Mo Money, Mo Problems
On March 9 shortly after midnight the critically acclaimed rapper Biggie Smalls, better known as the Notorious B.I.G. was killed in a drive by shooting in LA. A lot of mystery surrounds his death and the authorities have never found the suspected shooter. Four months later, Biggie's record label released "Life after Death." You can read more here. Biggie had a difficult life but was still able to create some of the most critically acclaimed rap of the late 1990s. I find it interesting that after he achieved significant financial success he wrote the song "Mo Money, Mo Problems." As is often the case with rock stars that die, their last few songs often seem prescient. While we may never know, it definitely seems like money could have been a root cause of the killing. In any case, I loved that song when it came out.
Now further in my career, I think it is kind of funny but I keep thinking about how Notorious B.I.G.'s "Mo Money, Mo Problems" lyrics apply to venture capital and entrepreneurship. For the vast majority of startups (and some venture funds), the more money you raise the more problems you will have. [As a side note, I find it interesting that something like over 90% of companies that raise a Series A venture round will raise a Series B. However, something like only 60% of companies that raise a Series B will raise a Series C. And the ratios keep dropping off precipitously after that in to the Series D, E, F range. It is also true that that the average amount of money funded in each of these series starts out lower in the Series A and grows with each subsequent round. While I would need to slice and dice the data to get to a firm conclusion, I suspect that this means that unless you achieve profitability or at least revenues by Series B, you are typically not increasing your chances of success with every subsequent round of funding and could actually be decreasing your chances of success. The reason I can't be sure is because many (perhaps most) hugely successful companies like YouTube have raised significant amounts of cash and tend to raise money in later stage rounds as well. [I will commit to doing some research here and post it later.]
I was skimming through a copy of the best business book ever in the airport today, Collins' Good to Great. Here is the WikiSummary. In his discussion of technology he stresses that successful companies use technology after they have achieved business breakthroughs whereas unsuccessful companies use technology to try to achieve business breakthroughs. I think that this same kind of thinking should, but typically doesn't, apply to venture funding. There are times when raising money (even lots of it) is totally, unquestionably OK. You might argue that the owner(s) is silly or even dumb to allow dilution in these circumstances, but you can't argue that taking the money is somehow hurtful to the startup itself. These times are when the company doesn't need money. I take the example of the recent Kleiner-funded company, LifeLock. From what I understand, LifeLock is absolutely killing it. They don't really need the money. Because of this, you can be almost 100% sure that they will put the money to good use. They have a business model that is working beautifully.
The problem is that LifeLock is an exception. The general rule is that the company raising money needs it desperately to continue searching for a business model that works. This search is problematic because we have learned over and over that necessity is typically the mother of invention, and if you fund somebody to search, you are, by definition, removing the necessity for invention. Plus, great entrepreneurs are defined by how much they can do with how little they have. Going back to my adaptation of the _Good to Great_ thought: funding should follow breakthroughs rather than precede them. To many entrepreneurs (and probably all first-time entrepreneurs) that probably sounds strange. But I think that many entrepreneurs are probably nodding their head in agreement because they have found that perhaps the most important and most defining skill that great entrepreneurs have is the ability to create results without cash. In a way, you could say that the defining characteristic of a great entrepreneur is either 1) the ability to create significant (even great) results without cash or 2) the ability to do more with limited cash than 99% of others.
So what am I saying? Am I saying that there is no legitimate purpose for venture capital? I don't think I am saying that. I think what I am saying is that we probably overuse venture capital in general and that we probably overfund venture-backed companies. BTW, there are probably times when VC seems to be the only option. You could view the entire VC process as simply this: finding the cheapest possible way to perform tests about the validity of a business model. It may be that some tests simply require a lot of capital. Biotechnology "tests" seem to fall into this category, and this, by the way, is why I don't really love biotech investing.
