Defying the conventions of Silicon Valley VC firms

Additional contribution by Konstantina Ferentinou

It’s pretty amazing that in 2020, many Silicon Valley VC firms are still following a policy of overfeeding monsters, instead of putting them on a more nutritional diet.

Defying the conventions of Silicon Valley VC firms

What does that have to do with anything? Put simply, venture capitalists continue to have somewhat of an obsession with unicorns. And they stick with the strategy of [unnecessarily] pouring money into companies that may look “cool and trendy” on paper but are ultimately doomed to suffer from the spiral of death.

And what’s amazing about this, is that there are much better and more efficient and profitable ways to handle fundraising, and generally investing in startups.

It’s all about capital efficiency. A term we often use around the corridors of Starttech Ventures.

In conversation with Phil Dur of PeakSpan Capital

Recently, we’ve had the pleasure of hosting Phil Dur, the Co-founder and Managing Partner at US-based investment firm PeakSpan, focused on growth-stage B2B software and SaaS companies. His mission? To pass on his wisdom on what remains a hot topic in investment and startup ecosystems.
But first, a word from “close to home”, on Silicon Valley VC firms.

Silicon Valley VC firms: irrational risk vs sensible investments

Our very own Co-Founder and CEO, Dimitris Tsingos, had a story to tell before introducing Phil. And it goes something like this:

“When we were working with Epignosis in the early stages, it was – and still is – growing very fast. In the beginning, we would approach Silicon Valley VC firms (among others) and everybody would turn us down. The feedback we got was that our idea was not that ambitious.” Funny, isn’t it? 

Dimitris added: 

“Then, after a period of time, suddenly people started knocking on our door. Not just from Silicon Valley VC firms, but from other corners of the world, as well. But we were a little bit afraid and hesitant. Our thoughts, back then, were ‘Should we really work with a venture capital investor? How wise is it to team up or dance with “the devil?”’ There were also a ton of misconceptions around what the Bay Area model is. The main one, for example, is one that says let’s do a pitching competition and the winner gets a trip to the Bay Area.

But, after having our first call with PeakSpan, we realized their mentality (through their own words) was completely different, as compared to the one we would typically associate with the stereotype of Silicon Valley VC firms at the time. Especially, after our previous experiences. And it’s here where the story really becomes interesting; and where Starttech’s journey with PeakSpan began.”

Teaming up with PeakSpan  

When Epignosis and Starttech teamed up with PeakSpan, it was the beginning of a solid relationship, built on the fact that all organisations involved shared the same philosophy. This defies the conventional approach Silicon Valley firms typically follow.

Now, let’s hear what Phil had to say, in his presentation.

Career and background

Talking about his background, a rather modest Phil Dur said: 

“For about 20 years I’ve had the opportunity to partner with many software entrepreneurs, which is amazing. I pinch myself every morning when I wake up, as I’m doing something I love. I’ve joined my 30th board just recently, which was an amazing but shocking milestone for me personally, to realize that I had the chance to work with 30 companies.”

The state of play in Venture Capital, generally in the USA

There’s a lot to be said about the “battle” between Private Equity and Venture Capital. And this was an area Dur touched on.

“Broadly speaking, I would say that private equity investors are looking for companies that are a little more mature. They tend to be focused on growth but that growth does not come at the cost of a lot of business risk. Private Equity investors promise to give you access to very stable businesses, not a lot of risk, but you’re not going to get a lot of growth.

Contrary to that,Venture investors tend to be focused exclusively on growth. They are much more risk-loving, much more risk-taking.  And what Venture Capitals usually talk about is that they’re going to give you access to the hockey stick growth. And that, of course, comes with a lot of risk.”

PeakSpan: Which side are they on?

“We are a growth equity investor. We sit in between Venture and Equity investors. Growth equity sits in between private equity and venture investors. We try and offer our investors the benefits of both of those things.  Growth, but growth at a sustained pace. Growth without as much risk as a Venture firm. That’s the lens that I look at the world through.”

