For all the criticism we throw at the venture capital industry (myself included at times), there is one undeniable positive outcome it has created – a world where an 18-year-old from a middle-class family with little to no savings can dream of building a billion-dollar business.
VC has democratized big-bang entrepreneurship, the operative word here being ‘big-bang’. Entrepreneurship has always been democratic. That’s what is special about it. Anyone can start a business. But it was mostly limited to starting a small store or business with local operations. Building a globally operated business or an uber-famous (pun-intended) brand or a billion-dollar revenue company was not a common person’s dream. Very very few locally run businesses started by a ‘commoner’ grew into global corporates and they were exceptions.
But with venture capital, building a billion-dollar business has been democratized.
I am generalizing here but most products that have the potential to be billion-dollar businesses need a significant amount of capital upfront*, much before hitting peak revenues. They need it either to create awareness (brand-building) or solve the chicken & egg problem (incentives doled out by platform businesses) or build out underlying infrastructure (logistics for e-commerce). There are more reasons like blitz-scaling, distribution, hiring that I won’t go into but you get the idea.
Now, in the absence of VC, the only people who have the capital to start such businesses are
- Someone from wealth
- Corporates (with enough free cash flows)
- The government
But what’s the problem?
Now there’s no problem with any of the above three starting a new business. But there’s a problem in only the above three being able to start certain businesses. Simply because they might not be the best people to start that business. They might not have the right DNA (innovation culture) to build that product. Or they might not have the drive and customer obsession to see the idea through. Or quite simply, they might not have the know-how (right talent). Whatever be the reason, you end up with a business that is more ‘could-have-been’ than ‘what-it-is’ resulting in sub-optimal capital allocation.
Venture Capital, by virtue of taking a chance to invest in any one regardless of wealth or social status, ensures the most optimal capital allocation. This is, of course, assuming the VC does his/her due diligence and exercises prudence (Did someone say Masa?).
** Here, I refer to only those businesses that need capital upfront and not those that always require huge investments (like construction, etc). So basically, a business that requires investment at first but then reaps the benefits of that investment for years later.
PS: This post had been lying in my drafts since Nov 2019. And then Reid Hoffman published this in Dec 2019. I finally published this in Feb 2020 and despite the validation, I feel like a copycat.