that these more gradual efforts could get any traction in building ‘new’ markets? Rather, bootstrapped companies need to confine themselves to attacking existing markets, trying to take customers away from established players. There will continue to be the very few success stories of bootstrapped companies, who slowly and deliberately become large like Ben&Jerry’s and Seventh Generation. Does this mean that most new companies will need to have only very targeted, small-scope, bootstrappable ideas with much more modest early valuations? How do these companies gain scale? We cannot underestimate the multiplicative effect of finding the right small idea, which appeals to and amplifies in a community, that can scale like threadless.com? (note that Threadless’ company name is ‘skinnyCorp’!). We need to begin to think about the new rules of entrepreneurial engagement on a small-scale.
