I wonder if the general problem now is that there's too much capital sloshing around the global financial system for the investment opportunities available. Kinda ironic, since the immediate problem is that banks are undercapitalized, but they wouldn't have made the bad loans if they didn't have spare cash and too few legitimate lending prospects.
Anyone ever play Civilization? There's a problem that occurs once you built a manufacturing plant, research lab, and stock exchange (or whatever the terminal improvements are) in every city: there's nothing left to build! So in Civ1, I'd start building city improvements I didn't really want, just to sell them as soon as they're finished and pad the treasury. The computer gamer's equivalent of Keynesian ditch-digging. In Civ2/3, they added a "Capitalization/Wealth" improvement that does this directly, so I just select that, set science to 100%, and watch the cash pile up. Ironically, this always seems to happen right around 1980 in game time.
In a computer game, extra cash is good, because it's just a way of keeping score. But in the real world, extra cash drives prices up. Cash itself is useless (except in times like the present situation), so companies try to invest it in ever-marginal investments. But companies want a return on their investment, and eventually there's no way you can justify the prices paid for these marginal investments, so prices come crashing down to earth in a financial crisis.
What if the limiting factor isn't the amount of capital itself, but rather the ability of the managers to determine whether a firm is likely to generate a return on that capital? An information problem, not a money problem.
I think this hypothesis might even be testable:
1.) If there is simply too little capital to go around, then interest rates should rise accordingly. Individual firms know the returns they can get on capital; they bid up rates accordingly, and the limited supply of capital goes to the most productive firms.
2.) If there is too much capital and managers cannot discern where to put it, and they realize that fact, then you'd see cash pile up while companies/individuals can't get loans. This describes Berkshire Hathaway over the last 5 years, and a couple of the better VC funds, but not really the economy as a whole.
3.) If there's too much capital sloshing around, managers have imperfect information about where to put it, and they don't realize this, then they will invest in poor prospects, those firms will be unable to pay back the loans, and they'll go bankrupt - soaking up the capital in write-downs. Then there's a temporary shortage of capital while everything gets reallocated and people work off the debts (or write-downs) they just incurred.
#3 sounds a lot like the world we live in. :-)
I have some ideas about how Google could help with this - probably not fix it, as that would require the ability to see into the future, but do a better job than the global financial system is currently doing. Ask me about it at work sometime. :-)
Although this describes something of a subset of the current economic situation, I think it's still safe to say that there is a lot of money available for "the next Google" (or Intel, or...). The problem isn't the money, it's figuring out who the next big players are going to be.
I mean, hell, is this not directly demonstrated by the entire YC process? Here's a model in which there's a very reasonably-sized fund available, and an entire business set up around trying to determine who's got a good potential product, and who hasn't, and then assist the ones that maybe have a chance.
I agree that the top VC firms are a narrow channel that already has enough money in it. But on the other hand the number of startups is certainly constrained by the amount of funding available. Which means that if there were another way to get money to them besides the top VC funds, it would increase the number of startups.
Of course, if the government tried such a thing it would almost certainly screw it up. But it's possible in theory.
paul, you innovated with a new form of venture capital called ycombinator. you've figured out how to get the right amount of capital to a new class of entrepreneurs and the results speak for themselves. you've attracted a bunch of copycats, some who will do good things and many who will not.
that's the kind of thing that i would like to see more of. we don't need more money flowing into the existing system which is at capacity and has been for years.
Do we know if Y Combinator is profitable yet? One quality that is likely to limit copycats comes from the fact that it is not like a VC. It is not out there with prospectuses advertising its performance to the deep pockets.
If the YC model is indeed profitable, then it might be time for an enterprising financier to go out, raise a fund, and do it ten times as big. Of course, the success rate will be somewhat lower, since the personal attention and advice that YC gives its companies just won't scale.
If the model is profitable, I would guess there would be private money to be had. I just don't think anyone knows how profitable the model is yet. It is still new, risky, and unproven.
Just because some guy with a ton of domain knowledge can earn a decent return off a few dozen companies a year doesn't mean it will work at scale.
If you want to see more YC-style funding and traditional VC is at capacity, can you (big VC) not take an active role by allocating some of your excess resources into YC-style firms? That could help these firms (and ultimately big VC) add more startups to their portfolios.
Of course, this is assuming they are honest about having to reluctantly turn down high quality applicants each year. I'm sure the relatively small number of mentors would become a bottle neck at this level, though.
I disagree that the number of startups around are constrained in any way by funding. Or, at least, the number of viable startups.
I think there are far more important things on the list of stuff that new startups need, like business guidance and planning, structure, strategy. There are so many avenues right now for "cheap" startups -- using AWS, for example -- that I just can't see that throwing more money at the problem will help at all.
