Institute For The Future

Venture Capital and Lightweight Innovation: The Growing Gap

James Suroweicki writes in this month's Technology Review looking at the looming crisis in venture capital. Suroweicki's analysis partly hinges on one of the core trends in our lightweight innovation forecast - the rapidly falling cost of bringing products and services to market, particularly on the web, but increasingly across other industries.

...the costs of starting companies and of making companies profitable in sectors like information technology have fallen dramatically thanks to open-source software, the globalization of engineering, the commodification of bandwidth and infrastructure, and other factors. Wilson, for instance, estimates that costs have fallen "at least an order of magnitude" in the past decade. That's given entrepreneurs more leverage, since they're less desperate for capital.

 

At the same time, however, venture funds have not found a way to effectively manage a portfolio of smaller companies:

And on the level of individual funds, huge amounts of capital combined with falling startup costs have, in ­Anderson's words, made funds "muscle­bound": a $500 million fund can't make too many small investments, even if that's what would make economic sense, because the partners don't have the time to supervise hundreds of companies. (This is one reason, along with the desire to limit risk, that many VCs have started to wait until later rounds to invest.)

 

Their retreat from risk, and early-stage funding of very small companies also reduces the traditional mentorship and management advising role of VCs:

...the "muscle-bound" problem is real, too: to the extent that having too much money means venture capitalists wait to enter until later rounds of financing, the value that they add is reduced. It's also likely that because the size of these funds has required VCs to spread their investments across more companies, their effectiveness as monitors of corporate performance has been diminished.

 

The natural question that I have following this train of thought - are VCs being made obsolete, or does their failure to adapt open the doors for a new kind of manager of innovation networks? We've certainly seen some interesting efforts in the last few years to create more distributed, bottom-up kinds of angel networks. Y!Combinator, Betaworks, First Round Capital's Entrepreneur Exchange Fund, and so on. But while these groups have managed to incubate a larger network of small startups they still haven't quite figured out how to scale. As one investor told me last year, the limit on our network is me and my partners time.

 

My bet is that we're going to need to develop platforms that routinize at least some of the hand-holding that early startups need, and social tools that can amplify investors' ability to manage large networks of startups. I'm keeping my eye out for models.