
Why Venture Capitalists Avoid Innovation: They Like Making Money - johns
http://onstartups.com/tabid/3339/bid/11886/Why-Venture-Capitalists-Avoid-Innovation-They-Like-Making-Money.aspx
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spolsky
I think this article is expecting VCs to do something that angels and founders
do: take a chance on a crazy idea in exchange for owning a BIG chunk of the
upside.

A VC is a later-stage beast. They want less risk, and are willing to accept
less reward (and ownership).

There's a spectrum of risk and reward and not everybody is in the same
position.

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fnid2
A lot of innovation happens in the shadows before metrics evolve that help
VC's determine probability of success. It's only when the VC's can judge among
a number of opportunites, that they will invest in any of them. Even with
quite a number of players, there is still plenty of upside.

Innovators think, "I'm the only one doing this and it's going to change the
world." Innovators think VC's want in on the ground floor to maximize returns
on capital. Innovators think their ideas are sure things. But they aren't.

It's good innovators think that, because if they didn't, they wouldn't waste
their time on their silly ideas that never go anywhere... but sometimes do.

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gridspy
The author contrasts "VCs want Innovation" with "VCs want a product and a
standard business model". They then claim that these statements contradict.

For example, Gridspy is making an innovative product, which is proven and
already has several customers. However our business model is totally standard.
1) Sell units for profit. 2) Residual monthly fees for profit.

You can make innovative products and companies with boring old business
models. VCs are right to be cautious around "We have a great idea but no
possible way to monetise it."

Then again, I agree with pg that you don't need to have a business plan to
have a great product. Companies such as twitter can turn into the most
exciting startups.

~~~
gridspy
I really liked "VC's generally don't support subsequent changes to the
business plan. A self-funded entrepreneur is constantly making major course
corrections, to the point of driving his colleagues crazy. VC's will deny
this, but a VC investment is basically a ballistic missile launch, without
course corrections."

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netcan
_That's a dangerous place for an investor (angel investors are incredibly
brave) because one of the tenents of the old rigid VC model is that follow-on
investors will usually try to squeeze out the early investors._

I've heard this in several places before? Can someone explain how this is
done? How can early investors be diluted without also diluting the founders?

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alain94040
In real life, both founders and earlier investors get diluted.

The meager extra stock options given to the founders don't even come close of
compensating from dilution for subsequent rounds.

~~~
netcan
Well obviously everyone gets diluted as more money is invested. That makes
sense.

But, founders do still end up with substantial stock.

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mixmax
Investments in innovation are very risky, but the payoffs match the risk.
Basically as an investor you need to understand this and to decide how much
risk you're willing to take. If you invest in a proven technology and a proven
team you're more likely to make a smaller profit, but investments in new
technology and often unproved teams can provide obscene paybacks but carry
considerably more risk. Google comes to mind as an example.

~~~
iBercovich
I don't think it's that simple. First of all, risk cannot be measured, so the
fact that a person takes as much risk as they can bear is incorrect, it's all
an illusion. I think it's easy to look back at let's say, Facebook, and say
that they were a risky bet with a huge potential for growth. But the fact is
that this kind of disruption cannot be predicted, in other words, no one in
their right mind would have predicted Facebook to grow this big.

What I am trying to say, is that there is no point on investing in a company
simply because they are risky/unpredictable and hope that they happen to be at
the upper end of the tail and give back huge returns-- that would be a
terrible strategy.

~~~
mixmax
Facebook is a great example of a very risky bet that paid off bigtime. As you
say, noone in their right mind would have predicted that facebook would grow
this big - but the VC's that did and took a huge risk got an enormous paycheck
out of it. The same Vc's probably invested in a lot of other companies that
turned out to be losses.

Basically my premise is that risk x potential payout is a fixed number. Invest
in a McDonalds franchise on your local highstreet and you will have a high
probability of a low return. Invest in crazy stuff like facebook abd you have
a low probability of a high return.

As you say, it's a simplicfication but I think it holds true in general.

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csmeder
I think a better argument is VC are only willing to bet on small amount of
innovation at a time. (However, the article is worth reading he does ask some
interesting questions.)

For example Zappos didn't innovate how you sell shoes. Others were already
selling shoes online. They simply innovated how you treat the customer and
your employees. Thats a small innovation that VCs are willing to bet on.

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inboulder
VCs, despite what they might claim, are not about innovation or even venture.
They function merely as a bank that buys equity, this is identical to the type
of banking setup that would finance railroads in the 1800s.

I propose a start-up test, if a VC is willing to fund you, you do not need
them, you are better off taking debt financing, you are already a sure thing.

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sdh
isn't this the purpose of patents?

... prepare for grotesque oversimplification ...

NewCo creates some innovation and spends a bazillion dollars creating a new
market for it (and fails because creating new markets is expensive).

NewCo ultimately runs out of money and dies. VCs retain the assets (including
the patents).

LaterCo comes along a few years later with new funding and taps into the
market NewCo created with a similar product. LaterCo succeeds.

NewCo's VCs send in their lawyers and LaterCo pays up.

Perhaps the article should be about why VCs have quit taking long term bets.

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gridspy
My version of events:

NewCo comes up with a reasonable extension on existing technology that anyone
in the field who thought for 6 months could have come up with. However they
fail to take it to market.

LaterCo is never formed because its founders discover the patents. An exciting
new technology never reaches the market.

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pw0ncakes
Most investment banking analysts aren't doing the job for the pay (which is
mediocre when the hours are considered) but the exit options, one of which is
VC. Investment bankers are, on the whole, mediocrities if not outright idiots;
the analyst position enables the talentless to trade in their health and well-
being in order to have career options that would otherwise be way out of their
league. Thus, many venture capitalists are former investment bankers.

Anyone see the problem here?

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wakeupthedawn
People do become analysts for the pay (in addition to the exit opportunities).
Despite the per-hour rates, there's definitely something alluring about the
idea of making more (even if only marginally so) than your peers right out of
college. Starting pay at VC's for analysts coming from banking is low relative
to other options (especially private equity, which is generally the top
choice). The bankers who come to VC either aren't good enough for better
options or are genuinely interested in being involved with innovation, or at
least the illusion of it.

