I was at an event with a group of MBA students a couple of weeks ago, chatting with two of them. One asked me how the venture deal flow was different in the past. I made the off-hand comment that the World of Could seemed to have grown much bigger, but the World of Should hadn't kept pace. That passing comment has stimulated a lot of thought on my part in the past couple of weeks. Here's some musing on what I meant by that casual statement.
As I commented a few months ago in this blog, I've found that even during the economic downturn, the “idea flow” from entrepreneurs has been unabated. In fact, the more I think about it, it seems like it has actually increased and continues to accelerate. That's sort of what I mean by the World of Could. It is the universe of ideas that one can now do and might be interesting to someone. I have the impression that there are many more possible startup ideas than ever before out there. There are a number of reasons for this.
First, the offline world of business ideas has been roughly doubled by the replication of those services as online businesses. It's like we've held up a mirror and “doubled” the number of business ideas. Add to that the interactivity and personalization that the web offers over traditional retailing. And recent technical advances have also made businesses possible today that weren't possible ten years ago (think genetic diagnostics). Technological advance has a feedback loop aspect to it, that makes the rate of change grow more exponentially.
So the number of business startups you “Could” propose has grown dramatically in the past decade. The World of Could has grown hugely.
By the World of Should I mean the subset of possible “Could” deals that “Should” be funded and, at least from the perspective of a VC, have the potential to become successful and self-sustaining.
The growth of the World of Should is gated by other factors. First, I think it is more limited by what people have money to buy. This has more to do with population and GDP growth, and the increase in the money supply and disposable income. These are growth rates that are typically more like 0-4% per year.
Furthermore, for an idea to draw investment from a venture capitalist, it has to be able to scale to a venture return. That means like $100M in revenue in 5-8 years. And, the World of Should is also gated by the amount of venture capital funding available. As everyone knows, that number has fallen from bubble highs at the beginning of the decade. It isn't growing exponentially, that's for sure.
An example: you could create a business selling an iPhone app that translates English into Lithuanian. But that market is too narrow to generate much investor interest from VCs. But twenty years ago, Borders could create an investible business selling English-Lithuanian phrasebooks (along with a lot of other similar books). Startup ideas have been granularized by trends like the growth of the app or web business areas. The good news is it takes much less money to start them. But the bad news is they won't always grow that big. They may become profitable but not be investible. VCs sometimes call them “lifestyle businesses”.
But old ways die hard. These smaller, granular businesses still hope to be the next Google or Groupon. You just need a little virality, and more people like you (who need a Lithuanian translation app on their phone). So I see a lot of pitches from startup ideas that I can't ultimately invest in, because they cannot scale adequately to give me the necessary return we need for our investors.
One side effect of the growth of Could over Should is that I may have to say “no” more often as time goes on. But another side effect is the growth of angel financing, since angels can take smaller bites and still make an acceptable return. It doesn't mean that the venture capital model is broken as some pundits have said. However, the venture capital field may have to adapt to the increased granularity of the startups they see. This is one reason why Claremont Creek Ventures is emphasizing our “life cycle venturing” process of making seed investments.