- LinkedIn co-founder and Greylock partner Reid Hoffman recently discussed the necessity of venture capital. Here is what he said.
In a recent article, LinkedIn co-founder and Greylock partner Reid Hoffman pointed out that it has become fashionable among entrepreneurs and venture capitalists to criticize the industry. However, the alternative to venture capital are much worse. This belief was reinforced while Hoffman was having a conversation with Xapo founder and CEO Wences Casares during a trip to Patagonia.
The first option is the government. But the world’s history of five-year plans and leaps forward suggest that this strategy is seldom successful and is often disastrous.
“Capital allocation decisions are based more on political concerns, such as ideological purity or connections, rather than merit. This isn’t necessarily the fault of individual government officials; many civil servants are intelligent and dedicated,” wrote Hoffman. “But unlike a pure financial investor, any governmental body making investment decisions is forced to take on additional, massive political risk. The failure of a government investment results in not just the loss of risk capital, but also what is likely a much larger loss of reputational and political capital (a classic example of this is the Department of Energy’s involvement in the solar panel startup Solyndra). This additional risk (which financial investors do not face) makes it almost impossible for any government to successfully provide venture capital.”
The second alternative is wealthy individuals and families. Wences told Hoffman that this is common in many parts of the world.
“You’re begging the 15 families who have the capital to see if they will give you capital. And if you haven’t gone to private school with one of their kids, you won’t get it,” Wences told Hoffman.
Risk capital should be available to entrepreneurs who did not have the privilege of growing up wealthy or attending an elite university. And venture capital opens up for the decisions for capital allocations beyond the wealthy families. Venture capitalists are incentivized to invest and distribute so they can only create wealth for themselves by creating wealth for others, including the entrepreneurs.
Hoffman pointed out that at the end of the third quarter of 2019, seven out of the world’s ten most valuable publicly traded companies were tech companies: Microsoft, Apple, Amazon, Alphabet (Google), Facebook, Alibaba, and Tencent. And all seven of those companies raised venture capital.
Often times, people forget that Microsoft raised venture capital. However, Microsoft co-founder Bill Gates had raised $1 million from Technology Venture Investors even though they did not need or spend it. Gates mainly wanted to work closely with venture capitalist Dave Marquardt on his team.
“Good venture capitalists are essentially networks in human form. They bring a unique network that provide the essentials of start-up growth — follow-on capital, talent, industry knowledge and access — in ways that a government agency or a wealthy family do not,” added Hoffman. “The problem with bootstrapping is that you’re going it alone. It’s much harder to build a network around you if no one else shares your financial incentives.”
