Chris Dixon

Every time an engineer joins Google, a startup dies

VC returns over the last decade have been poor. The cause is widely agreed to be an excess of venture capital dollars to worthy startups. Observers seem to universally assume that the solution is for the VC industry to downsize.

For example, Fred Wilson says about VC:

You cannot invest $25bn per year and generate the kinds of returns investors seek from the asset class. If $100bn per year in exits is a steady state number, then we need to work back from that and determine how much the asset class can manage…. I think “back to the future” is the answer to most of the venture capital asset class problems. Less capital in the asset class, smaller fund sizes, smaller partnerships, smaller deals, and smaller exits

Similarly, Bill Gurley writes:

There are many reasons to believe that a reduction in the size of the VC industry will be healthy for the industry overall and should lead to above average returns in the future.

All of these analyses start with the assumption that aggregate venture-backed exits (acquisition and IPOs) will remain roughly constant. I don’t see why we need to accept that assumption. The aggregate value of venture-backed startups, like all valuations, is a function of profits generated (or predicted to be generated). In technology, profits are driven by innovation. I don’t see any reason we should assume venture-backed innovation can’t be dramatically increased.

For example, innovation has varied widely across times and places – the most innovative region in the world for the last 50 years being Silicon Valley. What if, say, Steve Jobs hadn’t grown up in Silicon Valley? What if he had gone to work for another company? Does anyone really think Apple – and all the innovation and wealth it created – would exist if Jobs hadn’t happened to grow up in a culture that was so startup friendly? Jobs is obviously a remarkable person, but there are probably 100 Steve Jobs born every year. The vast majority just never have a chance or give a thought to starting a revolutionary new company.

Some people blame our education system, or assume that there is some fixed number of entrepreneurs born every year. I think the problem is cultural. As much as we like to think of our culture as being entrepreneurial, the reality is 99% of our top talent doesn’t seriously contemplate starting companies. Colleges crank out tons of extremely smart and well-educated kids every year. The vast majority go into “administrative” careers that don’t really produce anything – law, banking and consulting. Most of the rest join big companies. As I’ve argued many times before, big companies (with a few notable exceptions) aren’t nearly as successful as startups at creating new products.  The bigger the company, the more likely it suffers from agency issues, strategy taxes, and myopia. But most of all: nothing is more motivating and inspiring than the sense of ownership and self-direction only a startup can provide.

Whenever I see a brilliant kid decide to join Goldman Sachs, McKinsey, or Google, I think to myself: a startup just died, and as a result our world is a little less wealthy, innovative, and interesting.

  • David N

    I know little about the world of VCs and startups and that fact kind of proves the point of the post. Sorry if I rehash something in the comments (I didn't have time to read them all). I do think there is a cultural element that excludes some from innovation. I work in health care, an industry of great innovation in certain areas. But in the area in which I have interest, there is little to nothing of real quality. I have started a company with a partner to try and move the industry in a good direction but the culture of my geographic location is not tooled for startups. It has been slow going for us to find qualified tech people to work on our project. But, thank goodness for social media. I have found more resources since being engaged in the social media culture than I have in months prior. I know this is a totally different bent to this topic but it is my perspective and I am glad to be a part of the social media culture, which will change many aspects of life as we know it, including innovation and health care. At least that's my dream.

    @citizenracer

  • dbv

    @chris and @jared hecht
    Totally agree with both of you. Some tangential points:

    The brain drain away from the sciences and engineering starting in high-school and colleges has been significant in the US over the past generation. Those kids all headed to Wall Street and steadily we have become a nation that makes less and less with China taking over the making. The apologists argue that it is better for Western countries to focus on the design and marketing of products and leave the nasty manufacturing stuff to China. Trouble is that design and marketing doesn't scale and secondly manufacturing of high-technology products is a complex process and Western companies have been training overseas workers to do it rather than our own.