It has become conventional wisdom in the VC world that VC funds (especially successful ones) continue to grow their assets under management. This, in turn, forces them to deploy larger and larger amounts of money in their "typical" deal. This, in turn, causes entrepreneurs to accept more money than they need or to artificially inflate valuations. Both of these things fuel the cycle of raising more and more money before achieving breakthroughs. All of this contributes to the "Mo Money, Mo Problems" cycle.
Now further in my career, I think it is kind of funny but I keep thinking about how Notorious B.I.G.'s "Mo Money, Mo Problems" lyrics apply to venture capital and entrepreneurship. For the vast majority of startups (and some venture funds), the more money you raise the more problems you will have. [As a side note, I find it interesting that something like over 90% of companies that raise a Series A venture round will raise a Series B. However, something like only 60% of companies that raise a Series B will raise a Series C. And the ratios keep dropping off precipitously after that in to the Series D, E, F range. It is also true that that the average amount of money funded in each of these series starts out lower in the Series A and grows with each subsequent round. While I would need to slice and dice the data to get to a firm conclusion, I suspect that this means that unless you achieve profitability or at least revenues by Series B, you are typically not increasing your chances of success with every subsequent round of funding and could actually be decreasing your chances of success. The reason I can't be sure is because many (perhaps most) hugely successful companies like YouTube have raised significant amounts of cash and tend to raise money in later stage rounds as well. [I will commit to doing some research here and post it later.]
I was skimming through a copy of the best business book ever in the airport today, Collins' Good to Great. Here is the WikiSummary. In his discussion of technology he stresses that successful companies use technology after they have achieved business breakthroughs whereas unsuccessful companies use technology to try to achieve business breakthroughs. I think that this same kind of thinking should, but typically doesn't, apply to venture funding. There are times when raising money (even lots of it) is totally, unquestionably OK. You might argue that the owner(s) is silly or even dumb to allow dilution in these circumstances, but you can't argue that taking the money is somehow hurtful to the startup itself. These times are when the company doesn't need money. I take the example of the recent Kleiner-funded company, LifeLock. From what I understand, LifeLock is absolutely killing it. They don't really need the money. Because of this, you can be almost 100% sure that they will put the money to good use. They have a business model that is working beautifully.
The problem is that LifeLock is an exception. The general rule is that the company raising money needs it desperately to continue searching for a business model that works. This search is problematic because we have learned over and over that necessity is typically the mother of invention, and if you fund somebody to search, you are, by definition, removing the necessity for invention. Plus, great entrepreneurs are defined by how much they can do with how little they have. Going back to my adaptation of the _Good to Great_ thought: funding should follow breakthroughs rather than precede them. To many entrepreneurs (and probably all first-time entrepreneurs) that probably sounds strange. But I think that many entrepreneurs are probably nodding their head in agreement because they have found that perhaps the most important and most defining skill that great entrepreneurs have is the ability to create results without cash. In a way, you could say that the defining characteristic of a great entrepreneur is either 1) the ability to create significant (even great) results without cash or 2) the ability to do more with limited cash than 99% of others.
So what am I saying? Am I saying that there is no legitimate purpose for venture capital? I don't think I am saying that. I think what I am saying is that we probably overuse venture capital in general and that we probably overfund venture-backed companies. BTW, there are probably times when VC seems to be the only option. You could view the entire VC process as simply this: finding the cheapest possible way to perform tests about the validity of a business model. It may be that some tests simply require a lot of capital. Biotechnology "tests" seem to fall into this category, and this, by the way, is why I don't really love biotech investing.
It has become conventional wisdom in the VC world that VC funds (especially successful ones) continue to grow their assets under management. This, in turn, forces them to deploy larger and larger amounts of money in their "typical" deal. This, in turn, causes entrepreneurs to accept more money than they need or to artificially inflate valuations. Both of these things fuel the cycle of raising more and more money before achieving breakthroughs. All of this contributes to the "Mo Money, Mo Problems" cycle.
posted by VentureReturns at
7:09 PM
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