What’s happening with Venture Capital firms in Silicon Valley

Undoubtedly, as you’ll hear from Phil, there is still somewhat of a Unicorn obsession going on. But how did it all start? And why does this “madness” still go on? Over to Phil to explain:

“Ten years ago, in Silicon Valley, a firm called Cowboy Ventures wrote a blog piece about something they called Unicorns – we hear that term over and over again now. Unicorns are companies that raised money at over a billion dollars valuation. Today, everyone talks about it. And the fascinating thing about that obsession is that the Venture Capital industry obsession with Unicorns was much less about what was happening in the Technology Industry and it was much more about what was happening in the Venture Industry.

What started happening in the Venture Industry about ten years ago was that Venture firms, early stage Venture firms, for the first time ever started raising billion-dollar funds. So, if you’ve raised a billion-dollar Venture fund, the first thing you do is that you celebrate, you honor with a drink and everyone is excited. But at some point, maybe an hour after the cocktails, someone might do the math and find that“If we don’t have about 3 or 4 really exceptional outcomes in this fund that we’ve just raised, we’re going to be in trouble.”

Because when you’re a billion-dollar stage fund and you’re making tons of bets — and obviously many of those bets are not going to work out — if you don’t have about 3 or 4 exceptional outcomes, that fund is not going to be a success.”

Under pressure

There’s tremendous pressure on startups to be successful. Especially where Silicon Valley VC firms are involved. Not just to be successful though, but to do it quickly. Phil likens the whole process to that of kids trying to make it as professional soccer players. The places up for grabs are so limited. 

“In this case, the position is actually the ball. You watch a bunch of little footballers playing and try to second guess which one of them might become a successful player one day, or the Cristiano Ronaldos. And selfishly, since you don’t want to lose that 30 million dollars, they’re going to get to you.

It’s difficult to guess. So, you decide to make them all. You promise all of them that they’re going to be the next Ronaldo, you make them (by signing a contract) devote themselves to that goal for the next 14 years. They promise that the only thing they’re going to do is practice. Play football all day. No school, no piano lessons. Only football.  

You ‘promise’ to all of them that they’re going to be successful, but deep down you know that there is only a 1% chance they will make it. But, you don’t share that information up front. Because, if you spend 14 years of your life and know that you’re not going to make it,that would be very disappointing.”

“As an investor, all I need for my interest to bear fruit,is for one of them to make it. So, I just marshal all them together and have them chase a goal that I know that they’re not going to hit. But I want to have the greatest chance at hitting my goal. It’s all about chances, and increasing those chances.The best way to do that, is have all those startups go after that goal. That is exactly what is going on now, in Silicon Valley.”

Billion dollar babies

The pressure to succeed is also translated into clear financial goals. The only problem is that the ‘goals’ are (often) insanely impossible. For example, entrepreneurs are often told: ‘You need to go after a billion-dollar exit. We need that billion dollars to exit in three years and if you don’t make it within three years you are a coward.’ Phil describes the crux of the problem next:

“Now, the problem with this may be the following: if you actually look at what happens with software and if you look at the last 12 years of market activity in software, you have to remember that it’s not always summertime. What do I mean by that? Well, we’ve had 12 years of high summer; people forget what the cold feels like. Winter is coming. The last 10 years have been really warm. There were no fluctuations. If you look carefully at what happened the last ten years and if you listen carefully to what Silicon Valley CV firms have been telling entrepreneurs, you quickly realize that we have a problem.”

First let’s all agree on something: if you start a software business and at some point, someone pays you a hundred million dollars US in cash, well, of course that is probably much better than many outcomes. Can’t we all agree that a hundred million dollars is not a bad start?  How about a billion? Well, a billion and beyond is what Silicon Valley VC firms are all about. That’s all they care about.”

The 0.3% factor

As a contemporary entrepreneur, the thing that’s most common in conversations, is passion. The passion that an entrepreneur has for his/her company, the enthusiasm for the product, the big idea.

The second most important thing they want to discuss is how they’re going to deliver the lottery ticket in three years. Phil says that this should not be the second most important thing to discuss. 

“But you see, Silicon Valley VC firms are obsessed with it. I would argue that on most technology blogs, all we see are articles about exactly that. This is what they talk about. But what’s fascinating about it, is the percentage of the exits. Remember that we’re only interested in successful outcomes—and the question is what was the percentage of the successful exits. What do you think the answer is? Most in Silicon Valley would say between 5-10%…”

“The truth is nowhere near that figure. Over the last 10 years, those companies posting a striking outcome of 1 billion dollars and above, were only 0.3% of all startups.”

