It’s time to stop VCs from driving entrepreneurship

We are in the midst of what Erasmus University research calls “the entrepreneurial economy,” with governments, VCs and others pumping record sums into the creation of new startups and the entrepreneurial ecosystems supposed to support them.

A recent article from the Global Entrepreneurship Monitor (GEM) taps into the zeitgeist by proclaiming that startups will be key to successfully tackling global challenges, such as Covid-19 and Brexit. However, when we look below the surface of all this activity, it’s not really a pretty picture.

The famous research of Stanford’s Nicholas Bloom illustrates the difficulties we face in turning the wheels of innovation. Bloom illustrates that even though we are spending more than ever on research and innovation, we are getting diminishing returns for that investment. Data from Accenture reveals that this is replicated at the enterprise level, with companies getting a valuable return on the roughly £2.5bn they have invested in innovation over the past few years.

Creation Engines

This suppressed innovation process is not limited to the transformation of large companies. Indeed, the data reveals that entrepreneurship rates have been in perpetual decline in the United States between 1978 and 2011. This has led to a decline in the share of overall employment in start-ups, from about half of the workforce in 1980 to only 39% in 2006. It was at the same time that the share of large companies fell from 51% to 57%.

This is compounded by the changing nature of the startups out there, with Wharton data revealing that the proportion of entrepreneurs with a high level of education fell from 12.2% in 1985 to 5.3% in 2014. This may explain -be partly the decline in the impact of startups being created, with the proportion of profitable startups when they go public at historically low levels.

It is therefore perhaps unsurprising that data from Rice University shows that market power today is more concentrated than ever in the hands of a relatively small number of incumbents. An environment of creative destruction is certainly not present.

A different picture

One could certainly be forgiven for not recognizing such an image, especially if you are a regular reader of the tech press, which daily exposes the huge sums raised by startups around the world.

Indeed, global venture capital investment is at an all-time high, with data suggesting around $300 billion was invested in the first half of 2021, more than the whole of 2020. That made the once-legendary unicorn a much more frequent sight. , with recent valuations reaching the sparkling highs of 40 to 50 times earnings.

When the term unicorn was first coined in 2013 by venture capitalist Aileen Lee, there were just 39 private companies with valuations and revenues of over $1 billion. Just seven years later, that figure had risen to over 600, with a collective valuation of over $2 trillion, with that figure now over 800, with these companies worth around $2.6 trillion at the time of writing.

It is perhaps illustrative that in all the hype surrounding such transformative ventures, the actual earnings barely deserve a mention. Indeed, while many startups are content to brag about the funding they have raised, they are much more timid when it comes to disclosing their revenues.

A failed flush?

That doesn’t necessarily mean that unicorns aren’t healthy businesses. For example, under standard investment metrics, to accrue a $1 billion valuation, the company would have to be expected to ultimately earn pretax operating profits of approximately $200 million, which, while certainly not a walk in the park, isn’t overly ambitious either.

Zoom, for example, became an instant darling of the pandemic, resulting in an incredibly strong float that valued the company at around $166 billion at its peak, before falling to where it is today (at the time). of the editorial staff) of 56 billion dollars. Even that is a considerable multiple given that its pandemic-boosted revenue was only $2.7 billion, with profits falling from $25 million pre-Covid to $672 million post-world distancing. .

The problem is that Zoom is relatively rare among the herd of unicorns, out of the 73 unicorns that have been made public, only six of them have managed to turn a profit, with many registering huge losses instead. Nor is it usually the case for a new startup finding its footing, as the overwhelming majority of unicorns were over 10 years old at the time of flotation. There seems to be general hope that they will emulate Amazon, which took four years to turn a profit after its IPO, and about 20 years before it became the profit-making giant we know today.

looking in the wrong place

In many ways, Amazon is illustrative, however, as in one of his annual shareholder letters, Jeff Bezos remarked that he likes entrepreneurs to be missionaries rather than mercenaries. In other words, entrepreneurs should focus on building great businesses that leave a lasting and positive impression on the world rather than making a quick buck at a time when the world is flooded with cheap credit after a decade in which the world’s printing presses have been running non-stop.

Recent research from Boston College’s Carroll School of Management demonstrated the nature of the problem, as it found that traditional venture capital-focused accelerator startups tend to seek rapid growth that forces entrepreneurs to make choices. that they wouldn’t normally do. This, in turn, makes more sustainable development much more difficult and turns entrepreneurs into the kind of mercenaries Bezos despises rather than founders who leave a positive impression on their local communities.

Moreover, the study found that the race to scale was such that entrepreneurs were forced to always choose the path of least resistance and homogenize their products for the largest possible market. This often meant leaving their hometown in search of more clients, more talent, more investment. The desire to make a difference in his community has been supplanted by the rush for quick money.

the wrong path

Various studies have shown that entrepreneurs start their own business not to get rich but to make a difference. They want to experience the freedom and excitement of entrepreneurship and use that autonomy to try to change the world in their own way.

The VC bonanza seems to be destroying that, with the torrent of cheap money barely helping businesses thrive. Indeed, WeWork is an illustrative example of a company that was so backed by venture capital funding that it was allowed to make mistake after mistake with little consequence.

Despite all of its many flaws, the company was at one point valued at nearly $50 billion. Rather than the outcome of the WeWork story serving as a reset point for the community to reconsider how tech companies are valued, supported and reported, however, the money continues to flow, with some saying such is the inflation. evident in the community that a new $12 billion benchmark is needed to describe these truly cutting-edge companies.

This runs the very real risk of crowding out startups looking to take a slower, more sustainable path to growth in favor of those seeking the fastest possible path to riches. This runs the risk that startups targeting niche issues will be crowded out in favor of those forced to chase mass market issues.

Right now, everyone from the startups seems to be playing the VC tune, and it’s time for that to change.

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