In the years since Bill Davidow co-founded Mohr Davidow Ventures in 1983, venture capital has changed dramatically.
A period of capital scarcity has turned into an era of capital abundance, and hundreds of millions of dollars pour into big rounds. Powerful new companies, such as Google and Facebook, define the Silicon Valley landscape and benefit from new internet-focused business models.
For Davidow, 83, the increase in investor competition has altered some of the industry’s fundamental tenets of risk taking, with likely pressure on returns. VCJ recently had the chance to speak with Davidow. An edited transcript of the conversation follows:
Q: Venture has changed a great deal since you first became involved. What do you make of today’s environment?
A: Early on we used to invest with the idea you would put small amounts of money in upfront. You would de-risk the deal and then, when you had things fairly well formulated and you understood a fair amount about the market, you would invest heavily in the things that made it through those screens.
In those times, my friend Tom Perkins (co-founder of Kleiner Perkins Caufield & Byers) used to say, ‘get the risks out early before the money goes in.’
Today, what I see happening is large amounts of money are going in before the risks are being taken out. That’s the competition in the market with so many dollars. As a result you’re going to see lower returns. But there are lower returns everywhere, so the question is, whether the illiquidity risks are adequately being compensated.
Q: In terms of startup innovation today vs. when you were an active investor, is it more or less substantive?
A: When I was investing, we were frequently creating new products for new markets. They had lots of spinoff effects. You created an integrated circuit and pretty soon you got a PC. Today what is really different is that most of the internet-based investing, where the really big market values have been created, is in what I would call displacement opportunities.
For example, Airbnb is displacing a hotel. Uber is displacing various forms of public and private transportation. You’ve got Google, it has a terrific search product, but it really is replacing a lot of the news services.
Q: How are displacement opportunities different?
A: In my day, investments had a lot more downstream spinoff opportunities that were really large. We did the transistor, which led to the integrated circuit, and then prices in our business went into precipitous decline.
But still the semiconductor business grew at 20, 30 percent a year. On top of that, you went from mainframes to mini computers to PCs to smart phones to the internet of things and suddenly you created trillion-dollar spinoff opportunities.
I could say the same thing about the internal-combustion engine, which created massive spinoff opportunities. It created the suburbs, it created the shopping malls, it created the need for gas and oil.
What’s different today is, I don’t think the investments are creating the follow-on opportunities of that scale.
Q: We’ve been in a long up-cycle in venture capital. Do you see any red flags?
A: There are certain things that bother me about the current environment. Global ad spending, which so much of this depends on, is around $600 billion a year. And it’s growing 7 or 8 percent a year.
You’ve got so many companies predicating their success on gaining market share in a market that really isn’t very big, $600 billion is less than 1 percent of global GNP.
I worry about the fundamental business model, which says we can continue to provide free services by penetrating the print media and the network media markets. I think what is going to have to happen to ensure the long-term growth of these things is we’re going to have to find a way to begin charging customers for the value we’re delivering.
Q: You mentioned Tom Perkins and his reminder to get the risk out before putting the big dollars in. Have VCs forgotten that?
A: I don’t think VCs have forgotten that. Art Rock, who was one of the classic venture capitalists, used to want entrepreneurs to put up a significant percentage of their own net worth before he would invest in the company. High-risk money was in short supply.
We’ve suddenly gotten to a point where money has flooded into the venture business. It was frequent when you’d do a startup and the first money in would have 60 to 70 percent of the company. The entrepreneurs would get 30 percent. Now we’re in an environment where the entrepreneurs get 70 percent of the company and the first money in gets 30 percent. This is all driven by competition.
The first money in getting 70 percent was unfair. Today the first money in getting 20 percent or things like that is not sufficient reward in many cases for taking the risk. These are market forces at work.
Q: How active are you today as an author and investor?
A: I’m really extremely active. I just finished the draft of a book, which took a lot of time.
A few years ago I did the most exciting startup of my life, Berkeley Lights. I’m still on the board there. I’m about to go on the board of advisers of another startup being done by a friend of mine, which I’m really enthusiastic about.
And I am committing significant amounts of time to philanthropic organizations.