Innovation Blog

“The sky is falling on venture capital…”

By Shlomo Maital


“Once upon a time there was a tiny, tiny chicken named Chicken Little. One day Chicken Little was scratching in the garden when something fell on her head.

“Oh,” cried Chicken Little, “the sky is falling. I must go tell the king.”

Chicken Little was wrong.  The sky was not falling.  In contrast, according to Joseph Ghalbouni and Dominique Rouziès, “the sky is falling on the venture capital rainmakers”.  Their Harvard Business Review article “The VC Shakeout” [July-Aug. 2010]  claims that “venture capital hasn’t worked for a decade and must be radically restructured if it’s going to influence innovation – and make solid returns to investors”.

“There are few signs that things will improve any time soon,” they report.

The VC model is broken in three places.  First, there are fewer promising startups in which to invest.  Second, VC’s are unable to create IPO’s and acquisitions, for their exits.  Third, the lengthening time it takes for VC’s to extract their money lowers the internal rate of return by spreading that return over many more years.

The VC value proposition needs radical change.  It doesn’t work for investors, because the return on investment is too low. It doesn’t work for entrepreneurs, because the VC promise of handholding, managerial expertise and daily mentoring is rarely fulfilled.   The same shakeout that is afflicting the entire banking and financial services industry is now assaulting the VC’s.

“Venture capitalists must return to their roots of being more patient, hands-on consultancies that nurture their startups until they are sustainable,” note the authors.

I have known many venture capitalists over the years.  Frankly, very few of them were humble – many were over-the-top arrogant – though for years the data showed they had much to be humble about.  That hubris may have kept the VC industry from facing the facts and radically reinventing itself, until, now, when it is almost too late.

This is bad news for America, which is counting on its innovation to pull it out of the deep hole it is in.  And it is bad news for Israel, which counts on global VC funds to fuel its startups.  Both nations will have to find a substitute, and there is not much time left in which to do so.

Oh – and as for Chicken Little?    The story ends,   “….just as [Foxy Loxy] was about to lead them into his den to eat them… …the sky fell on him.  “Oh dear,” said Chicken Little.  “We’re too late,” said Henny Penny.  “Poor Foxy Loxy,” said Ducky Daddles.  “No sense in going to the king,” said Goosey Loosey.  “Nothing to do now but go home,” said Turkey Lurkey.  And they did.

Poor Foxy Loxy.   If only he had listened…