The Role of Investor Risk in the Lost Decade for Entrepreneurs

Welcome to the Lost Decade (for Entrepreneurs, IPO’s and VC’s) « Steve Blank:

Steve Blank puts together a good overview of the history and current environment for start-ups and why the lack of an IPO market has changed the game for venture investors.

It is also good illustration of how risk-adverse the venture community is when it comes to making investments. When the IPO market was hot, which in-turn drove a hot acquisition market, VCs passed risk on to later investors – cashing out before the validity of an idea was proven as a business.

Today, with a cold IPO market, and more rational acquisition market, investment risks have risen – or to paraphrase Warren Buffet “the tide has gone out and we are now seeing who is wearing swimming trunks.” Unfortunately for many entrepreneurs its looking a lot like a nudist beach.

The result has been a shift to more cautious allocation of capital to start-ups. VCs are waiting longer to invest and are less willing to bet on new teams or concepts. In theory, this should lead to better capital allocation to start-ups – which would be better for good entrepreneurs by eliminating irrational competition for customers and resources.

It hasn’t…  Things, instead, have gotten worse for most entrepreneurs.

Things are worse because capital allocation to start-ups continues to border on arbitrary. In the past this mis-allocation was masked by a market willing to pay huge sums for unproven businesses – bailing out bad bets. Without that bailout VCs need to become better at sourcing, identifying and supporting investment ideas – not easy given the nature of the traditional VC model.

At least in the old days, when money flowed easy, the good ideas and teams had a chance of getting funded – even if only by accident. And the rush to put money to work meant that capital raising was, while an inefficient use of a start-up manager’s time, not horrible. Today, the fund raising process has become even more inefficient – as if anyone thought that was possible – which further lowers the probability of survival for start-ups.

Who knows if the IPO market comes back. The point is that it doesn’t matter – because even if it does the relief will be only temporary. The capital allocation process, and therefore the firms serving that market, needs to change permanently to suit the new reality of the start-up market.

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