Do Investors Matter?Latin American Venture Forum

Bucarmanga, Colombia, April 14, 2016

Venkatesh Rao, Ribbonfarm Consulting

@vgr ribbonfarm.com breakingsmart.com

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“In Schumpeter’s basic definition of capitalism…entrepreneur and lender are two sides of the innovation coin…The accent has almost invariably been on the entrepreneur to the neglect of the financial agent, no matter how obviously indispensable this agent may be to the innovation.”

Carlota Perez, “Finance and Technical Change: A Neo-Schumpeterian Perspective” (quoted in William Janeway, Doing Capitalism in the Innovation Economy)

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Okay, so you’re trying to stay honest… (source: http://lavca.org)

Your best: 74 Weakest comparison: 78

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Outsiders sorta agree…

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So how good is your best…?

My Chile experience

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So do investors matter? [to innovation] • Wall Street: Nobody beats S&P consistently • SV in the past: “Legendary” investors win for 20 years • SV in the future: Kickstarter, JOBS act, China in

AngelList… who the hell knows?

WHICH Investors matter? WHEN? WHERE? HOW? WHY?

Are you one of them, HERE and NOW?

Are you SMART MONEY or DUMB MONEY?

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Four Features of a true VC markets

1. VC returns depend on the state of the IPO market 2. Returns are (VERY) HIGHLY skewed 3. Individual fund managers can have persistent

returns4. Only 1-2 sectors are “VC fundable” at a time

Point 3 is NOT true of mainstream fund managers

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“As expected, the returns are highly concentrated: about ~6% of investments representing 4.5% of dollars invested generated ~60% of the total returns. Let’s dig into the data a little more to see what separates good VC funds from bad VC funds…”

http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-capital/

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“The home runs for good funds are around 20x, but the home runs for great funds are almost 70x. As Bill Gurley says: “Venture capital is not even a home run business. It’s a grand slam business.”

http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-capital/

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Why?

1. Missing the “Grand Slam” deal is a serious mistake that matters more than having low error rate with low-multiple (<10x) opportunities

2. Grand Slam companies and alumni create and dominate ecosystems for decades (just like supernovas create heavy elements for life)

3. Grand slams create enormous social network capital — and winning VCs are at the center of it

4. They can make big things happen for newer portfolio companies with single phone calls

5. Winning funds get first pick of dealflow, everybody else gets deals they don’t take, so have to live off Top 5 mistakes

6. Unlike Wall Street, VC fund managers can actively use results of one winning fund to increase chances of next “crop”

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A FULL-STACK economy has

…MANY types of SMART MONEY

…and MANY MORE types of DUMB MONEY

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Type PureExample Vehicle Risk

TypeCreated

value (societal)

Captured Value

(investors)

“Smarts”Needed

Hedge Funds Subprime CDS Unique instruments

Technical, agency, capture

Clear out economic deadwood

Big piles of capital

Global macro env; market-

technical

Mainstream Index funds Broad-based portfolios

Global downturns

Societal stability

Individual prosperity for

all

Gauging health of nations

PE DellMature

company dying faster than

market

Overwhelming operational

cancer

Save jobs, reduce volatility

Bounded upside

harvesting

Turnaround competence

Venture Facebook Growth startups

“Missing the big one”

Spillover new wealth

creation 90%

Big company, “creative

monopoly”

How to build a big business

Angel Ron Conway, Dave McClure Individuals Immature

growth marketTalent,

knowledge liquidity

Small-multiple exits

Local ecosystem knowledge

Corporate R&D

Transistor iPhone, Hololens

Upstream Labs “Fumbling the Future”

Business model

renewalNew LOBs “Self-

disruption”

Government R&D Radar Defense Labs Theft by

Political RivalNational Strength

National Secret

Political wisdom

Academic R&D Number theory Universities Low scientific

cultureCommons Knowledge

Cream of immigration

Philosophy of science and technology

Types of Smart Money in a Full-Stack EconomyIn

nova

tion

Econ

omy

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VC

PE

FraudBasicR&D

High Upside withHard-to-HedgeMortality Risk

OperationalUncertainty(bad waste)

OntologicalUncertainty

(good waste)Structure of theInnovation Economy

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Is imitation closer to PE or VC?

Baidu vs. Google Alibaba vs. Amazon

Ryan Air vs. Southwest ARM versus Intel

WeChat vs. WhatsApp

Good question. The most important question for non-US geographies

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1. The costs of imitation are 60-75% the costs of innovation

2. Time-to-imitate is dropping… 1. Early 19th century: ~100 years. 2. Between 1877-1930, Average “time to

imitation” dropped to 23.1 years. 3. 1930-39: Dropped to 9.6 years 4. 1950s: ~2 years. 5. Now: 12-18 months

3. Pioneers who create new markets generally end up with around 7% of the markets they create. The copycats get the rest.

Data from Oded Shenker, Copycats

What about imitation? A bit of both VC and PE…

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“Smart Money” = CASH + CONTROL

Kinetic Energy

KNOW-HOW of CAPITAL DEPLOYMENT

• RIGHT SCALE… • RIGHT SPEED… • RIGHT KNOWLEDGE.. • RIGHT INSTRUMENTATION

Potential EnergyExists in SUFFICIENT

CONCENTRATION In SUFFICIENTLY LIQUID FORM

(“Low entropy cash”)

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DUMB MONEY ECONOMY No successes to create wealth Nobody learns anything from failure Vanity “angels” dominate the system Static/decaying ecosystem Wealth gets locked up in low-entropy, illiquid, degrading forms

Low-Grade Cash High-Grade Cash

Effective Control

Weak Control

SMART MONEY ECONOMY Investors WORK HARD Create more value than they capture High liquidity of talent and know-how Work to strengthen commons Make ecosystem smarter “Giving back” is a norm Protected from crony capitalist sectors

INNOVATION THEATER Lots of sincere people… working hard on the wrong things… at too small a scale… with too little liquidity in key variables lots of coworking spaces, hackathons lots of brain drain, few actual companies best case: feeder for a bigger market

EXTRACTIVE ECONOMY Fraud, crime returns > Innovation returns Low trust, high bureaucracy “Curse of resources”, “Dutch Disease” Weak property rights Elites and “connected people” dominate Smart outsiders not welcomed

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“Smart Money”

MONEY is not the problem

Trillions in capital already seeking returns. Trillions more in distressed assets waiting for redeployment

SMARTS is the problem

How do you deploy capital RAPIDLY and AT SCALE?

