The Power of Venture Myth

Some time ago when Skype-Hype was all the rage I made a flippant remark in this blog about Skype and Paris Hilton.  I couldn’t really understand why the blogosphere was all atwitter – since nearly no one was really affected by the outcome, except a few employees (too few it turns out) and some VCs.

Recently one of our companies, Riya.com, has had it’s turn in the barrel of speculation.  For several days multiple “authoritative" blogs repeated a rumor that Google was buying Riya.com.

Rarely does one get a chance to sit back and watch the media frenzy for the ‘scoop’ with absolute knowledge about the truth of every single report. Every report was factually incorrect at the time it was printed.  I did not see one accurate characterization of any discussions Riya.com may or may not have had. 

We were in the middle of a financing.  Plain and simple.  And Riya had multiple attractive options.  None of us commented because you don't talk about stuff until it's done. The CEO did discuss  some of the people he'd met in the process, without discussing specifics. The Company has now selected its path and it will announce it path once it is completed, probably early January. Regardless of the path, the service will continue to grow and expand, executing the same vision, only bigger.

I think the fascination with Riya, Skype, Del.icio.us, and every other potential tech acquisition is  really driven by the Myth of Silicon Valley.  The Myth of Silicon Valley is the myth of Lottery – Meets Horatio Alger – Meets Revenge of the Nerds.   The Myth usually has two protagonist hero inventors – Dave and Bill (HP),  Steve and Steve (Apple), Bill and Paul (Microsoft), Jerry and David (Yahoo), Sandy and Len (Cisco) and Bill and Andy (Sun).  Most recently Larry and Sergey (Google).

There are often two other, less heroic, but fundamental players in the mix --  a charismatic (or at least entretaining business person (often CEO) and a lead VC.    Ballmer, Markkula, Koogle, McNealy, Chambers, Schmidt on the business side. And a VC cast as the savvy invisible hand. Rock, Doerr, Valentine, and Moritz are among the most notable VCs.

The glitter of the rumor of instant tech wealth is the affirmation we all seek for devoting ourselves to the irrational pursuit of the Myth.  The Myth of the Hero Hackers, who, with a computer and some Red Bull, can create Being from Nothingness.  The Myth of the Hero Executive who can join a wobbly little start-up and ride off into the sunset with personal wealth and fame.  The Myth of the Hero VC who can take credit for finding (and claiming to have “built”) the next Big Important company, thereby confirming how much smarter s/he is to have been luckier than all the other VCs.  Business journalists know we all have the hunger and feed our appetite for the Myth.

And the Myth is powerful.  The Myth is the basis for the Entrepreneur Bubble.  It is the basis of every investment bubble.  And it is structurally part of the venture capital industry, The median venture capital investment loses 36%. This is a hits business, and the rates of return are positive in aggregate because the hits are so big as to swamp the losers.  But if VCs lose 36% on the median investment, it means that the Preferred Stock loses money.  If the Preferred loses money, the Common sees nothing.   The Myth is built on Survivor Bias, not base rates.

So the median outcome is a loser for everyone. But so is the state lottery.  So is every casino.  But venture capital investing and starting small companies is more like a casino than a lottery.  The lottery is a blind pool.  It's a game called midnight rain-out baseball in poker. All random.  In a casino you have a choice of games, and some games have better odds than others.  Some games have odds that actually can be influenced if you are smart enough to know how.  The casinos call it counting cards and will throw you out.  The VCs call it risk minimization and will reward you for it. The current built-to-flip chatter is the ultimate pursuit of pure Myth.  As most any VC will tell you, built-to-flip doesn't work because you can't reliably time someone else's agenda. You can't time the Myth. Myth happens.

So the next time you see a frenzy about a rumored payday for someone else, pay attention to your attention. Pay attention to why this is so meaningful to you and what you can do to change the odds of the game in your favor.  And your mother was right.  You have to love what you do, because the rest is probably Myth.

Comments

[Kevin Burton]

Nice. this is the first blog post I've ever seen use the word "atwitter"... :)

[Zach Coelius]

Keep up the great work, these are great posts lately.

Though I really beg to differ from an entrepreneurial perspective. The reason why build to flip companies fail is not that they depend on what others, which they do, but rather more importantly that nobody who builds to flip can truly have the passion, drive and desire it takes to make something great.

[Norm Waite]

If Silicon Valley wants a higher average return, and also a better median return, then a good first step is to set aside the several elements of "myth" and pay closer attention to reality.

With the elements of "myth" along with the hype, fads, snap judgments, lack of careful reasoning essential in engineering, "Never be between a VC and the door when the lock-up period is over", laughing at everything on the shelves of the research libraries, etc., no wonder the median return is disappointing.

Instead of such emotionalism comparable with marketing fashions to teenage girls, there really are some solid foundations for doing advanced projects in engineering. E.g., the Manhattan Project's gadgets worked just fine on each of the first three trials. Clarence "Kelly" Johnson's airplanes, from the P-38 through the SR-71, flew as promised. Project Apollo was to put a man on the surface of the moon and return him safely to Earth before the decade was out, and it did. FedEx was planned and was a major success essentially just as planned. Similarly for the F-14, F-15, F-16, F-117, B-2, and F-22.

People all across the US start and run successful businesses. Businesses in information technology, carefully selected, well funded, should be much more successful. Should nearly always get a profitable business from the effort.

As Darwin would appreciate, one thing's for sure: The limited partners can understand reports of averages. If the averages get too low, then the limited partners will insist on something different or just close their checkbooks.

