Venture's Role in Innovation

A big debate was spurred by Vivek Wadhwa last week when he lashed out at the venture community through a post on TechCruch.  Wadhwa contends venture capitalists do little, if anything, for innovation and even detract from innovation. His post comes on the heels of the National Venture Capital Association (NVCA)’s most recent “Venture Impact” report which highlights the importance and impact of venture-backed companies in the macro U.S. economy.  The report does make some outlandish claims, such as 12 million jobs, and 21% of GDP can be attributed to venture-backed companies. Clearly venture capitalists cannot realistically lay claim to those statistics. The report, meant to be a lobbying tool more than anything, includes any company that has received any type of venture funding at any point in its life under its definition of “venture-backed,” which is pretty misleading. Not to say that venture capital does not have a positive impact on the economy - it does - but it is definitely not responsible for the numbers the NVCA presents.

Wadhwa took things a bit further in his post though, and cites research (itself a bit questionable) that shows not only do the vast majority of successful entrepreneurs not need venture capital, but that those who do take it see their companies become less innovative. This leads Wadhwa to conclude that “gold digger” venture capitalists with MBAs have increasingly been simply funding “me-too” companies resulting in high failure rates and declining returns. Looking past the VC-bashing, his main argument really is that venture capital does not facilitate innovation and therefore does not play a meaningful role.

The argument that venture capital does not facilitate innovation is really not much of an argument at all; aside from the rare cases when VCs start their own companies, entrepreneurs are clearly the innovators - no VC would argue with that. So then the next question is around the role venture capital plays. VCs are not simply “middlemen” as Wadhwa states. It would be ignorant to group VCs into one bucket - some are better than others, but almost all VCs play a role in their portfolio companies’ management and strategy. Wadhwa points to research that shows a company’s innovation decreases after it receives venture capital. This is actually a product of maturation. Most companies far enough along to receive venture capital funding would see a decline in innovation regardless of whether or not they received that venture funding.  Venture investment is meant more to take an innovation to the next level, raising its impact and growing its reach, not to prompt innovation.

The role venture capital plays varies by industry as well. In the more visible internet sector, there is limited need for venture capital investment, particularly because the cost associated with starting and scaling web startups has become so low. Venture capitalists won’t always admit it, but it’s a space most do not understand well, and because of its high visibility they catch the more flack for failures. Other sectors such as biotech and cleantech need venture investment to scale. Innovation can be halted if not for investment by venture capitalist. Wadhwa does not account for this at all.

Looking at the big picture, there’s not necessarily causality between venture investment and innovation, rather the two go hand in hand. Innovation can only have limited impact without scaling which is often made possible by venture investment. At the macro level, as the US is faced with increase competition from abroad from countries like India and China, innovation will be paramount in our global competitiveness. The only way the US can continue to compete and maintain its current standard of living is by creating new jobs through innovation. Entrepreneurs will be at the forefront and VCs will continue to be there to back them. The innovation ecosystem is fragile and the last thing it needs is people like Wadhwa causing an unnecessary break in trust.

As an aside, Wadhwa in his piece also mentions that “VCs are looking for bailout money and tax-breaks.” I’m not sure what the basis for this claim is. Surely anecdotal evidence is not what bears the proof. There’s not a single VC I know of that would want to touch bailout money, given the caveats it would come with. Nor are VCs aggressively looking for tax breaks. The only major activity on that front is resistance against a change in capital gains tax, which is reasonable. The one exception where tax breaks have been asked for by VCs is in the cleantech industry where government subsidies have led to increased investment by not only venture capitalists, but by a wide range of investors. And finally, I’ve written about this earlier, but venture capitalists are sitting on approximately $120 billion of “dry powder,” not a figure that indicates the VC community is looking for handouts.