The venture model has always been an extension of Research and Development (R&D). The notable failure of Xerox in recognizing the value that its PARC initiative was creating can largely be seen as the defining moment in the death of corporate R&D. Executives who have made their career in the core business model of a given enterprise will have a hard time justifying initiatives outside of this profitable niche – this is the bias that caused Xerox to overlook the gold it was mining at PARC. As such, a market opportunity emerged for venture capitalists to become the brokers of R&D to corporates.
If the middleman aspect of VCs is not yet clear, we only need to look at how investors in startups actually make their money. Quite simply, a financial event is needed, either in the form of an IPO or an exit, with an exit being the far more common outcome. And what is an exit but the acquisition by a larger company? What this amounts to is none other than what we used to call R&D, only that it has all been done outside of the corporate entity. The premiums paid to VCs – one that would have originally stayed in the pockets of corporates – is for their ability to back the right teams to build the right products at the right time. This speaks volumes about the dearth of innovation in corporates or, rather, how corporates structurally inhibit their employees from innovating. It probably has a lot to do with the short-termism imposed by quarterly KPIs, such that it’s easier to streamline operations through outsourcing rather than investing in the risky work of launching something new: streamlining guarantees that the numbers will meet expectations whereas genuine innovation will have no such guarantees.
In any case, the state of corporate incentives aside, we would be blind to not see a twofold opportunity: either cut out the middleman or foster a deeper partnership with the middleman. Given the Xerox experience, we can rule out the former option. There will always be a suite of myopic execs who are unable to see beyond their current business model – they should truly have every authority they deserve to dictate the existing business lines but that’s where their authority should end. The conductor of a train has no place piloting an aircraft. With this in mind, the real opportunity exists in VCs partnering with corporates in order to fund startups tailored to solve existing problems within the industry of a given corporate.
The biggest waste of LP dollars comes from VCs investing in startups that they hope to become IPOs. In reality, there is only room for one king per company category (shout-out to Play Bigger) – as soon as a category king starts to form is when everyone should be divesting from its competitors. Thus, there should really be two classes of VCs: the IPO-pursuers and the Exit-pursuers. Realistically, only VCs like a16z have a shot at backing future IPOs and they constitute the 20% of the VC population that accrues the big 80% of returns. As such, the remaining 80% of the VC population that gets the 20% of returns should content themselves as Exit-pursuers. If one is going to be an Exit-pursuer anyhow, one might as well optimize for it through strong pre-existing partnerships with corporates.
The situation for VCs is analogous for startup founders – know whether you’re IPO-material or Exit-material and have no delusions about your status. The next logical step if one acknowledges that one is Exit-material is a burning desire to know if the problems one is working on corresponds to real corporate needs. As hinted above, such is the market opportunity for the Exit-pursuing VC. In this emerging model, the Exit-pursuing VC’s role is to foster deep partnerships with various corporates, in various industries, and to extract the needs of these corporates; the role of the Exit-material startup team is to fulfill those requirements in ways that the corporates themselves could never think of. The unspoken rule of this arrangement is that there needs to be a near guarantee of acquisition otherwise there is no reason for the startup team to accept this relationship.
This model may sound rather mercenary and bland but it is the inevitable by-product of a winner-take-all entrepreneurial arena. The development of the purist Exit-pursuing VC and the purist Exit-material startup team is the height of pragmatism.
Above all, know yourself. Choose the battlefield commensurate with your abilities: a receipt of defeat is served to those who engage in self-deceit.