Nov 28

Marc Hedlund

Marc Hedlund

Google Does Not Compete With Venture Capital

I'm surprised again to see another article about Google competing with venture capital firms. This has become quite the Googlewatcher meme of late, and it's just plain wrong. This one ends with the line, "The [entrepreneurs] could have easily won millions in VC cash; now they're working for Google."

What a false dichotomy! If you take VC funding and put it into your own pocket, that's called embezzlement, and you can go to jail for it.[1] If Google (or any other acquirer) buys your stock in your company from you, you are well within your rights to put that money in your own pocket. Google isn't competing with VCs; if anything, it is competing with the IPO market. And the IPO market isn't all that great right now. As a result, many entrepreneurs who might otherwise believe their companies could go public and get a higher return for themselves and their investors believe instead that acquisition is the best path to liquidity. And Google can get good deals on smart companies.

Sure, you could say I'm nitpicking. I think the distinction is important, though. Venture capital is never an end in itself, and it's a huge mistake to think it is. Venture capital is one way to accelerate a company's growth. If the IPO market suddenly improves, neither Google nor the VCs need to change their behavior at all for this so-called "trend" to all but disappear. The question these entrepreneurs are facing is the same as always: how do get I the best opportunity for my company? Google is using saber-rattling -- "your product is really a small feature" -- and cash reserves, plus a good working environment and a huge audience, to make an argument that the opportunity is much greater selling early than it is trying the hard road of growing a company.

What this story should tell you is how entrepreneurs are evaluating their choices. Another way -- a better way -- of thinking about this is, what is the prospect for building standalone companies these days? The behavior of these entrepreneurs suggests it isn't that great. Good news for established companies like Google, and good news for contrarian entrepreneurs!

[1] Well, usually. It sometimes happens that VCs will buy founders' shares from entrepreneurs in order to give them "pre-IPO liquidity." This might come about if the entrepreneurs have gotten the startup to profitability and don't really need additional investment for the company, but for whatever reason can't sell their own shares to the public in the near future. The VCs will then take the chance to buy shares from the founders as the only opportunity to get in on the deal. The companies discussed in the Google article, though, probably aren't in this position.

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Comments: 2

  Dave Taylor [11.28.05 11:02 PM]

Splendid commentary, Marc. Having worked in the VC space, I do have amusing memories of "yacht money", the portion of a VC's investment that startups would immediately turn into non-liquid assets. One startup we funded just to have them go into "quiescent mode". A few weeks later I bump into the young CTO and he's driving a brand new Harley. Uh huh.

If it's done RIGHT at least, VC money, or any investment money, should definitely not be an end unto itself, and VCs have different interests and different areas within which they focus. And Google as a VC? Doesn't make sense to me either. They have the money, but they're not an ostensibly disinterested third party...

  Jason Ball [11.29.05 12:04 AM]

It looks like the times might be changing. "Cashing out" early as part of series A rounds is a hot topic in the VC blogosphere right now.

The idea is that entrepreneurs take some cash off the table as part of the deal. This provides some returns ($500k) to them immediately while they set their sights on a much larger sale a few years down the road. It takes away the "all or nothing" aspect for the entrepreneur to promote greater risk taking in the future.

In this context VCs are competing with Google- by offering early liquidity for entrepreneurs. I don't think it's a problem a revived IPO market would solve- it's an inherent part of the high stakes VC model.

Our fund doesn't take this approach- but we are considered pre-series A investors. I would be interested in seeing where this approach has and hasn't worked.

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