I'm officially arguing with Felix Salmon about venture capitalists. You can read the previous installments here and here. We've got even more fodder for debate now, based on Felix's excellent piece in the latest issue of Wired.
First off, I think he's talking about two things at the same time:
1. Why IPOs suck for tech companies (Duh, it's the title of the piece!) — and why the IPO model, once so useful, is now broken
2. Why venture capitalists are doing all kinds of things that are borderline despicable when it comes to funding companies and maximizing their greed
I don't entirely disagree with point number one. It's taking companies longer to get to the IPO stage, and it's debatable whether companies that are already quite successful really need to go public. Also, as William Cohan has argued, investment banking has become a Wall Street cartel, with the same big firms — Goldman Sachs, Morgan Stanley, JPMorgan et al. — getting to run all the IPOs. The model that Bill Hambrecht developed — the so-called "OpenIPO" model — and used to take Google public in 2004 has fallen by the wayside.
On point number two, I disagree, less gently than I have in the past. Here's Felix:
VCs and angels may talk about changing the world, but their business model rests on a more prosaic calculation: Buy low, sell high. They invest in companies they think will become more valuable, so they can sell their stake for a sizable profit. From the time that VCs invest in a company, they have five years—10 at the most—to sell their entire position, hopefully for many times more than their original investment. After that, it doesn’t matter to them whether the company survives a year or a century.
To put it another way, the VC model is based on creating wealth for investors, not on building successful businesses. You buy into a company early on and sell out a few years later; if you pick well, you can make lots of money. But your profits don’t accrue to the company itself, which could implode after your exit for all you care. Silicon Valley is full of venture capitalists who have become dynastically wealthy off the backs of companies that no longer exist.
Of course, once VCs make their investments, they don’t just sit back and hope for the best; they push the companies to grow as fast as possible. That may work for the likes of Apple, Facebook, and Google—all-or-nothing bets on legitimately world-changing technologies. But it creates problems for more modest startups, which might have the potential to grow into perfectly sustainable medium-size firms.
If you're talking about the big, late-stage VC firms that define Sand Hill Road in Silicon Valley, sure, you could apply aspects of this critique. Kleiner, Perkins or Sequoia Capital might be a tad demanding about growth, and Felix replays the minor horror story of Zappos CEO Tony Hsieh being pressured by Sequoia and selling to Amazon to provide an escape hatch.
Another company that doesn't want to do an IPO is Facebook, which as far as I'm concerned is only going public because the SEC is making it, given that it's run into the limit on the number of private shareholders it can have (500). Felix focuses on this issue in particular, but really, it's about time Facebook, which is making billions, shared the wealth with the many thousands of people who are currently providing it with mountains of free content to sell ads against — even if it only does so through a meager little low-float IPO that, as Mr. Salmon would rightly point out, is designed to make investors a lot of fast money.
Anyway, whether a company wants to IPO or doesn't, the VC ecosystem is far more diverse than just the big-name Silicon Valley firms. It's also not just about companies working their way up the funding ladder, from angels and early stage investors to larger and larger firms that can provide multiple funding rounds. Later-stage firms are working with early stage VCs to get companies more money, sooner. Then there are the incubators and the accelerators.
Not all these VCs are looking for mega-exits. Many are also planning to work serially with entrepreneurs, because there's no substitute for a track record, succeed or fail. It's a kinder, gentle type of VC than what Felix describes.
And besides, as greedy as some VCs might be, they're not exactly choosing the simplest path to fulfilling that greed. There are other ways to invest that might not deliver substantial payoffs within their timeframes, but that will still offer a very satisfying return. So ultimately I find Felix's argument that all VCs want to do is max out returns, not build good businesses, to be unconvincing.
That said, I think I know what he's getting at by taking a battle axe to the VC world. If the IPO model is broken and should be replaced, then maybe the whole innovation-and-funding paradigm also needs to be reinvented.
Right now, it goes like this: innovative company bootstraps for a while, then seeks (or is sought out for) VC funding and eventually looks to (or is pressured to) go public, via an IPO that's run by a consortium of usual-suspects Wall Street investment banks. Let's call this the Standard Model (or the Broken Model).
That could become: Kickstarter or similarly crowdfunded company could pursue more-or-less organic growth, take its time to naturally scale up, and to avoid the onerous IPO participate in a private market for shares, such as Second Market. Call it the Alternative Model (or perhaps the Indie Model).
But heck, maybe you avoid venture funding of any sort, settling in at a more sustainable scale that rewards employees rather than investors. That would be No Model.
All good, perhaps, but obviously you have to get those demonic, dynastically wealthy, predatory VCs out of the picture. Except that there are already plenty of VCs who don't fit that description. So you could wind up denying yourself the growth, scale, and in the end, wealth that your vision and your company deserve. Not to mention the chance to see your VC as your partner.