The March 2019 issue of Venture Capital includes a largely pessimistic article about “the evolving environment for the formation and financing of new firms.”
Written by Martin Kenney and John Zysman, the article bears the title ”Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance.”
Kenney and Zysman are co-directors of the Berkeley Roundtable on the International Economy (BRIE) posit that in the early years of the new millennium, after the dotcom crash, the venture capital system in the United States re-invented itself. The “remarkable decline in the number of IPOs since” the 2000 crash is the negative part of this transformation. On the plus side, the VC world has discovered that the cost of creating platform-based startups is “exceptionally low.” New entrants into particular industries now routinely see themselves as disruptive, creating “software/data analytics-based applications targeting particular segments.”
The combination of this negative and this positive is that for entrepreneurs and their investors, getting in is easy. There are lots of would-be “unicorns” eager to take a VC or PE investor’s money. For early investors, getting out again, though, is becoming trickier given that dry-up in the IPO market. This dynamic is unfortunate in that it means “money-losing firms can continue operating and undercutting incumbents for far longer than previously—effectively creating disruption without generating profit.”
Technical Changes and Experiments
Cloud computing services, from Amazon Web Services or from Microsoft Azure, have abolished the need for a start-up to create and to be able to afford an IT infrastructure. What was once a capital expense, then, has become a variable cost. Likewise, open source software downloadable from GitHub has eliminated the need for a would-be disruptor to hire a lot of coders. These and other technical changes permit the entry of far more firms than ever before. That encourages a lot of experiments and slows down the process by which they are weeded out.
When a startup is successful, where success is defined by the traditional avenues for the successful exit of the early money—IPO or significant acquisition, the time that success requires has expanded. Kenney and Zysman cite a recent study by Pitchbook, which says that the time between start-up and exit has expanded to 8.2 years for an IPO and five years for a buyout or acquisition.
Some of the old-line Silicon Valley VC firms no longer invest in projects that require amounts of less than $1 million dollars, because that amount is too small to justify the expenditure of time that could be spent working on a $100 million start-up plan. This has created a market gap for the smaller scale startups and the ecosystem has come up with six responses to that gap:
- Angels or super-angels, often successful entrepreneurs themselves, who have sold their own companies at a profit that has allowed them to move to the investors’ side of the table (for television viewers, this is the “Shark Tank” response);
- Accelerators, such as YCombinator, that provide capital and incubator-style coaching in return for equity;
- Digital platforms for crowdfunding in the Kickstarter mode;
- Smaller VC firms specifically focused on the startups that the big players must neglect;
- Late-stage investments by open ended mutual funds and sovereign wealth funds, and finally;
- There is a development these authors consider “perplexing,” the use of initial coin offerings and their blockchains to raise capital. They are concerned that ICOs may leave a lot of investors owning only snippets of code rather than actual assets.
Through these six means, and through the seventh (those old-line VC firms that continue to do what they do what the large-scale project comes along), there are lots of firms in a pipeline, but the other end of the pipeline is clogged. Kenney and Zysman are not very clear on where they think this situation will lead, but they clearly do not believe that it is sustainable indefinitely.
The financial world, as Kenney and Zysman see it, is now tied to a single narrative, the story of a unicorn who emerges from the mists of legend and, with enough nurturing, enters triumphantly into the public markets. It is an entrancing story. But the world needs other stories as well, distinct growth models specific to different industrial “contexts, resources, and possibilities.”