6. Is Venture Capital a Good Place to Produce MCIs?

Why or why not?

In some instances, VCs have been an important part of successful market-creating innovations. VCs largely funded many of today’s most innovative companies including Apple, Google, Cisco, Amazon, Starbucks, Costco, Amgen, and Genentech. The market-creating importance and economic impact these VC-backed companies have had can’t be overstated.

Conversely, VC returns have been mixed over longer periods and appear subpar in comparison to overall stock market performance when adjusted for risk and illiquidity.  Furthermore, many see the VC industry having evolved toward investments in sustaining innovations in businesses that operate in known markets, not creating new ones.

So, when might venture capital be the best place to launch a MCI?  When might incumbent companies be the best place?  When are the best results derived from partnership between the two?  What about Corporate Venture Capital (CVCs) arms – good idea or poor use of shareholder resources?

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4 thoughts on “6. Is Venture Capital a Good Place to Produce MCIs?

  1. VC seems great at sending out lots of feelers–wild catting, so to speak. I’m worried they lack the patience and power to make kinds of big gets that overcome the lock-in and sunk costs that keep “developed” economies stuck on trajectories set by their earlier investments in infrastructure and interlocking business models. It really pains me when innovation has to go to “developing” economies because they don’t have the established interests that hold back innovation. It’s great for them, but I wish we’d start seeing the OECD economies as “developing” with respect to what they could be!

  2. From what we learn in Entrepreneurial Finance, VC’s often look at investing as a series of experiments. Instead of spending all the money on one lump sum investment, they step through a series of smaller experiments that hint as to whether a business will succeed or fail. I wonder how this concept is dis/similar to money that is impatient for profit and patient for growth.

    The experiments that are run by VCs can encompass any aspect of the business, like technology or business model risk. For example, an experiment on the viability of optical communication in space might be a higher priority than finding profitable customers for optical communication products. Therefore, I question if VC is a natural home for MCIs that have high investment barriers. Certainly, their first priority is not always about finding a sustainable cost structure, but rather minimizing what they see as their greatest risks.

    However, I have thought about whether in the good money, bad money framework encompasses the notion of conducting experiments successfully. The challenge that most corporate managers face is a lack of ability to diligence innovative ideas (not because they don’t have the ability, but more because they haven’t not been taught the skills). While the innovator’s dilemma provides a framework for identifying a disruptive business, I often think of experimentation as a process for allocating capital in a nuanced.

    1. Ishan — I like your comment that VCs “often look at investing as a series of experiments.”

      The experiment-focused lens VCs use to evaluate businesses is a double-edged sword. On one hand, it ensures products and business models are de-risked through a series of milestones. (This is great for preserving capital in pursuit of moonshots.) On the other hand, it limits the universe of VC-backable endeavors to projects that can be efficiently tested. (This means that long-term, expensive-to-test moonshots aren’t ideal for VC.)

      In the world of lean startup experimentation, “failing fast” is often seen as a positive because it ensures resources aren’t squandered on doomed projects. Failing fast also means that capital can be spread across a greater number of enterprises running ever-cheaper experiments. In essence, smart capital will always be most efficiently allocated to projects that are cheap to test. Specifically, cloud computing has drastically decreased the amount of capital required to start a company and test a product; it has enabled asset-light models that are well-aligned to VC search criteria.

      If we look at the last 100 VC-backed exits with valuations over $1Bn (i.e., “unicorns”) over half of all unicorns are asset-light, a small subset of which are MCIs. In aggregate, asset-light unicorns have generated total valuations of over $270Bn at an average valuation per company of $3.8Bn.

      VCs are spectacular at identifying and investing in MCIs when the MCIs are asset-light. The asset-light unicorn is the ultimate VC prize.

      However, not all MCIs are asset-light. Some MCIs many take years of expensive experimentation before we know whether the product will succeed. Biotech is one example. This hasn’t stopped some intrepid VCs from backing these more asset-intensive businesses. However, on average the VC asset class may not be as well suited to make such long-term, arduous investments given that LPs expect returns within a few years.

      For asset-light MCIs, venture capital is the perfect source of funding. Other types of MCIs may need more creative sources of capital. Curious to hear the perspective of someone with CVC insight on the topic of MCIs.

  3. A really good analysis of the impact VCs have had on MCIs and the economy since 1979 (after a regulatory change known as the Prudent Man Rule allowed pension funds to invest in VC) was done by finance professors, Ilya A. Strebulaev and Will Gornall. In their paper for Stanford Business School titled, “How Much Does Venture Capital Drive the U.S. Economy?” the authors assert, “the VC industry specializes in investing in innovative companies with a huge potential for growth. Because these investments are risky and most of these companies fail, VC funds seek to invest in companies where small investments can generate huge returns. That naturally leads to a focus on certain industries. The industries most impacted by investment have been technology (for example, Apple, Google, or Cisco), retail trade (Amazon, Starbucks, or Costco), and biotechnology (Amgen, Celgene, or Genentech).

    VC-backed companies play an increasingly important role in the U.S. economy. Over the past 20 years, these companies have been a prime driver of both economic growth and private sector employment. VC-style financing is not the sole reason these companies succeeded; in fact, VC was not even the sole source of financing for many of these companies….However, large and growing fractions of entrepreneurs are choosing VC financing. These entrepreneurs think VC financing is the best way to grow their companies. That makes it clear that VC is an important part of the innovation ecosystem and has helped some of the world’s most successful companies to grow.”

    https://www.gsb.stanford.edu/insights/how-much-does-venture-capital-drive-us-economy

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