    When parents have forked over tens of thousands of dollars in a good education they want to see a return on investment and will push their kids towards where the growth and money is which is Wall Street. There is also the keeping up with the Joneses effect too.

    The Western countries where science and engineering still thrive are Germany, Japan and France. It won't reverse in the US until there are government policy changes and cultural changes but I really doubt this will happen.

    There is literally a Mount Everest of VC cash out there but it is almost next to impossible to access it because apart from the hoops to jump through, the majority of VC's are not interested in building great companies (irrespective of what they say on their website) because the majority of VC's have never done it before and are instead looking for simple and quick exits to improve their IRR.

    Quite a lot has been written about the VC and Entrepreuner/Startup disconnect. The entrepreuner wants to make a difference but the VC just wants to screw you as quickly as possible to improve the firms IRR. I once attended a presentation delivered by a prominent VC talking about how VC's operate and it really is a different mindset from the entrepreuner. It is two orthogonal models trying to find points of compatibility. Since the VC holds the cash they have greater leverage to bend the entrepreuner to fit their model. Of course, by doing so the VC usually loses and so does the startup.

    I always like to ask budding entrepreuners trying to raise VC cash that why is the failure rate of VC-based startups so high. After all, the startup is literally one in 10,000 (business plans) to get VC funding. The VC's come with an armful of MBA's from the most prestigious colleges and they sit on the company board to ensure the right decisions are made at the right time. Yet, the failure rate of VC-backed startups is high.

    The standard responses are that it was a team issue or a market issue or a technology issue. Strange that.

    I'm sure that if you put all VC cash into one giant pot and gave each begging entrepreuner $500K (after passing some basic criteria) the returns would be phenomenal.

    • http://www.cdixon.org chris dixon

      “I'm sure that if you put all VC cash into one giant pot and gave each begging entrepreuner $500K (after passing some basic criteria) the returns would be phenomenal.”
      I agree the VC process is messed up but wouldn't go this far. My main issues with VC: too many non-entrepreneurs, screwed up incentives (2/20 – “putting money to work”), too much emphasis on presentation skills, herd mentality with respect to themes etc.

      • Aviah Laor

        we tried that actually, in 1999

    • http://twitter.com/adean3 Alex Dean

      I cannot possibly deny that cultural issues push smart kids away from science/tech/free thinking and into finance/law/medicine. Kids are taught to respect authority and every authoritative figure or advisor in their lives tell them to take the safe job (which while high-paying, is by definition non-innovative).

      There is also a ton of actual American culture dedicated to glorifying certain professions. I would venture to say that American Psycho is one of the most popular cult movies of my generation (I'm 22). And with Grey's Anatomy and House and Wall Street 2, it's no wonder why kids decide to go into banking and medicine–they think they can get money AND hotties. Sex doesn't just sell products–it sells career paths.

      What the startup industry really needs is better PR with the American public. Get the 100 million American kids thinking about startups as cool places where smart people work, make money, don't have to wear suits, don't have to kiss ass to get promoted, and finally, get hot bitches. Probably the best way to accomplish this goal is to make either a TV series or movie.

      I'm thinking an Entourage-style show centered around a NYC startup in a very competitive industry. Lots of drama from the startup, nightlife, NYC-specific problems such as arctic tundra, romance, bromance. Call the show something catchy, like The Hyph Life.

  • absartaqvi

    I loved the post. So much more to write and say…

  • http://avc.com fredwilson

    your critique of my analysis is spot on.

    however, until i see signs that something has fundamentally changed the annual value of venture exits, i think my “venture math” model is the right framework to be using.

    i hope that something will fundamentally change that number

    startup accelerators like YC, Techstars, Seedcamp and others is one thing to be hopeful about

    the decline of big business as an attractive place to work may be another

    however it happens, it won't happen overnight

    i always like the bill gates line about not much happens in one year but so much happens over ten years

    • http://twitter.com/cdixon chris dixon

      I agree that if I am say a venture LP I wouldn't count on a huge change overnight and would be wary of investing in a non-top tier VC.

