This summer, I flipped an electric bicycle at 30mph, dropped out of the University of Michigan, and most recently pulled a friend away from a seance in a cave. Hooked? Well at-least i’ve learned something about writing in the last four months.
For an industry synonymous with innovation, it is hard to imagine how predictably the cogs actually turn for those at the helm of creation. Right now most investors are more Gordon Gekko than Tony Stark. Who can blame them, after all many of the greatest ideas are not venture capital fundable.
Venture capitalists report to their limited partners and are incentivized to reduce risk by investing in companies that match the strategic objective of the fund from the date of its inception.
If you follow the world of entrepreneurship, you likely have heard the phrase start-up “unicorn.” These billion dollar creations are becoming more prevalent by the day and yet we are no closer to solving many of the greatest challenges of our time. Sure, SpaceX may be an exception with its lofty goals of multi-planetary colonization, but the majority of the 100+ companies are in the e-commerce, software, and consumer internet sectors.
Theranos, long believed to be a contemporary SpaceX for its radical scientific approach to problem solving recently ran into hot water for succumbing to the pressures of Silicon Valley to produce fast, to create under the radar, and to secure returns for investors. However, new financial instruments are starting to change the textbook operating procedure of the start-up finance process.
We are at a time of change, while venture capital funds are still elite institutions, start-up capital is more accessible now than ever. Universities have become more democratized and more meritocratic in the last three decades and so has the innovation they often catalyze.
When Alexander Graham Bell invented the telephone, he was financed by what would be referred to as an angel investor today. Gardiner Greene Hubbard, with the pedigree of a degree from Phillips Academy, Dartmouth, and Harvard Law, financed Bell’s research work and eventually secured large returns as founder of the resultant Bell telephone company now known as AT&T. Other famous inventors like Thomas Edison funded their research from the sale of a prior invention. The Menlo Park research facility that led to the lightbulb was largely financed by the sale of the Quadruplex Telegraph. Today, investors like Peter Thiel operate much the same way, reinvesting personal fortunes from prior creations in more risky endeavors.
The history of financing great inventions is important to understand because the structure of innovation ecosystems directly influence the conduct of the financiers and entrepreneurs within them. Simply put, different incentive systems result in radically different inventions.
Right now the most radical leaps forward are supported by corporations like Alphabet (Google) with Solve For X, and philanthropic efforts like Bill Gates’ new multi-billion dollar clean energy fund and Thiel’s Breakout Labs.
Lots of negative press has recently emerged regarding alternative finance structures like special purpose vehicles. Special purpose vehicles (SPVs) also known as special purpose entities are essentially shell corporations that aggregate investment dollars from investors outside a traditional venture capital investment fund.
Traditionally, venture capital syndicates have been used when firms desire to invest alongside another venture firm. This process, known as co-investing, is often done to increase the network of resources available to portfolio companies and decrease investment risk. Additionally, co-investing provides an opportunity for investors to remain a part of later funding rounds even when valuations soar and the VC no longer has adequate capital to facilitate the investment on their own.
Access to these SPVs is restricted and comes with additional risk. In some cases, investors must rely on due diligence of companies provided by the lead or primary investor. Additionally, due to the high demand for investment access into companies financed with SPVs, these deals often move very quickly. Investors can be given just days to evaluate an investment opportunity and decide whether to join in. These investors understand that if they opt-out there is a backlog of others willing to jump on the bandwagon. SPVs are typically only utilized by large venture funds on the coasts to facilitate investment in late-stage companies.
While SPVs can be scary, they do not have to be. SPVs had the power to kill Enron but they also have the power to catalyze the growth of non-traditional frontier startups while retaining vital collaboration among investors.
SPVs offer two key benefits over other financing structures. They allow risk to be shared between multiple investors and enable longer timetables for capitalization. This directly benefits entrepreneurs pursuing more research intensive ideas. Companies do not need to operate under the pressures of a venture capitalist’s 10 year fund and necessary profit sharing with limited partners on a deadline.
Unfortunately, even with SPVs, there is often still not a strong enough incentive for investors to put capital and time into a radical idea when a less risky idea will likely offer adequate returns. Radical change can only happen if the process of catalyzing non-traditional innovation can be separated from our current intellectual property laws. Currently universities and private corporations own a lot of the intellectual property in these sectors. For too long it has been impossible to get such risky endeavors off the ground without institutional backing. However, while universities have brought resources together behind companies, they also limit information sharing and significantly reduce incentives to innovate. They also isolate radical ideas within the halls of academia. Technology transfer offices have been working to commercialize these ventures for a long time but much of their work involves building relationships with corporate entities who take over once academic ideas become viable in the private sector. However, much like how Hubbard financed Graham Bell, these companies are going to prioritize funding companies that align with their strategic interests.
In innovation we truly get what we pay for and right now economic and legal realities incentivize a more tame, risk averse version of innovation. Alternative financing structures and philanthropic investment provide a short-term solution but public policy action will need to be taken to reorganize incentives towards those who dream and will ultimately have the largest benefit to society.
As parents and educators, we can give students permission to be brave explorers. We can emphasize that the highs and lows are both useful because they reveal what makes them tick — what sparks their intellectual curiosity and brings them joy.
- Phyllis Fagell -
Having had time to reflect on this issue after coming to college, I could not agree more with the idea that, "we [need] to give students permission to be brave explorers." There is no doubt that student's at America's top colleges are ferociously smart, but there is an absolute pressure to conform that has only grown stronger in recent years.
My high school experience was consumed by working to stand out. What crazy (as the author puts it) gymnastics or art could be created such that admissions officers would believe in the innate creativity of my peers and the ability to execute they possessed from within. In a sense, it was always an attempt to break free of the rigidity that grades provided.
Looking back from the vantage point of college, from a world where grades do not matter as much, the activities we used to do to seek identity seem to have become far more rigid themselves. After coming to college, I was down for a long while. It seemed that success was defined by getting a prestigious consulting, tech or finance job or getting accepted to further education at a law or medical school. Somewhere in the process of being judged in K-12 on the basis of grades and SAT scores and being judged in college for meeting the formulaic criteria necessary for one of these jobs, students have lost the creativity that brought them to a top college to begin with.
"Our economy isn't money its our people." - Martin O'Malley
I was having a conversation with a girl who came from a similar K-12 experience as mine but in Michigan and she said something that stuck with me:
"Nobody is truly unique in that we all strive for uniqueness to escape fear."
This is a rather depressing reality to accept, that fear of missing out on a top college as opposed to the alternative of hope in being able to leverage the resources of a top school to do something amazing is what drives today's college students. However the fear of carving ones own path outside of the name brand academic institution or name brand corporate conglomerate seems to only have become more pervasive.
There were a lot of things in high school I wish I had a chance to learn in the classroom that I strived to learn outside of the classroom, but one thing I wish my peers were more confident in was taking a risk and having enough confidence in ones own ability to not need validation, and yes I include parental alongside that of any brand recognition. There is a sense of freedom and almost peacefulness in that mindset, however I know there is more that can be done early on to nudge students into that mindset. I'm scared of what to expect from the world in the next five years. At what point will people break from the need for validation that has been driving many students actions since the day they first walked into a schoolhouse?
The world frankly needs that break to happen soon. The innovation economy will not be confined to the Bay Area forever and soon, being a "brave explorer" won't simply be an attitude needed to assume the role of a budding entrepreneur, but the role of a majority of those in our modern, technology based, economy.