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Do we need a new funding model for starting businesses?

Three separate issues / trends that I’m looking at, and hoping to address:

  • Entrepreneurship: An increasing interest by younger people entering the workforce to create their opportunities (forming or joining startups or smaller companies) rather than have their opportunities handed to them (joining a larger company).
  • Collaboration: Rapidly decreasing startup costs [1] and continued development and usage of inter-company interaction and communication platforms leading to reduced interaction costs and an increasing need to develop collaboration core competencies. [2]
  • Venture Capital: A “funding gap” in the venture capital community, where there is a dearth of investors funding early-stage companies in their growth from seed stage to established companies.

All of these trends are addressed far better elsewhere: search for “millennial entrepreneur”, or “venture capital funding gap”, or read John Hagel, Paul Graham, Fred Wilson, Umair Haque or Marc Andreesson, to start.

I’ve touched on some aspects of these trends before, but instead I’ll address a different (although inter-related) set of questions:

  • If more people want to be entrepreneurs, will they want to form the same kind of businesses that exist today?
  • Does a company have to get big for it to be successful, or can “lifestyle businesses” be a successful end goal?
  • And if so, do we need an entirely new structure and economic model for funding new businesses that does not depend on exit M&A-events to create economic value for investors?

Following on, some unstructured thoughts about these trends, issues, questions…

1) Aren’t we seeing venture capital address the funding gap?

The “Y-Combinator Approach”… the buzz is there, not just in Silicon Valley, and not just about copying Y-Combinator. The key in this space is to learn the lessons from the incubator approach in the early 00s. Y-Combinator is an early success story because a) they eschew coddling entrepreneurs to the degree typical of most early-00’s incubators, b) they do a great job of using social media to create deal flow and c) we are in a vastly different cost structure and market environment for startups than we were then, especially in web software.

And angels are in fact starting to become more institutionalized and move up the funding ladder, pursuing later, bigger deals. But from what I’ve seen the interest is more in partnering with institutional money, “validating” their investments, rather than continuing to fund startup risk.

And at the same time, venture capital continues to get farther and farther away from the market it used to serve. Read Haque, Wilson, and a lot of influential and forward-thinking venture capitalists and you’ll see the trend exists; there are a lot of people interested in “fixing” venture capital (and not just from entrepreneurs looking for funding).

2) What happens if people want to create lifestyle, cash-flow built businesses but venture capitalists wants to invest in scalable, big hit and big exit businesses?

It’ll be tough for the two to work together. Entrepreneurs always have the option of bank debt to fund a new company by getting business loans from a bank. While that model still works in a physical asset business, it just doesn’t fit the needs of the bank or the entrepreneur in the digital asset / knowledge / communication industry. And banks have a serious skillset mismatch in funding non-physical asset based businesses. [3]

3) If the model of creating new businesses change, how will the rest of the ecosystem adapt?

I’m more curious how things change when startups get even cheaper to start and maintain, or if/when people truly prefer starting companies to getting jobs (is it fundamental to the Millennial Generation entering the workforce or something more?), or the “value of collaborating” gets higher and the transaction costs between companies get even lower.

What role does venture capital take? What risks does venture capital take on to take a company to scale (market, technology, etc.)? When is money really necessary (what stage)? Will venture capital investors focus on enabling business to scale rather than to start?

Venture and angel investors make money when deals get made - M&A - for the big hit multiple. But what if the goal of entrepreneurs is sustainable, life-style businesses, that for the large part will never have a big-hit M&A event, just annual cash flow, which just doesn’t fit the venture capital economic model. If the risks of starting a company decrease, does the deviation of returns decrease?

Can we make it easier for people and companies to collaborate? When will people start mini-companies, one-person, two-person shops? How do we improve on the freelance / consultant marketplaces like Guru.com and Elance.com? How can social networks help to fill this gap to connect mini-companies?

Is there an alternative route towards funding startups based on a different economic model?

Or am I misguided, overly idealistic (”everyone wants to get rich”), biased by web economics, out of touch with most small entrepreneurs, thinking about a very small niche, or just flat-out wrong? I’m looking forward to finding out.

—

[1] At least for web software
[2] Ethan has been pushing my thoughts on “collaboration core competencies”
[3] Maybe venture debt is an alternative viable funding model, but I’m not as familiar (yet) with venture debt economic model or history of returns. Would love to learn…


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    • This entry was written by Taylor Davidson, posted on June 4, 2008 at 0:12, filed under Business & Society, Unstructured Thoughts and tagged , , , , , , , , , , , , . Bookmark the permalink. Follow any comments here with the RSS feed for this post. Post a comment or leave a trackback: Trackback URL.

