A Dim View of Betting on Start-Ups
“There’s too much money chasing too few deals.”
Sean Parker, the entrepreneur behind Napster and Facebook now turned investor, was talking about the state of the venture capital industry last week over coffee. At 30, Mr. Parker, who was recently portrayed by Justin Timberlake in “The Social Network,” has been thinking a lot about innovation — or the lack of it — in the United States.
And he’s come to a depressing conclusion about the money industry that he says used to be “the engine of innovation” for this country.
“The risk-reward doesn’t work out in favor of putting money into venture capital anymore,” he said, even though he himself is a partner in a venture capital firm that owns stakes in Facebook and SpaceX, the private spaceflight company run by Elon Musk, a co-founder of PayPal.
Mr. Parker, a night owl who had awakened before his usual rising time of noon to meet with me, said the problem plaguing the venture business represented a “systemic risk” to the country that he believed meant “innovation could gradually grind to a halt or at least become less effective.”
Mr. Parker may tend toward hyperbole, but ever since the bursting of the dot-com bubble, there has been a steady drumbeat of “venture capital is dead.” In the last year, however, that drumbeat has gotten louder as it has become clear that many of the best-known venture firms in Silicon Valley and elsewhere have returned a pittance to their investors.
According to the Cambridge Associates U.S. Venture Capital Index, venture capital returned a paltry 8.4 percent to investors in the last decade, starting in 1999. Ernst & Young reported last month that venture capital investing had fallen off a cliff this year, down 47 percent in the first half of the year compared with the period a year earlier.
“You’ll see big old established firms that everybody thought were here to stay probably splintering,” Mr. Parker said. That’s in part because he is convinced that the industry’s biggest backers — institutional investors — are going to seek a haven elsewhere. “I can’t name names but certain large university endowments have lost as much as half of their value,” Mr. Parker said.
For every Facebook, there are dozens of start-ups that never make it. That is the model — it is all about swinging for the fences. Even Facebook, still private, having not pursued an initial public offering, has yet to see the big payoff for its largest investors.
One of the problems often cited for depressing the venture capital world is the perception of a tight market for I.P.O.’s. Bill Gurley, a partner at Benchmark Capital, which was an early investor in eBay and OpenTable.com, says he believes exaggerated expectations are the problem.
“We may also have a perturbed notion of what a healthy I.P.O. market looks like,” he wrote last week on his blog. “The I.P.O. market of 1999 was a myth, a facade, a once-in-a-lifetime mirage that you will never see again.”
That the market for initial offerings is dead may also be a myth, however. It may just be Silicon Valley. Only 11 of the 42 high-tech, venture-backed offerings since 2008 came from Silicon Valley. As Mr. Gurley pointed out, “In other words, 74 percent of these I.P.O.’s hail from outside of the S.V. echo chamber.”
Silicon Valley’s latest, greatest hopes — clean tech and green tech — also seem to be failing despite big investments from the likes of John Doerr of Kleiner Perkins Caufield & Byers and Vinod Khosla, a former Kleiner partner.
“It is not clear anyone will make money on their green-tech investing. It looks like it was a bubble, “ Mr. Parker said.
But worst of all, from the standpoint of innovation, entrepreneurs may be changing the way they are thinking — they are becoming less ambitious.
“Ten years ago, venture capitalists would ask the question: Do you want to build a company and flip it or do you want to build a company and I.P.O. it? It’s a trick question. The correct answer was always, ‘I want to build an incredibly valuable stand-alone business and maybe we get bought, maybe we go public but we’re going to build an incredibly valuable company,’ ” Mr. Parker said. “Now it’s actually not clear that that’s the right answer. There’s a lot of venture firms that are clearly interested in building something and selling it either to Facebook, Google, Microsoft.”
That’s not to say that Mr. Parker is all doom and gloom. His firm may actually have another venture capital-backed winner on its hands in Spotify, an online music service that some analysts suggest could one day challenge Apple’s iTunes.
But before you get too excited about great leaps in innovation in the United States, consider this: Mr. Parker didn’t discover Spotify in his backyard. It was founded in Stockholm.
Given his own status as a rock star entrepreneur, just how did Mr. Parker feel about Justin Timberlake’s portrayal of him in the “The Social Network?”
Pausing for a moment, Mr. Parker reflected: “It’s hard to complain about being played by a sex symbol.”