A debate recently raged in the blogosphere on what venture capital has really done for innovation, writes DFJ Esprit CEO Simon Cook.
A debate recently raged in the blogosphere on what venture capital has really done for innovation, writes DFJ Esprit CEO Simon Cook.
It was started by a guest post on TechCrunch by Vivek Wadhwa, an entrepreneur turned academic. He was spurred on by claims by the venture community to have been responsible for a variety of successful industries and businesses, such as Google. In his response, he made the point that it’s the entrepreneurs themselves who should receive credit for the businesses that are created. Or as he puts it, ‘Google became a huge success long before the deep pocketed VCs arrived to ride Larry and Sergey’s coat tails’.
My partners and I couldn’t agree more that entrepreneurs and not VCs deserve the credit for building successful businesses. However, the issue that is really raised here is the specific role of venture capital in a financial ecosystem. Venture capital is for accelerating, and not creating success. Like any ecosystem, the whole is greater than the sum of its parts, but it is important for each part to be robust and play its role in success.Â
Rocket fuel
Many of the key innovations at companies such as Twitter, Google and Spotify were made before VCs invested, but the injection of capital to accelerate further product, company and market development was critical. The initial funding that goes into a business is often from friends and family and perhaps a business angel or a customer.
Sometimes a venture capital fund will get involved at a very early stage. Such seed investments often create later-stage opportunities into which larger amounts of cash can be deployed.
Recognising the importance of funding at the early stage, the VC industry in Europe has also been known to join forces with business angels and other groups, for example at Seedcamp, which acts as a micro seed fund to invest in start-up companies and helps to support the next generation of entrepreneurs. Again, these activities often stimulate potential later-stage deals for VCs.
But even venture capital funds have limits to the growth they can fuel. Given the size of typical VC funds, no single fund can really invest more than $20 million to $40 million in a single company. As some of you will know, once you get more than five or so VCs involved in a company, the dynamics can quickly become dysfunctional as this limits the total VC cash a company is likely to raise to maybe $100 million to $200 million. And while $200 million may indeed seem like a lot of venture capital to invest in a single company, this level of risk taking is happening among European VCs, for instance at Icera, one of the companies we recently acquired from 3i.
But to create multi-billion dollar companies requires access to even more capital beyond the world of VCs. This is why IPOs and public markets play a vital role in the building of global businesses. Many industry commentators and public officials focus on early-stage risk capital as the key to building new companies, but it is only one part of the puzzle, and we shouldn’t forget that we need equal focus on capital at all stages of a company’s life, even long after the VCs have done their job.
Public markets
It’s easy to forget that Yahoo! and Amazon had IPOs at valuations of around $300 million, and even eBay was a mere $600 million IPO. The public cash they raised at that stage helped them to become the titans of the internet they are now â“ after the VCs had helped accelerate them from their start-up phase. In Europe, venture-backed companies such as Autonomy have gone from blue-sky ventures to billion-dollar businesses by being able to access public capital markets.
Perhaps we are now seeing a shift back to the US for public market growth, as evidenced by the recent $300 million-plus IPO on Nasdaq of LogMeIn Inc, a software start-up that originated in Central Europe. To fully support high-growth companies, we must ensure we develop the seed, VC and public markets they need along the way as they climb their path to success.Â
Companies grow and develop, and the shareholders and investors change as they grow. I don’t disagree with Wadhwa’s statement, but what the growth cycle of a company shows is that venture capital accelerates innovation at a crucial time in its journey so that it is capable of becoming a fully fledged market leader. VCs are just one part of the chain, and a vital one needed to accelerate and build on true innovation, but equal effort needs to be spent on ensuring the health of capital markets above and below the VCs if we are to truly develop the entrepreneurial ecosystem that Europe deserves.