    Viewing 10 Comments

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      • v
      My thoughts on Milllennials, business start-ups and a new model of funding. http://is.gd/1ml0
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      • v
      Jessie: loved your response using Utterz, and I appreciate your time and thoughts. Couple key points I picked up on:

      Collaboration: you pointed to a potential trend of people (Millenials) hired in groups because of their peer-oriented nature and lifestyle / workstyle. That's an interesting trend I have not considered.

      Thinking of "entrepreneurial groups" as you pointed out is an interesting way to think about how small companies could form. I've always believed that entrepreneurs need partners and that the most successful startups were founded by two people; not sure if the data supports that, but I've seen at least anecdotal evidence.

      Lifestyle businesses: but the cash can't come just from friends, family and government. That structure exists today, and it's not enough. Burning friends' money and bootstrapping on credit cards are just bad ideas.

      Risk and gambling: interesting, I had always considered Millenials (Gen Y) more as risk-takers, but you draw an interesting distinction in the risks they are willing to take. Based on your commentary, I would draw that Millenials are less willing to take big risks (including the risks involved in starting companies) and that Gen X takes bad risks. It is a frame I had never really considered, and an interesting add.

      Maybe the key is to make entrepreneurship more possible for the masses, and then it will not be seen as a bad risk? Perhaps an opportunity exists in revising entrepreneurship structures to mitigate risks, test more, reduce personal exposure?
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      • v
      Dear Taylor,

      You are not alone. I'm the Treasurer/CFO of a late stage startup that has been able to raise $5MM from traditional angel investors only (traditional in the sense that they are every day high net worth individuals interested in a potential high ROI, and not in taking control of our company, or how that ROI is achieved, i.e. M&A, they have not become "institutionalized" like you mentioned in your article - I completely agree with you, most angel group presentations we've made feel like VC presentations - they expect the same terms and exit.

      We believe in home grown businesses that are nursed and maintained by the founders. As my partner said to me last week, if Enron had had someone's name at the door, that disaster would never have happened - there would have been a "person" responsible for the company, not a myriad of investors with no direct influence on everyday operations.

      We have been lucky enough to attract investors to keep us moving forward without having to give in to the terms placed by VCs. We've worked hard and long to build this company and we plan to stay with it for the long haul AND more importantly, to give our investors a return on their investment that will be unprecedented (even if there is no M&A).

      I congratulate you for bringing up this subject and I encourage you to contiue with it. We plan to create a fund in the near future to help startups and the top requirement to qualify (other than a sound business idea and management team) is 1) there will be no IPO or M&A - you the founder will manage and keep your business - we will just help you become successful.
      • ^
      • v
      Good points, and I don't think you are misguided at all. Look, children are now being taught on computers via software and Internet applications at a very young age (like 1 I think). They are hearing, seeing and understanding that this is *business*, this is where it's at. I suspect/hope they'll be teaching *entrepreneurship* starting in elementary all the way through college in the very near future.

      Why can't every major city in America institute some sort of program similar to Y-Combinator ? I am not sure how profitable/successful their portfolio has been but, they are certainly optimistic enough to continue. We need mentors, motivators, & money. It's sad how many amazing ideas are "stuck" out there. Actually, just addressing this is giving me a few ideas right now ;)
      • ^
      • v
      Many cities are trying, but in misguided ways. Tax credits to draw in industry, research parks, "innovation agendas", focused efforts to create specific industries, etc. Read NVCA (http://www.nvca.org/) and their news is full of efforts by cities to create the business and economic climates to spur innovation and business creation. However the history of government forcing innovation and business creation along specific, selected industries is mixed at best.

      Read "The Creative Class" or anything by Richard Florida to get a taste of the other side of the debate, how cities need to focus on creating the right social, cultural and business environment to draw in the "creative class" of people that will naturally create businesses and economic growth. There's an active debate on both sides, and the answer (like most things) is that it's probably a mixture of both.

      The better question is what you point out: what are we teaching kids now that could lead to changing attitudes on what "business" and "jobs" mean?
      • ^
      • v
      Thanks for the shout out, Taylor! Although I'm no more than a living, breathing hyperlink to all things Umair ;-)

      I like that this discussion came down to: "How are we educating and preparing people to take these actions themselves?"

      In my own career, "business" was a dirty word for a long time. So I really think there is merit in reorienting people's idea of what "work" actually is.

      To borrow a term from Jerry Springer, here's my "Final Thought":

      We're going to need to come up with a slammin' new world view (which you are getting at) and a way to motivate our workforce ASAP to compete with the pace of innovation that is happening in India/China/etc. (Yes, the "let's collaborate" guy used the word "compete"; we can't let it get to the point where these economies would rather not collaborate with the U.S.; that's a recipe for violence).