[Nenad Spirkoski]

You have remark that in some previous post you talked about skype and Paris. The link is wrong (404), and i had to google to find it :) For all those that are interested here's the thing:
http://earlystagevc.typepad.com/earlystagevc/2005/09/skype_is_paris_.html

[Jason Wood]

Peter,

Great post. On the heels of the nonsense bandied about this week on building companies to flip, this news of Riya.com going it alone has brought out the best counterargument to "building to flip" anyone could ask for. Munjal and his team didn't build Ojos to flip, but they were willing to consider the option. I would argue it was the fact they didn't bank on such a scenario which opened the door in the first place.

All the best, your blog continues to entertain and engage...

[Simon Brocklehurst]

Hey Peter,

You have to wonder where these leaks in M&A discussions come from, eh?! In my experience, it's rarely from management of the respective companies; and it's almost always from bankers or VCs ;-) But these leaks do usually come from somewhere...

Now, I have no idea whether: you had offers for Riya during the period you were getting the financing done; if you were actively trying to sell the company; or if you were trying to get some external validation of valuation for the next round of financing... But, at the time, I thought the Google stories was actually pretty interesting because the rumoured valuation was so high, given the stage of the company (for those that are interested, see my old blog entry Riya, Google, Innovation & Tech Value from that time).

I will be intrigued to see what Riya's post-money valuation is, after the i's and t's on the financing are dotted and crossed...

[Peter Rip]

Simon:

I honestly don't know where any of the rumors originated. We actually hadn't planned on raising money for a while. We originally financed the company for about two years. But we were approached by several parties on the basis of the impending launch. Our fiduciary responsibility was to investigate the options. We did. Part of that investigation meant talking to a lot of individuals, all of whom who had only their piece of the puzzle. When you have several groups with trying to do their homework, tongues will wag.

As to the valuation -- it's just Mythical, too. It's not real money. It's like a mid-term grade. It's an indicator at a point in time, but it's not the permanent record. You can still screw up. Believing it is real is what kills the hunger to win.

[Simon Brocklehurst]

Thanks for that Peter - your point about valuations is really well-made. I'm always look to see new investors leading new rounds of financing - at least it makes the valuations a little bit real.

What never ceases to amaze me about the valuation Myth is that both VCs and management teams are prepared to spend (waste) such huge amounts of time finessing (arguing) about term sheets (valuation in particular); instead of getting on with creating something *genuinely* valuable.

[Hooman Radfar]

Myth is a double-edged sword. Although it has the power to potentially mislead us as a collective, it also imbues would be entrepreneurs, managers, and financiers with an imaginable power--the power to create. In the case of high-tech innovation, Myth is an enabler of self-fulfilling prophecy. The high-tech entrepreneur, inspired by legends of Jobs & Woz and armed with a vision for the future, begins a quest. He convinces a team to build products to fulfill that vision. Investors that believe in the vision provide the capital to fuel the efforts of the team. Before you know it, the collective belief in Myth has fueled the transformation of our reality, yielding a technology that alters the course of human history. And what made it all possible? What was the fundamental driver that got everyone through the long nights, conflicts, and heart ache? Belief in Myth. People often attribute the relative success of the Silicon Valley economy to money, talent, technology, etc. Although those are the necessary ingredients for creation, they are not sufficient. We need Myth. Myth empowers man to attempt the unthinkable. Myth gives man the courage to persevere. And, it is the desire to become part of the collective myth that inspires us to forge the next generation of innovation.

[Daniel Burgin]

Why such a negative post against the dreams that drive entrepreneurialism? I can't imagine why a VC would feel this way. Aren't entrepreneurs and their ideas the fuel that drives a VC's car? Of course. Hooman Radfar says it best in his post - myth drives the entrepreneur to believe, to inspire others (including the VC infidel) to do something great. Without this myth, this (sometimes) irrational belief in the art of creation to yield greatness (and yes to yield great wealth for the entrepreneur) the world, and VC's livelihood, who cease to exist. Tom Evslin says it best in the tagline to his Blog "Fractals of Change" - when he says, "Nothing great has ever been accomplished without irrational exuberance".

Cheer up!
Dan

[Peter Rip]

Dan:

Sorry if this sounded negative. Not meant to at all. I am a strong believer in the culture. Irrational exuberance is fundamental to great outcomes, no doubt. But rational expectations are also appropriate. VCs know this well. Our business allows us to diversify irrational into rational. Perhaps the tone of this reflects my underlying view that life is more of a marathon than a sprint.

[Chris Tolles]

Peter:

Nice channeling of Joseph Campbell here! I think you're on to something here -- the power of the story.

Given what you've posited, perhaps any good deal these days attracts a Google/Yahoo rumor, simply as part of the package -- if it's hot, Google or Yahoo must me in on the deal...

Personally I think of life more like a multi-stage bike race a la the Tour de France -- you can optimize for an individual stage or for the big win, and teamwork matters a lot (even superstars need a great team, who often doesn't quite the attention of the press). Anyway, nice post.

[Travis Reeder]

Very interesting post. I agree with some of the other comments: a product built to flip, is not a product built to last. It's just a get rich quick scheme, but it does seem like a lot of people are making it happen doesn't it?

[Jonathan Aberman]

The existence of the "myths" you describe are an essential part of the venture captial cycle -- as is greed and fear. What you have touched on as a concerning trend, however, is the entrepreneur's idea that a company should be built for sale. While we investors need an exit -- trying to predict its timing, or to whom, at the time of investment is impossible. I always look for entrepreneurs who want to grow a big business. Period, end of story. These are the folks that change markets and make common stock valuable and drag our preferred stock along the for the ride!