What does all this mean, you may say. Well, put simply, it suggests that there are entrepreneurs out there who have a really deep conviction that they know how to deliver, within three years, something which only has a 0.3% chance. Yikes! 

Like Dimitris says: 
To emphasize the insanity of this mentality, this person not only has the confidence and believes that they will achieve this 0.3 percentage of probability, but that it’s achievable within three years!”

The ugly truth about Silicon Valley VC firms: companies swell up and then burst

A recent analysis made by TechCrunch suggests that if you take money as an entrepreneur from the top twenty VC’s in the US, the minute you take their money, the odds of you being dead in three years is 70%. 

And as Phil points out:

“it’s not that you are dying due to starvation, you are dying due to indigestion”. 

It’s true: companies swell up and then burst. That’s what we currently see in Silicon Valley.

It’s like the example of having a group of grossly obese children (that’s the startup companies) and people keep feeding them sugar soda (that’s the Venture firms).  And then they are surprised when those kids can’t run or do push-ups (vs growing their revenues in a healthy way). Hello, capital efficiency anyone?

“In Silicon Valley if you’re successful,it means you have twenty million or more in revenue. If you look at companies that were successful, for every dollar of revenue they generated they required approximately 3.5 dollars of capital. And that’s 70% higher, compared to anywhere else in the US.

Silicon Valley was supposed to be the easiest place to do a startup, but the truth is that it’s the most expensive place on earth.And that’s not because there’s something in the water or the air. It’s because you’ve got the equivalent of drug dealers on every corner that want to give you money.”

Venture Capital money as a drug addiction

We’ve compared Venture Capital money to steroids on this blog post. Hey, we’ve even likened it to the more popular analogy or metaphor of a gambling addiction.

Phil likens VC money to opioids. 

“The first time you take it, it feels great. You feel very self-affirmed. And if you keep taking it, then five years later it has ruined your life. You can’t stop taking it. So, this, to us, is the problem.

In particular, the problem is that we have an entire industry that has entrepreneurs going after their goal and plan their record, at a very early stage in their career. Recalling the example mentioned above, with children and soccer players that want to go after a successful career and their likelihood is a 0.3% chance, even if they apply the plan of training for the next 14 years, as mentioned above. Again, it’s the wrong goal. It’s a waste.

So, what is a healthy goal instead? Well, maybe the right goal is just ‘let’s get you in the Elementary team, then if you do well, you should join the Highschool team. After that, if you do well,you could join the University team. And, by the way, if you want to stop at High school, that’s ok, as long as we didn’t set this as the goal in the very beginning.”

Now that sounds like a proper set of “sensible” goals, don’t you agree?

The moral of the story: healthy growth is the key

The Silicon Valley VC firms’ model has become obsessed with this overambitious approach. And a byproduct of that is that startups and fledgling companies take on tons of [unnecessary] risk, by accepting more capital than they should or need. They’re narrowing the number of options they have for the business. They are being forced into artificially/unnaturally trying to grow. And this is why so many of them expire under the weight of it all.

The solution?

Easy. It’s sensible, attainable, sustainable, healthy growth. Like Dur says: 

“What I love about the culture and mentality of Starttech, and what I love about the culture of Epignosis, and what I love about the culture of Yodeck is that I see something happening that’s very special. There are wonderful entrepreneurs, wonderful innovation and also a desire to pursue that in a very responsible, mature and thoughtful way.”

“And that is so consistent with how we, at PeakSpan Capital, see the world. I think it’s candidly a huge asset, that you have an embedded DNA that thinks about resilient value, that thinks about doing things in a very purposeful way, while still going as fast as you can. That’s the healthy way to do things. Because if you try to do things faster than you can, that is when things break down.”

NOTE: Read the second part of the series, on “How the European startup ecosystem shapes up to Silicon Valley “.

Defying the conventions of Silicon Valley VC firms was last modified: April 16th, 2020 by Graham Wood
Graham Wood

Graham Wood

The Starttech Ventures Storyteller. Studied Journalism with Business at the University of Central Lancashire. Has worked in various product marketing management positions for the likes of Nokia, Samsung and Vodafone, as well as in several journalism and media roles since 2000.