And, even in the case of "expensive" startups -- those that need serious capital for manufacturing or prototyping -- they need a strong business plan and a solid structure before they need money.
I suspect that pouring money into the startup sector would have a result very similar to the dot-com boom and bust cycle, and we don't need another of those right now.
Our motto should be, “Start-ups, not bailouts: nurture the next Google, don’t nurse the old G.M.’s.”
The capitalist way is to reward risk. However, banks are notorious for not giving out non "asset-backed" loans. And even with the billions of bailout money received, they aren't exactly taking risks by investing in the innovators; they're even more risk-averse.
So how does an entrepreneur who is bursting with good ideas surpass this obstacle?
I think that people -- for example, those who lost everything in one of those natural disasters during the last 8 years -- who have nothing (no assets, so to speak) are in the prime positions to innovate.
Maybe what we need is a stimulus plan more to reward non-asset backed risk takers . . ..
> However, banks are notorious for not giving out non "asset-backed" loans.
I wouldn't say notorious, that has a negative connotation. All jokes about the current situation aside. Banks aren't supposed to make risky loans, they aren't supposed to lose their capital. All loans they make should be guaranteed by something, even if it's just the word of a wealthy individual like a parent cosigning a loan for a child.
True, true. What I was thinking (but didn't expound upon) was tangible vs. non-tangible asset loans. The "word of a wealthy individual" in your example would be the latter. Most intellectual property would also be the latter.
| So how does an entrepreneur who is bursting with good ideas surpass this obstacle?
I've been thinking about this a lot lately ... business has been good to me, and I'm on my first "cusp" -- the point where I've got too much business to handle, but not enough resources to expand -- and so I've found that I'm starting to get ahead of myself in thinking about what's going to happen next.
The thing about good ideas is, they're almost worthless by themselves. They're only one part of a much larger formula involving things like hard work, dedication, focus, and good teams.
The funny thing about more money is, it doesn't really make any of the other parts of the formula any easier. A little, maybe -- I'd love to have just a few thousand dollars extra to cover my first employee's paychecks and do a little marketing -- but it's not going to make sure that I keep working hard, or that I stay focused on the task-at-hand, or that I remain dedicated to my purpose.
So, to get back to your question, an entrepreneur needs to write down their good ideas, when they have them, and then remind themselves to get back to work, and realize that funding is just one minor obstacle, and solving that one won't make their business much more viable.
Almost. A lot of banks took lots of risk - too much risk. Eventually the risk has to be managed, and if it's managed poorly we get what we have today. The capitalist way is to reward the providers, not the risk takers.
as long as its legal to lobby congress it'll never happen. The startup system can't get the help it needs from the government since they are more less powerless. The old GM on the other hand can invest a couple mil into buying congress, because they'll get that money back with the first bill that passes in their favor
Maybe not a plan for vcs, but I am all for the government setting up a 20B dollar fund to purchase from startups. In fact there is a need for it.
Selling to the government is extremely hard or nearly impossible if you are two guys with a software that could benefit the Department of Defense. The fund could ease the process.
I'm not sure how much gamesmanship goes on with larger companies using smaller ones as a pass through, but 23% of federal spending is supposed to be targeted towards small businesses.
Another program that might be relevant would be the http://www.sbir.gov/ program(s).
There's a lot gamesmanship that goes on. For some sbir grants you can subcontract out 50% of the work.
So you get a grant to work on some subcomponent of one of the major defense contractors (Raytheon, Lockheed, etc). Then you turn around and subcontract that piece right back to the defense contractor, up to 50%. Then you take the remaining work and give it to ex-Defense employees who become your employees for a bit.
So the small business wins b/c they get some % profit plus can do work at a high dollar amount per hour. The big defense contractor wins b/c they get essentially free R&D work on their subcomponent.
It seems to me the average quality of startups is inversely proportional to the money (and the ease of getting it) sloshing around the system. Having another round of circle-jerking will do nothing for long-term revitalisation of the economy.
Anyone ever play Civilization? There's a problem that occurs once you built a manufacturing plant, research lab, and stock exchange (or whatever the terminal improvements are) in every city: there's nothing left to build! So in Civ1, I'd start building city improvements I didn't really want, just to sell them as soon as they're finished and pad the treasury. The computer gamer's equivalent of Keynesian ditch-digging. In Civ2/3, they added a "Capitalization/Wealth" improvement that does this directly, so I just select that, set science to 100%, and watch the cash pile up. Ironically, this always seems to happen right around 1980 in game time.
In a computer game, extra cash is good, because it's just a way of keeping score. But in the real world, extra cash drives prices up. Cash itself is useless (except in times like the present situation), so companies try to invest it in ever-marginal investments. But companies want a return on their investment, and eventually there's no way you can justify the prices paid for these marginal investments, so prices come crashing down to earth in a financial crisis.