Have Tech Investors Gone Too Timid?

Several articles have lately been speaking of decline in the VC culture and performance.  These arguments posit that the VCs are (a) not backing truly disruptive innovation, (b) sprinkling capital across too many young companies that are founded on racy hope, not viable business models, and (c) investing in a vast number of me-too ideas that smack of Wall Street’s momentum-driven culture.  You know, grab a fast mover and sell off to the next fool before it starts to crash.

These discussions are fueled by multiple trends.  One is the hyped up valuations of social networking companies, both in public and private markets, that defy measurable metrics and financial logic.  Though a handful of companies have generated remarkable returns for a handful of VCs, most observers see signs of a boom-to-bust cycle rather than a sustainable return to healthy investments and returns. 

The other is lackluster financial performance of the venture firms in the last decade.   A recent report by the Kauffman Foundation, the entity that founded the Kauffman Fellowship program to train the next generation of VCs, highlights the sub-par distributions from their investments in venture firms. 

Entrepreneurship in Mexico

It seemed odd to me that the Kauffman Fellows would choose Mexico City for the recently concluded annual summit.  When one thinks of Mexico, venture capital rarely comes to mind.  Well, I was in for some big surprises.

Robust Economy: Mexico seems to be enjoying robust economic health.  Despite its heavy reliance on the northern neighbor (US accounts for 80% of its exports which are 40% of its GDP), the economy is growing about 5% a year.  The peso is stable and the country has recovered all the manufacturing jobs it lost during the recession.  One can also see a rise in Latin American pride – a sense that the country can emulate the success of Brazil, Chile and Peru, and that entrepreneurship holds the key to success.

Young VC: Naturally, PE/VC is nascent in the country.  Regulations that permitted the insurance companies to invest in venture firms were put in place as recently as 2001.  There are only 5 or so VC firms that invest in small entrepreneurial companies with high growth potential, and they are typically small with less than $100 million of capital.  Many VC-funded companies incorporate in Canada to avoid double taxation.  A lot more can be done to promote innovation (here is a nice article), but that has not prevented gritty entrepreneurs from bootstrapping very high performing businesses with global ambitions. 

Can Cleantech companies achieve escape velocities?

Many investors in the Cleantech space have been soured by lackluster industry returns in the past few years. Startup companies in solar, wind, batteries and electric cars, even when successful, are not known to generate 10x returns that sustain the VC industry. To compound the problem, too many companies and investment themes appear to have low survival rates – witness the micro-bubbles in fuel cells, corn ethanol, and algae.

I do believe in the promise of the Cleantech industry, but clearly the current practices are not working very well. To understand why, let us define a logical framework that adequately captures the industry's unique challenges and opportunities. One such framework is offered by the elementary principles of space flight.

The launching of a startup company can be compared to the process of launching a rocket. The startup attains success when it achieves enough velocity to escape the earth's gravity. Now, the principles of Physics state that a spacecraft’s ability to achieve escape velocity and reach its destination depends on four important factors:
1. The force of gravity
2. The quantity of fuel and rate of burn
3. The weight and design of the spacecraft
4. Careful alignment and timing between launch and destination sites