The StarTribune noted recently that the University of Minnesota is rethinking its venture capital strategy. Is this smart?
I don’t mean to single out one university, because I find similar thinking at some other universities. So it might be useful to bring this into the open and see if the above strategy makes sense. Essentially the StarTribune article noted the following key points.
Firstly, the original plan was for the University to start two larger venture capital funds to invest in new technologies on campus and around the U.S. but changed its mind for many reasons. The new fund will offer smaller amounts of early-stage financing to transfer university technologies to the market. But are even these small amounts of early-stage financing justified?
Data shows that early-stage venture capital (VC) financing has worked in Silicon Valley but has not done well elsewhere – if the goal is to earn a financial return. And about 98% of VC funding is provided after Aha and not at the research and development stage. This suggests that even the most professional VC funds wait until after the technology and venture has been proved before investing. The university funds are being considered for the development stage, so they are taking higher risks than most VCs.
Secondly, the University plans to work with university-related students and researchers who will need to have a “qualified management team,” secure matching grants, and also have commercial experts. And the business plan will also be reviewed by “experts.” It is good that the university has so much confidence in “experts” and “commercial experts” who can examine new technologies at a seed stage and pronounce its future success. However, the university’s confidence may be misplaced.
The only ones who have tremendous confidence in their ability to forecast the future seem to be economists, venture capitalists and astrologers. Both Apple AAPL -0.21% and Google GOOGL +0.52% were rejected by more than 10 VCs when they were seeking early-stage financing. It is tough to forecast the future – especially at the development stage of a venture.
Most studies suggest that professional VCs fail to reach their goals 80% of the time and become a home run only 1% of the time — after rejecting 99% of the deals they see. And we can assume that these professional VCs are “experts” since someone has entrusted them with money to invest. And as noted before, most professional VCs invest after Aha. With these daunting odds, very few VC funds succeed. Only 4% of funds earn 66% of the profits of the industry. These 4% are in Silicon Valley (with one exception).
The success of companies such as Intel INTC +0.89%, Apple, Microsoft MSFT +1.66%, Cisco, Google, and Facebook suggests that most home runs are launched when a new industry is emerging – they don’t try to create the new industry. What trends are the universities jumping on? Or are they trying to create a trend? Without a trend, technologies need to wrest market share from other alternatives or create a new industry. Both are difficult.
The goal of the University’s strategy seems to be to spend money and throw many darts and hope that something sticks. Is that a smart strategy?
Silicon Valley has done well in the capital-intensive venture-capital strategy. By standards such as VC-fund returns and development of billion-dollar ventures, no other area of the country has done well. In Minnesota and around the country, more entrepreneurs have succeeded and grown to the billion-dollar level by being capital efficient and knowing how to build giant companies without venture capital. 88% of Silicon Valley’s billion-dollar entrepreneurs used venture capital. 91% of billion-dollar entrepreneurs outside Silicon Valley used capital efficiency.
Maybe universities should put their money where their mouth is — when they say they build leaders — and try capital-efficient venture development, which depends on entrepreneurial leadership not venture capital.
Another caveat — Exit: Universities should state their policies about exits at the start. If there is a home run, will this company be sold and move its headquarters elsewhere? Will the state lose existing and potential jobs and the potential for growth and spinoffs? Will universities seek short-term financial gains, and sacrifice long-term gains to the state? One of the major differences between pure venture capital and community-based venture capital is that one of the most profitable exit strategies, a sale to a strategic buyer, may also cause the venture’s benefits to be lost to the state. Will this happen? It would be good to know the benefits the state is getting and the rules by which to judge this program – before investing in dreams.
MY TAKE: Hope springs eternal, and especially among those who consider themselves venture capitalists – so long as they get to invest other peoples’ money and get paid for doing so. And it is tempting to look back at missed opportunities and wish that you had invested in them. Hindsight is 20-20. But the Googles and Apples of the world do not come with a sign that says “winner.” Each of these winning companies was turned down by many VCs. Maybe the University should rethink its rethink. My suggestion would be to teach students and researchers how to build their business to Aha without capital. Then decide whether to be capital efficient or capital intensive. But demand that the business stays in Minnesota. It would not be smart for Minnesota taxpayers to take the risks and give long-term benefits to someone else.