We need a new financing model to build new, better companies
Two decades into a software career, I’m still moved by its potential to improve people’s lives through connection, automation, and access to information, yet I’m less convinced than ever that our financial systems are built to get the most out of it.
This is the first post in a series I’ll be writing on the structural problems in venture capital. These problems aren’t a condemnation of the industry, they’re an attempt to outline where the industry fails the market. This failure helps to explain people’s experiences, but I think also helps to outline the opportunity and need for other ways of funding companies. These ways will also have flaws — they’ll likely not be great at building unicorns — but they’ll be finding people and markets ignored by the current environment.
Like the general financial industry, the world of venture capital has become adept at using money to create more money, but it does not consider of the wisdom of its actions. It chooses easy answers, thus leaving harder but better questions unexplored, and accepts high collateral damage to the employees, customers, and industry that at best is painful and at worst is pure exploitation.
I am pulled to build more software that, like Puppet, helps people get higher quality work done in less time and with more joy. But that kind of utopian phrasing is used by every company in silicon valley, whether they do advertising arbitrage or sell you pet food, all while asking their workers to work crushing hours for lottery pay, no safety net, and 19th century ideas of labor force participation. The devaluing of women and minorities as either workers or buyers is both discriminatory and bad business. It’s true I’ve heard no overt support for child labor, but I expect that’s mostly because kids don’t have CS degrees from Stanford or Harvard.
I believe it is possible to design a kind of financing vehicle that is less subject to these flaws. There is a lot of money to be made in enabling the whole market to participate in the technology economy, and given that productivity has stalled since 2004 (coincidentally around the time that social networks and attention-seeking advertising-driven business models took over), there’s a lot of opportunity to deliver value by increasing productivity.
The major concern about increasing productivity is that it generally means fewer jobs, and the lowest-skilled workers tend to be first and hardest hit. I do actually believe in reeducation and the movement of labor to new opportunities, but you can’t ignore the trauma of career changes and industry churn. My work at Puppet showed that empowering people at the front line is how you drive both change and value. Too many industries focus on getting rid of the experts at the coal face, when instead they should look to elevate them. This would improve productivity while developing careers, instead of destroying them.
Unfortunately, venture capital is structured to require trauma to everyone involved except the investors. Too often, even the limited partners who are the source of capital suffer, with only a few firms delivering the kind of returns that the asset class purports to offer. The industry is built around making many bets and expecting most to fail. Even worse, every company who wants to participate must make a claim to be able to reach these heights, even if they don’t believe it, and then they must risk their own death attempting to keep that promise.
The model itself requires that companies either go public or kill themselves. Nothing else fits in the spreadsheets. Again, this guarantees trauma to nearly everyone involved — even the ones who make it out suffer the whole way, leaving a trail of burned out employees and failed customers.
I think there are amazing companies waiting to be created that can deliver life-changing benefits but can realistically “only” generate $30m, or $50m, a year in revenue. At 25% margins for software, these can be huge sources of profit, but a venture capitalist would derisively call that a lifestyle business and either not fund it, or force it to kill itself in an attempt to scale beyond its natural size. These can be great businesses, but because business funding generally fits into either conservative bank loans, or 10x-oriented venture capital, there’s no model today that respects them. Jason Fried and DHH at Basecamp have done a ton of great writing on this.
Jennifer Brandel, Mara Zapeda and others have launched the Zebra movement, focused on helping founders shut out of the VC world start companies that enrich themselves and their communities rather than their investors. I think this is an awesome effort, and has been an inspiration to me.
It’s true that this kind of company could not have as high a failure rate as venture capital does, but, ah, that’s not exactly complicated. I mean, VC literally requires failures of most of their companies, so I’ve got a nice anti-pattern to work against. There are well-worn practices for improving operations, people, and efficiency at even young businesses, but VCs haven’t bothered to invest in any of them, because again, they expect most everyone they work with to fail. Vista Equity, among many others, has shown that being more than dumb money can be more than just talk.
You might say there aren’t enough entrepreneurs out there, and all the great ones are focused on building unicorns in silicon valley. I say phooey. Tell that to the millions of people who start restaurants, corner shops, and franchises around the US. Frankly, tell that to all the people who pitched the valley but weren’t white men, or couldn’t afford to live in the bay area, and thus could not get funded. Because the valley itself refuses to believe great entrepreneurs can be women of color, or uneducated, or have a humanities degree, there is a long waiting list of great people ready to be given a little money and a little trust.
Silicon Valley today is baseball before Jackie Robinson, golf before Vijay Singh and Tiger Woods, tennis before Arthur Ashe and the Williams sisters. It’s the World Series with only North American teams, the World Championship game with only American athletes. It might do great things and be a great spectacle, but it’s weak sauce, because you know you’re not really competing with the best. In fact, you’ve structurally guaranteed you won’t, with all your stories of pipeline problems, lowering the bar, and various other grandfather clauses.
I do not believe in the primacy of ideas. I do not believe great entrepreneurs are in short supply. I do not believe we will run out of awesome opportunities in software in my lifetime.
I want to collect funding that will enable those unsupported entrepreneurs to reveal and develop their greatness, I want to build software companies in spaces that currently have no software, and I want to generate great returns for everyone involved without hemorrhaging people and money.
Yes, I know that means I have to find a different way to deliver returns to investors, because I don’t want my portfolio companies to have to sell. Yes, I know that means I will be creating a new asset class, with all the complications that entails around convincing LPs to invest in it.
The fact that others dismiss it out of hand for being impractical is exactly what excites me about it.
Please follow along in the rest of my series as I delve into the individual structural flaws in venture capital that I think outline what a competitive funding instrument must find a way around.