Can you deploy $250mm+ in <4 years?

See: http://avc.com/2009/04/the-venture-capital-math-problem/

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Four Noble Truths of Global Innovation Economy

1. Productivity gains account for 80% of economic growth (Solow) 2. Most countries rely on foreign sources of technology for 90% or

more of productivity gains. Only the US shows the reverse pattern

3. An increase in cross-border spill-over by 10% would overshadow domestic [R&D] for all but 3 countries: US, Japan and China.

4. Large companies are more globalized than markets in general. In 2008, the world’s largest 100 companies had 60% of their assets outside home markets. 40% of US imports are internal to MNCs

(Data from Pankaj Ghemawat, World 3.0)

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• Null Hypothesis for ENTREPRENEURS: Learn English, emigrate to the US. Hard enough to build a great company in IDEAL conditions, why take on extra burden?

• Null Hypothesis for GOVERNMENTS: Give up on startups. Just increase knowledge spillover by 10% by attracting right kind of MNCs with market access, require local participation, IP sharing (China)

• Null Hypothesis for INVESTORS: Unless you can access the top 5 VC funds in Silicon Valley, you probably cannot beat the S&P

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Maybe “Create a Local Startup Scene” is a Bullshit Political Conceit?

Like building a big skyscraper?

Or *cough* hosting the Olympics?

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Four Alt-Noble Truths of Global Innovation Economy

1. VC is a HIGHLY LOCAL business: Only 15-20% of venture capital investment is outside the home country.

2. Local innovation is cheaper: In the G7, $1 of foreign R&D is worth 74c of domestic R&D at distances less than 2000 km, 37c at distances between 2000-7000 km and 5c at larger distances

3. Talent is geographically illiquid: First generation immigration is only 3% of the world’s population. 90% of people will never leave their home country. 60% of immigration is from developing world to developing world, 37% is from developing world to developed world, 3% is from developed to developing world

4. Silicon Valley is bandwidth constrained, BUT Telepresence is getting better and better and better…

(Data from Pankaj Ghemawat, World 3.0)

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1. Alternative Hypothesis for ENTREPRENEURS: Find the smartest local money, smartest global knowledge, work where developed world is constrained

2. Alternative Hypothesis for GOVERNMENTS: Make high-skill developed-to-developing immigration/circulation easier, create REGULATORY ARBITRAGE opportunities, put as much GDP as you can into low-cap-ex basic R&D and wait 20 years

3. Alternative Hypothesis for INVESTORS: Where US-based startups struggle to globalize LEARN TO COPY and don’t get hung up on VC vs. PE vs. “Originality” pride (not-invented-here syndrome)

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Necessary Conditions for True VC Markets

1. Unencumbered access to big-enough markets 2. Modern state, rule of law, accountable government 3. Enough smart money to scale companies rapidly 4. Large, liquid talent base to scale rapidly (~ 500 engineers

in 1 year) <— KILLER CONDITION5. Enough “graduated entrepreneurs” for scouting, angel funding,

deal-sourcing, mentorship needs 6. Enough “capacitance” in system (university labs, big

corporations) for renewable talent lifecycle 7. Supply chain from a network of 2nd tier hubs that can seed but

not scale investments 8. Steady pipeline of upstream research coming from government

R&D

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So… do investors matter?

Up to you…

Do you WANT to matter?

Or do you want to PRETEND to matter?

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Don’t be a Scenester…

Wantrapreneur: Somebody who dresses, acts, talks like an entrepreneur but isn’t building anything meaningful

Wantainvester: Somebody who has money in meaningful concentrations (High-Grade Cash), but isn’t willing to put in the hard work required to make it SMART money (Weak Control)

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via @AdamRFisher

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Best Practices in VC… LIVE on blogs/twitter

1. Fred Wilson avc.com 2. Chris Dixon cdixon.org 3. Paul Graham http://paulgraham.com/articles.html 4. Sam Altman http://blog.samaltman.com/ 5. Dave McClure https://500hats.com/ 6. Ben Horowitz bhorowitz.com @bhorowitz 7. Marc Andreessen blog.pmarca.com 8. Good podcasts a16z.com 9. Mark Suster (Los Angeles) bothsidesofthetable.com 10. Brad Feld (Boulder) feld.com 11. Chris DeVore (Seattle) crashdev.com 12. Good roundup+posts: Mattermark newsletter

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And beyond…

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This is just the tip of the iceberg

1. Entire VC blogging scene has emerged since 2000 2. Highly open, wisdom-sharing investor culture 3. Opposite culture from Wall St… use it, add to it4. Regional and sector-level blogs 5. Plenty of coverage in interviews, video chats 6. Several good books on every stage of investment

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Thanks to…

Marc Andreessen, Chris Dixon, Chris DeVore, Luke Blackburn, Skinner Layne, Balaji Srinivasan, Bryan Johnson… many more

And LAVF sponsors

Bancoldex, the Colombian development bank

Inter-American Development Bank

Bavaria Foundation