Unscrambling the unicorn correction

Jon Callaghan stepped into the role of National Venture Capital Association chairman more than 10 months ago at a time when unicorn investing was in full swing and venture seemed endlessly up and to the right.

His experience in office has done little to dampen his excitement for startup innovation, though he does see a unicorn “reset” ahead.

“We‘re a small, tiny, little industry that can take enormous technology and market risk safely and prudently,” says Callaghan, co-founder of True Ventures. “That is what we need to remember.”

The next couple years may be a period of down rounds, company layoffs and valuation adjustments, he said. But not all will be dark and grim. Talent and assets will be recycled to new opportunities, and tomorrow’s entrepreneurs will benefit.

Callaghan has yet to let up on his chairman’s promise to challenge the industry over risk taking and “purpose.”

“I have been consistently provoking GPs to push their partners and push the discussion – to be bolder and be more science based,” he said. “Autonomous chat apps are not the best use of venture capital dollars, as an example. I would much rather see us as an industry in robotics, space, edtech and health care.”

To that end, he is quick to point to the innovation of Moore’s Law, cloud computing, horizontal computing platforms and the mobile Internet to argue disruption is occurring not just horizontally, but in every vertical where clever entrepreneurs make use of mobile and the cloud.

VCJ recently had the opportunity to speak with Callaghan. An edited transcript of the conversation follows:

Q: What has serving as NVCA chairman taught you about the industry?

A: “That we have an even more vibrant, innovative and powerful ecosystem than I appreciated before becoming chairman. Representing all of those interests on various issues, and spending time with those GPs, has been exhilarating.”

Q: Why is this industry depth important?

A: There has been a myth in Silicon Valley for the last five to 10 years that only a few companies, and, therefore, only a few firms, matter. I have never believed that and I do not believe that.

I believe great entrepreneurs are starting companies that don’t need to end up being valued at $20 billion. Our industry is funding entrepreneurs in Chicago and different places, obviously New York, San Francisco, Seattle and L.A. but in other markets, that are building really important companies in lots of different fields: educational software, health care, devices, big data, software and consumer.

It’s very important for us to recognize the power of that breadth.

Q: So we shouldn’t cling too firmly to the notion that returns are concentrated in a top few companies.

A: You can look at one or two companies in any two years that make up the vast majority of distributions. But that misses the point, the point of our strength.

The tide is turning. The unicorn fiasco is going to come back and disprove that myth that only one or two companies matter. There are a lot of great returns that don’t have unicorn financings along the way.

It is just phenomenal hearing about device or healthcare investors who have right-sized funds in different geographies and who are just cleaning up, with 3x to 5x funds consistently.

That story has been lost. That’s our strength as an industry. It’s not just about one or two firms.

Q: You sound cautious about the late-stage unicorn reset.

A: I think 2016 and 2017 will be the years in which it’s clear that that didn’t work out too well. It is going to be a very painful reset of that capital stack.

But that’s OK. That’s what venture capital can do. It brings opportunity to a whole new set of entrepreneurs who will get their inputs for a whole lot cheaper than they would have in 2015.

We’re really focused on the creative part of that bit of destruction.

Q: It would level the playing field, wouldn’t it?

A: One of the good things that will come out of this unicorn reset, or whatever you want to call it, is that things like unit level economics and creating value out of your products, versus out of a traffic purchase arbitrage, will prove enduring.

Buying a customer for a number you can make up in three or six or eight or 10 transactions, those are not enduringly valuable businesses. Many of the unicorns got caught up in that game and they were heavily, heavily funded. I have personally never believed in those businesses. Our industry can do better than those businesses.

I hope there is a return to more fundamental, less momentum investing. What we know about startups is it takes five to 10 years to build a great company. There are no shortcuts.

Q: What have you observed about the regulatory process in Washington, D.C., as it relates to issues important to venture?

A: What we know about venture capital is these issues are no longer industry sector issues. These are national issues. The things our industry creates impact cyber security, data security, employment law, big national policy issues, such as immigration, obviously and patent reform.

We used to be a cottage industry that wasn’t terribly visible. But now IT companies represent an enormous share of GDP and we are innovating faster than the laws of the country understand.”

Drones are a great example. The interesting challenge is dealing with technologies that are so far ahead of legislation.

Q: What does this say about effective lobbying?

A: Having a strong voice for the entrepreneur is critical. Entrepreneurship is not well understood across the U.S. It is important to ground policy makers in the reality of entrepreneurship, which is usually not like it is shown on TV.

It’s usually incredibly risky, incredibly scary and that the entrepreneurs have to put everything on the line. They risk livelihood and career.

Photo illustration from ©iStock/Yuri_Arcurs