      They have the need, they have the drive, and they have a chip on their shoulder, after being viewed as second-class economies for half a century:

      "As Ratan Tata, chairman of the Tata group of companies, observed in an interview with The Times of London: 'A bunch of entrepreneurs could establish an assembly operation and Tata Motors would train their people, would oversee their quality assurance and they would become satellite assembly operations for us. So we would create entrepreneurs across the country that would produce the car. We would produce the mass items and ship it to them as kits. That is my idea of dispersing wealth. The service person would be like an insurance agent who would be trained, have a cell phone and scooter and would be assigned to a set of customers.'"

      "In fact, Tata envisions going even further, providing the tools for local mechanics to assemble the car in existing auto shops or even in new garages created to cater to remote rural customers."

      http://www.businessweek.com/innovate/content/fe...

      I mean, that is just top-to-bottom genius! Co-creating value, networked distribution, viral franchising, AND a self-reinforcing social motivation? Get outta here!!!
      • ^
      • v
      If you want to see entrepreneurship and ingenuity, go to India, I can speak for that. If you want something done, you can get it done on a street corner or market in any major Indian town.

      Tata's model may seem genius, but really only to a Western world view. In fact, this disaggregated model of economic value creation is how things are done in India. India already knows how to do this.
      • ^
      • v
      Oh, I'm quite aware of the context of India's genius!

      The exact same dynamic is present when you compare Indian music and Western music (especially the Western music rooted in the African-American tradition, e.g. blues, jazz, r&b, rock)

      It's still effing genius ;-)

      But yeah, if you read the rest of that article their main point is: these economies have to deliver more value at less cost. When they apply that same value prop to a Western context...
      • ^
      • v
      Sorry, but I think 'social investing' is a sideshow, a diversion from the problem you address and not a solution.

      The core problem is that our great grandfathers burdened us with the Securities Act, a bad idea even at the time, which has by no means stopped securities fraud in this country.

      The Act was intended to be highjacked by the syndicalists, moving control of the means of production from owners with their names on the door to labor unions through their pension funds (where would the Vc be without pension funds?). To accomplish that, and serve the big boys on Wall Street, it was necessary to suppress the angel investor market, and as you know there is no angel market in this country today. SEC would move very briskly to suppress any attempt at a true angel market.

      You'd literally be better off in RED China.

      The nation has been paying for this bad idea and will continue to do so: Cleveland, for example, 100 years ago was the hub of the oil, steel, machine tool, and auto industries. There were more independent automakers in Cleveland in 1907 than the rest of the world combined. Between the M&A racket and the estate tax, there are neither any large manufacturers there, nor anyone with the capital to start up more than a coffee shop. Result? In March, the Times of London called Cleveland a "ghost town" - and they're right!

      How does a city or a nation recover when it's productive capacity has bee whored off for a $.05 two-day bump in a public share price? You start over, from scratch. If the Chinese and Koreans and Vietnamese will let you. They threw away state socialism twenty years ago, and with all due haste they've taken over the real production on the planet.

      I'm afraid the next generation will have to tear down the superstructure and restore the order of 1900 to avoid becoming a second-world, rust-belt nation. You should see from the obseession with persnal financial security and the resistance to change here that this society has a bad case of atherosclerosis.

      Creative, energetic young guys like you should consider moving your skills - your lives - to a more progressive nation.
      • ^
      • v
      It's not just about "social investing". This is a step beyond lending debt capital from one person to another (e.g. Prosper and LendingClub), and not just about making equity investments in people (e.g. My Rich Unkle). It's about thinking about how to create better opportunities for people to start participating in the economy in smaller chunks of activity. Finding better ways to collaborate and get paid for their efforts. Marketplaces for talent (Elance and Guru for consultants) and products (e.g. Etsy and other craft marketplaces for DIY'ers) is a step, but it is not the end solution, since we know most business is created through personal relationships and personal contacts.

      And part of this is figuring how we can help add to the supply of entrepreneurs. Figuring out ways to help them eat when they start is a big part of that. Maybe the Millennial Generation is more willing to eat less when they're young to take more of a financial risk when they're young? Will they be happy if they don't get rich and don't get the big exit? How will they adapt?

      I don't know: I'm not 22.

      A friend of mine had a couple pretty insightful comments earlier today, one of which was: "Whereas VCs invest in ideas and people, this approach leans more toward simply investing in people."

      I understand the issues with how the securities legislation and "qualified investors" and reporting rules make it difficult to create and distribute securities to masses of people. But why can't we create easier ways to facilitate the creation and maintenance of one-person LLCs and other corporate structures to provide the corporate structures people need to run lifestyle businesses?

      How can we work within existing government legislation to create the best opportunities for people to create and live?
     

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