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What went wrong with venturing?28/03/2007. Source: Kyield. Mark Montgomery 
Over the past twenty years Mark Montgomery has communicated with entrepreneurs, professors, and communities all over the world who wanted to recreate the magic of Silicon Valley, but rather than follow the SV model, he often points them to Seattle, San Diego, Austin, or more recently Northern Virginia. Over the past twenty years I have communicated with entrepreneurs, professors, and communities all over the world who wanted to recreate the magic of Silicon Valley (SV), but rather than follow the SV model, I would often point them to Seattle, San Diego, Austin, or more recently Northern Virginia. My reasoning has been that it's questionable whether the world could sustain even one SV, much less dozens, and for most modern regions the secondary markets served as a more appropriate benchmark that was more achievable and sustainable.
In looking back to my youth in the 1980s when Seattle was a small dynamic environment that spawned several global leaders, I find much to be admired and considered from the entrepreneur's perspective (as well as communities):
- A generally intelligent and well educated society.
- A culture and economy steeped in, and dependent upon, global trade.
- Critical mass of the talent necessary to build global companies (largely sourced from global companies and universities headquartered locally).
- Loyal local customers willing to support local start-ups.
- Sufficient local capital in experienced hands willing to accept some risk.
- Not yet faced with a glut of institutional capital locally or in competing markets.
- Excellent relationship between the private and public sectors (Team WA).
- A relatively business-friendly environment with competitive costs.
- A healthy high quality of life (except for light deprivation in winter).
- Diverse multi-cultural community with no dominant influence (80s).
- Investors engaged for equity growth and achievement, not management fees.
- Very low competitive risk from investors or the community.
- Investors who are experienced global execs or entrepreneurs in complementary (not competing) markets.
- A real commitment to building enduring companies.
- A culture that encourages prudent risk taking by entrepreneurs.
While these attributes do not guarantee success? the dynamics for success are far more complex than a bullet list, it did prove to be an excellent base recipe for a functioning entrepreneur and venture market. Most markets today however are missing one or more essential ingredients due to global trends, and the ensuing reaction to same.
The exceptions consist primarily of extremely favorable cost benefits such as India (relative to quality), and/or nationalist protectionist policies as we see emerging in venture capital worldwide (China for example), that leverage large growing markets to attract direct investment.
In sharp contrast, the state of Arizona where I have lived for 15 years is a more common experience than Seattle and in painful ways has been more educational. While of similar size, AZ and many other states and countries have never experienced the assets that Seattle and others enjoyed.
Given that consolidation has reduced or eliminated global headquarters in Arizona and many other areas, and that the world is now informed on the benefits of local headquarters of global IP related companies, it's not surprising to observe the increase in economic development (ED) venturing, and the associated systemic decrease in quality (ED is properly viewed in my view as a byproduct of good venturing, rather than the cause).
Like most other subsidized efforts however, once the tipping point is reached, which is now evidently in our past, competitors have little choice but to employ similar tactics, and in such situations it often becomes increasingly difficult for private efforts to thrive. Arizona for example has yet to embrace a state funded approach to venture capital as has its neighbors to the west and east (CA via institutions and NM directly? latter more honest and visible even if yet less effective), and is increasingly paying dearly for its free market philosophy in an increasingly subsidized endeavor.
Some of my peers will of course argue that subsidized competition doesn't matter in the case of venturing, and that no one has their individual ability to build companies, cut deals, and create equity, or even perhaps that a few large exits translate into a free market. While it's true that some individuals and firms are clearly better than others, it's also true that venturing can be learned, particularly with good hands-on experience and mentoring. And all things being equal (such as absence of unethical tactics), the best should experience similar results over long periods, but only if markets are functional and free from bias, which clearly is not the case in early stage venturing.
Let's review the trends and experiences on the ground from the entrepreneur's perspective (and their communities) that led to the emergence of the ED model (mid to late 90s):
- Very high competitive risk in the fund raising process, particularly for those who must mine for capital in competing markets.
- High probability of being declined for capital by the same firms who then back local firms in very similar ventures within a few months.
- Lack of transparency in relationships (viewing of sensitive information).
- Firms that claim they are not regionally biased, but actions over time prove otherwise.
- Forced exporting of the most valuable assets of the community (best and brightest), and often paid for the opportunity to export.
Now let's review the results of the ED model (current):
- Rather than a few global competitors in each emerging niche, we now often see dozens competing globally.
- GPs increasingly relying on fees rather than carry (profit) for compensation.
- Unlimited institutional funding (quasi ED), increasingly raising the bar far beyond potential ROI or sustainability, unless factoring in economic impact.
- Majority of individuals engaged with little if any real entrepreneurial experience outside of institutions.
- Need to exit to competitors as regional companies are less likely to become sustainable within VC exit windows.
- Emerging giants that claim to be early stage investors, but are morphing into global private equity firms.
- Escalating costs across the ecosystem due to increased institutional funding and decreased accountability.
- Lack of competitive early stage investment options in most regions within the U.S. and the world.
What can we expect in future venturing trends?
- Entrepreneurism will continue to move to institutions, particularly in technology, as independent entrepreneurs are abandoned.
- ROI will fall across the board, unethical tactics will rise (insider deals, for example), or some combination thereof.
- Regions that don't employ similar tactics now adopted in most of the mature countries (and increasingly emerging markets), will not be able to compete in large cap tech sectors.
- Regions will increasingly need to act as collaborative initial customers for start-ups if they expect ventures to survive the valley of death in their region.
- Overall innovation may increase for a variety of reasons, most having little to do with capital markets, but fewer (if any in some sectors) disruptive innovations are likely to make it to market.
- A sharp decrease in quality of individuals attracted to venturing.
- Look for continued growth of larger independent incubator models with internal funds free from politics.
- Emergence of a national U.S. venture program more closely resembling the EU's recent efforts than that of the U.S.
Mark Montgomery is a serial entrepreneur and was founder of Initium Venture Capital in '02. He's currently founder and CEO of Kyield, a software start-up related to the semantic web. He can be reached at markm at kyield.com.
Mark Montgomery © Copyright, 2007, All Rights Reserved
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