      But people close to entrepreneurs like you, Y Combinator etc have the power to grow the base of entrepreneurs.

      • http://avc.com fredwilson

        i agree

        but i am doing that with one foot in the reality of today and on in the hope
        for a better tomorrow

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  • http://twitter.com/cwren cwren

    I know a lot of hackers who would gladly trade money for the absence of bullshit. Many of the best innovators I know are motivated less by money than they are by the right culture and a reasonable shot at seeing their work not go to waste.

    I'm new to Google still, so maybe I've just still have my fanboy-colored glasses on, but prior to coming here I tried a number of innovation jobs: academia, startups, and industrial research. Google feels very innovative to me. In my experience fruitful innovation requires an interdisciplinary pool of experts, an idea-centric culture, and a strong desire to get technology in the hands of real people… a desire strong enough to push the bullshit out of the way. Google has all that as far as I can tell. Even in a startup it's hard to assemble a strong team with the right culture and the proper focus.

    I hear that the VC environment out West is different than in the Northeast. I imagine it helps a great deal when the people with the money have experience in tech innovation. Maybe you should come visit.

    • http://www.cdixon.org chris dixon

      I do think it's different in CA (and NYC). Also I'm not saying Google
      isn't a pleasant place to work. I knows few Googlers who barely work
      and just sit around eating gourmet food. Cool environment != most
      innovative environment.

    • http://twitter.com/adean3 Alex Dean

      Google is “successful” and all but what percentage of revenues come from all these homemade, so-called innovative products that 20,000 people have been working on? (Exclude the companies/employees/ideas Google purchased over the last 5 years post-IPO.) Seems to me that Google creates a lot of interesting products and features, but not a lot of standalone businesses. I imagine it would help a great deal if the people working at Google had some finance or operational background rather than just programming skills or “experience in tech innovation.” No doubt Google is ahead of the curve in terms of innovation, but there is no reward for being first in the tech industry–there is only a reward if the innovation is cheap, simple, and marketed superbly. Free innovative products aren't going to please institutional investors in the long run.

  • dbv

    A related and interesting post “A brief history of investors (and their investors) by George Zachary was posted today at http://venturehacks.com/articles/history-of-inv….

    The comment post by Anonymous is a terrific read.

    • http://www.cdixon.org chris dixon

      Let me guess, Zachary's next post is going to say entrepreneurs should
      take money from firms like CRV because they have solid LPs (which
      would be very bad advice).

      • dbv

        Probably! Zachary's post is interesting from a historical perspective but will most likely be self-serving when we get to the punch line.

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  • http://www.itsportsnet.com David Cooper

    Great discussions on this issue, however I don't think there is a lack of innovation at all. No matter what, those that are driven to create and innovate will find a way. Good ideas/innovations are a dime a dozen, what is lacking in our culture is the ability to commercialize innovations. There is a theme through this discussion that the start-up risk is too high, established companies pay too well, etc… Overall 70-80% of start-ups fail… I suspect it is higher in technology.

    Why is this?

    I don't know if this is the top reason, but I do know that our business schools do not teach commercialization at the level it needs to be taught at. Mostly because there is no research money for business schools for commercialization. Big business funds our business schools so that is where the research goes. Are there any VC's that fund an entrepreneurial chair? All of the companies mention above pour lots of money into business schools to make sure grads are trained for their business.

    In my alma matter, Haskayne School of Business, even though they have a new venture development program, you walk through the building and see who the funders are by the names of the rooms, lots of oil companies and banks.

    I propose that an important solution to more innovation would be to start funding some serious research into commercialization.

  • LifeafterMBB

    I agree with your conclusion if you were talking purely about web start-ups. Expand the focus to other types of start-ups, then GS and McK won't look so bad.

    As a McKinseyite who has decided to leave the Firm to start a company, I can assure you that the “death” you speak about can be reincarnated.

  • http://caterpillarcowboy.com dlifson

    Wow, that's a ton of comments.

