Robert X. Cringely on Venture Capitalists

Robert Cringely has a great column on venture capitalists and went wrong:

Last week's column, if you missed it, was about how you really can't emigrate to India even if you wanted to, and about how our current economic malaise can be traced back to irresponsible venture capitalists who are refusing to dump money into new ventures because they are afraid. They could change things in a heartbeat, but they don't. Well, Mac had a corollary story that looks at the same effect from a different angle.

"In times of uncertainty," wrote Mac, "don't be Mark Twain ("Put all your eggs in one basket, and watch that basket!" -- it didn't work for him anyway). Instead, bet on serendipity -- don't invest in ONE big idea -- invest in 10 ideas that are your best guesses as to the widest range of possibly big ideas. You don't know but what the heck, NOBODY knows."

"This gives you ten chances to win, instead of one."

"This is in fact where the awful statistics that traditionally are quoted for VCs originate: They invest in many possible companies too early to tell if they are brilliant or dumb. Six fail, some spectacularly. Two limp along. One does pretty well. And one is a huge hit -- and not the one you would have bet on had you been forced to bet on just one."...

There was a time when American industry believed in Mac's field of flowers. New business units were started to prove or disprove product and service ideas. Most of these ideas didn't work out, but most of them didn't cost very much money, either, so big companies like GE and 3M had no trouble carrying the bad ones for just long enough to see if they'd work. But then came the 1980s with its spreadsheet jockeys, and the game changed to letting little companies come up with the new ideas, then simply buying-up those little companies as they started to succeed.

This new system required capital to start and build the little companies and the VC community was able to provide that. The goals were modest -- a 20 percent compounded annual rate of return to venture fund investors. And it generally worked. But then came the Internet fever of the late-1990s when the goal changed from that 20 percent return to what the VCs liked to call the "hundred bagger." A hundred bagger is a startup that returns 100 times the original investment. There have been very few hundred baggers, but the fact that for awhile there were some has had a horrible effect on the venture capital business, because now any investment that doesn't have hundred bagger potential is viewed as not worth making at all.

That's just plain stupid, of course.

The goal is no longer to make a certain return, but to find a hundred bagger -- something that is just about impossible to do. You can stumble on a hundred bagger, you can luck into it, but actually setting out to invest only in businesses you feel are likely to return 100X, well that pretty much means you'll never invest again, which is the way the VC business feels right now.