Jonathan Lu

@jonathan_lu

Is there a new beginning for distressed VC-backed companies?

New beginnings are often disguised as painful endings” — Lao Tzu

Graduation. The hats have been thrown in the air. The corks have been popped in celebration. The tears have been shed in farewell. This magical year has come to an end, and I have said my goodbyes in sadness to 90 people who have become as close as family, and in anticipation of the great things they will do — Change Lives, Change Organizations, Change the World.

Considering the impact that venture-backed companies have had on the economy, it’s no surprise that the Stanford GSB feeds more entrepreneurs back into this innovation ecosystem than any other business school (15% of the graduating class). In their 2015 paper The Economic Impact of Venture Capital, Will Gornall from UBC’s Sauder School of Business and Stanford GSB’s Ilya Strebulaev showed that only 0.9% of companies in US history have been backed by VC financing, but they comprise 17% of public companies and 44% of R&D expenditure today. Looking at modern times (post-1974), the numbers are even more staggering:

This is especially impressive when you consider that only 0.31% of new businesses receive venture funding each year: a pretty good ROI for the $60B in annual VC funding, in aggregate at least. Just like most statistical distributions, the 80/20 rule applies to VC financing. According to the 2010 study on Risk and Reward in Venture Capital by Harvard Business School Professor Bill Sahlman, this great economic success is a result of only 15% of funding! A 2014 study of venture returns by Correlation Ventures over a 10-year period shows just how skewed the returns are (Courtesy of Fenwick & West LLP):

If you want to hit home runs, you’re going to strike out a lot too — they don’t call it venture for nothing, just like options trading the name of the game is risk. While the lure of the top 1% draws in the dreamers, and the ire at the bottom 1% draws equal media attention, as Thomas Piketty described in Capital in the Twenty First Century, the incentives of capital investment mean that this is exactly how the game is played.

The natural human inclination is to judge. It’s easy to come up with a list of pros to support why venture is great or a list of cons to attack why it’s not. The more interesting BHAG question to me is what can we do to improve it?

  • How much value is left on the table with those 70% of distressed companies?
  • Why are they failing?
  • What happens to them?
  • What was their success criteria?
  • How sustainable was their burn rate?
  • How long was their runway?
  • How many could have had a positive outcome if privately-held, without the return expectations of venture financing?

Can we find new beginnings from painful endings? You have to kiss a lot of frogs to find a prince — how many frogs do you have to kiss to find the blacksmiths and carpenters?

This article was originally published on Jun 28, 2017.

More by Jonathan Lu

Topics of interest

More Related Stories