    I think there is an assumption embedded in here that, holding talent, intelligence, and ambition constant, people's risk profile is evenly distributed. Which I think isn't true. I think there are many more people who would prefer a steady paycheck and a job at Google (with the promise of “20% time”, real or not), than those willing to live day by day not knowing if they can afford to pay rent next month.

    You gotta be a little crazy to be an entrepreneur, IMO.

    • http://www.itsportsnet.com David Cooper

      “You gotta be a little crazy to be an entrepreneur, IMO.” Yes one of my profs suggested it is a mental illness!

  • spencerh

    Simple reasons why:

    many, maybe even most people aren't interested in building the next big anything. They want to settle down, have a family, buy a house, and live in the suburbs. Even the brilliant ones. Some people don't see this as a problem. Some of us think it's just lame.

    It's just too risky. Even if you're brilliant, it doesn't mean you'll succeed (and you may not even /know/ you're brilliant.) If you fail, you may have no more health care. The function your theoretical startup provides may get outsourced before you bring it to market, and you've just invested years of your life for no return. Unemployment pays very little, and in the “New Economy” you may be looking for work for a long time (less than those who aren't as brilliant, sure, but longer than you feel comfortable with or have the wherewithal to survive.) You want people taking more risks? Make it so that failing doesn't hurt so damned much – universal health care and a guaranteed income would go a longggg way. Who wants to take risks when you're one job loss or company failure away from the street?

  • http://twitter.com/johnstepper John Stepper

    I liked this post and was pleasantly surprised to see it broadcast via Yammer by a colleague in London. (I work in a very large investment bank).

    I put the last line on my office wall.

  • ntoper

    If I had been at Stanford or this kind of school, of course I would have chosen to go work at a big company. Think about it: no real work to do, big salary, assured career path,…

    Point is if you go to these schools you want certainty in life (or at least a nice backup plan if everything else fails) and startup does not offer this.

    And if it could then it would defeat the purpose I assume

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  • http://launchgrowipo.com/ Trevor Owens

    this post is amazing

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  • omkubera

    Excellent blog Chris…

    As corroboration, it is a rather misguiding system we live in. Even VCs tend to view professionals with “Ivy League” academic and professional backgrounds more favorably. One can't really fault enterprising professionals for choosing however staid but well-reputed “McKinsey” career tracks.

    Recruiters everywhere seem to view these labels act as credit ratings on a stream of cash flows that “Corporate America” (which here includes VCs) is investing in. “Better the credit rating agency and rating, lower the risk.” This in return is proving to be counterproductive (for VCs) as these very “less risky” human assets are not risky enough to produce needle-moving innovation!

    It's what we measure as success that will define the quality and quantity of success. E.g. not VC returns but innovation and contribution to society (which could include wealth generation) could be a better guiding metric?

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  • http://technbiz.blogspot.com paramendra

    If Fred Wilson thinks there is too much money in venture capital, obviously he is not thinking global, and he is too narrowly defining the tech sector, not just in terms of geographical reach, but all that drama waiting to happen beyond the dot com horse goggles. What do you call those things?

  • Hugo Estrada

    Great article.

    You should also factor in the economic forces at the time. Especially now, with reduced VC capital as you are reporting, there will be less start ups.

    Today's graduates have been burden with school debt that previous generations only acquired when they bought a house. This debt will be the biggest factor slowing down the creation of new start ups and innovation.

    It boils down to this: you can't afford to start a company with a big school debt. You probably can't afford to join a start up either if the start up doesn't have enough VC to pay you enough to pay off your loans.

    And even if people get together and start a new company with no salaries on a shoestring, the parents and friends off these people will pressure them to get “real” jobs. Never mind that 10 years ago doing this would have been a cause of pride: with a huge debt that you must pay each month the same family and friend network that would have been supportive of you now will nag you to get a paying job and stop fooling around with a time wasting project; time that you should look for a real job.

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