1. Lots of Startups
3. New Attitude to Acquisition
4. Riskier Strategies are Possible
5. Younger, Nerdier Founders
6. Startup Hubs Will Persist
7. Better Judgement Needed
8. College Will Change
9. Lots of Competitors
10. Faster Advances
X. A Series of Tubes
Paul can be long-winded at times (me too) but he's usually well worth the read (me not). In the above essay, he suggests that the increasing trend towards more startups is likely to continue, as well as a new trend toward smaller, more frequent acquisitions. He also suggests that startup founders are getting ever younger, and that the value of university education is decreasing, except to the extent that you get to meet other interesting new startup founders. All of these points result in system acceleration, and in particular will begin to force changes in the education ecosystem.
I don't disagree with these points. And i also am fairly pessimistic about the value of most education systems (side note: altho i barely graduated from college, i never graduated from high school... and in hindsight i don't think i miss the diploma much). If you read Paul's most excellent book Hackers & Painters, in it he's fairly negative about the entire education process -- he equates most schools to jails that we sentence our children to, mainly because we're too lazy / cheap to give them a real education, and because we don't trust them to enter the workforce until they're much older.
However, i think Paul's essay misses the real target of destruction for startup system acceleration... it's not the Education System, but rather the Venture Capital industry which is about to be Destroyed.
Let me explain.
While i won't delve into a long historical description of the VC business (read The Venture Capital Cycle by Gompers & Lerner), suffice it to say that Venture Capital exists because of several private equity market inefficiencies surrounding the market for funding startups:
- liquidity is limited (exits are relatively infrequent)
- transparency is poor (private company valuation is difficult)
- debt capital doesn't exist / is minimal (new, unprofitable startups can't get loans)
- transaction efficiency is horrible (deals take months to execute, not very standardized)
Now i'm not saying venture capital is evil or bad here... i'm just saying they exist because the market is not very efficient. And because it's not efficient, capital is VERY VERY expensive. And because VCs get hits on average WAY worse than baseball players, VCs are VERY VERY risk averse.
Wait, WTF you say? McClure's got his head up his ass! Who is he kidding? This is the BEST of times for entrepreneurs. VCs are overflowing with money, there are LOTS of deals happening, and it's EASY to get funded, right? Furthermore, how can he say VCs are risk averse? Aren't they in the BUSINESS of making risky bets on unknown startups and markets?
Wrong, wrong, and wrong.
These are only the BEST of times for entrepreneurs compared to the dot-com bust when there was NO capital to be had, or compared to a decade or two ago when the # of startup deals was a fraction of today's market. And exits took 5 rounds of funding and 5 years. Now that some companies are taking 2 rounds of funding and getting acquired in 18-24 months, it seems like a walk in the park.
VCs take big chunks of equity from startups in exchange for very little capital, and in general for very little expertise, because they are CRAPPY at investing in startups, and they need to juice their crappy performance at the plate with steroid-level ownership stakes in order to get anything close to a decent return. What do i mean by crappy? I mean if a VC firm is getting decent wins 1 out of 5-7 times, they're probably doing pretty good.
But if they only get a win 15-20% of the time, then they need 10x performance or better just to get a decent return. This creates misalignment of interest with entrepreneurs, who might very well look at a sale of the company for just 1.5x-3x as a good deal... but for VCs, that's not such a great deal, because they know how BAD they suck at the plate. They HAVE to swing for the fences every time, because they're just terrible bunters & baserunners, because they so rarely get on base.
Furthermore, most VC funds FAIL TO BEAT THE MARKET. One quarter of them make a killing -- largely because they have huge chunks of equity in companies to which they contribute precious little except capital. but outside the top quartile, they probably don't beat the overall market, and they certainly don't justify the risk.
So how can we justify such terrible plate performance from VCs?
Simple: because there ain't no other fucking alternative. Banks don't lend money to unprofitable startups. Neither does your uncle, if he's smart. And the government doesn't have an equity-equivalent program to the SBA (debt, not equity). Well, they do... they're called SBICs, and unfortunately the capital is not really available to most startups. basically these are government-subsidized venture capital / private equity companies, and it's *their* job to find, filter, and invest in startups.
but here's the thing. the market is changing.
ten years ago, technology startups were capital-intensive businesses. they required years of development & financing, lots of expensive sales people to generate revenue, and exits tended to be larger and much less frequent.
these days, the world is quite different.
servers are cheap or hosted. software is often free. pipes are fatter, more audience is online. so technology startups can easily get going for less than $2M, often less than 250K -- hell some startups began as weekend coding projects.
and acquisitions are happening more quickly.
not exactly sure i understand why this trend is happening, except that there are now easily 5-10 large internet platform companies (Google, Yahoo, Microsoft, eBay, Amazon, Newscorp/MySpace, IAC, AOL, etc) all of whom have millions of users and are generating billions in cashflow. and they need to buy new products to throw at their customers, but they can't innovate internally due to bureaucracy, so.... they buy startups. WAHOO!
but this isn't even the most interesting part.
imagine: if you could measure startup performance more accurately, and if you could do company valuation more accurately, and there was a liquid market for quick, efficient transactions based on standardized metrics & standardized online transactions documents... what would happen?
well, if you had such market conditions... why, you could sell out at any time.
huh? why would i do that?!? I'M AN ENTREPRENEUR GOD DAMMIT.
well, ok... an entrepreneur with bills and a car payment. and two kids. so bear with me... supposed you could sell out at any time, at a reasonable market price. So what?
so if you could accurately value the business at any time, and you can get an exit at any time, and transaction cost efficiency goes down... then you don't have to go to a VC for capital. once you start having a liquid, transparent, efficent market, the cost of capital becomes very cheap. and you could just start BORROWING money instead of SELLING equity to raise capital. and when you wanted to sell, you wouldn't need any expensive VCs or investment bankers, you'd just sell to Mr. Market at whatever rate he's willing to pay. lenders could accurately value businesses, bet on a rate of success/return, and quickly undercut the cost of capital for VCs.
ok, right. like that's gonna happen next week? dream on, mcclure.
well i sure as hell hope so.
and whether Facebook or Google or someone else figures out how to provide such a metrics infrastructure tomorrow or 5 years from now, the resulting market should hopefully be a much bigger fishpond for us all to play in.
ok, i'm tired... haven't explained this as well as i might, but i gotta get some rest.
i'll fill in the gaps and provide some pretty pictures & charts later.
"... the proof is left to the reader as an exercise.."
or just read alex iskold's post