I am pleased to publish this column in partnership with my friends at the MENA Private Equity and Venture Capital Association, as part of their efforts to stimulate an emerging VC ecosystem in the Middle East & North Africa region.
Money knows no boundaries, the saying goes. Apparently, no one bothered to tell venture capital. Despite the fact that money can theoretically go almost anywhere in the world, venture capital to fuel growing companies is still strongly correlated to geography. And most regions have little to none.
Why should that be so? Why are free markets not so free? And what are the lessons for new regions trying to create their own venture capital?
Governments around the U.S. and the world have invested billions of dollars in attempts to foster their own vibrant, sustainable VC industries. They have almost all failed. The geographical imbalance is stark. According to the recent PWC/NVCA MoneyTree report, about 40% of all VC in the U.S. is concentrated in Silicon Valley. And according to Ernst & Young, about 2/3 of all VC in the world is concentrated in the U.S.
The uneven distribution of venture capital might seem like an academic question, but its implications are real. I am convinced that thousands of companies with potentially world-changing innovations – whether life-saving drugs, alternative energies, or countless other new ways to solve big problems – fail each year because of their inability to access capital. If money is just money, then it should flow efficiently, and great entrepreneurs with great companies should always find it. However, in the real world that's not the case. The capital markets may look free, but they don't work freely.
So, where do we look for possible answers? We know that venture capital is not just a result of writing smaller checks (that is, portfolio allocation). Lots of people have tried that and failed. And we know it's not just a matter of picking winners and losers in order to buy low and sell high, like one would in a stock market (that is, arbitraging). That has been tried, too. So the answer must be something else. And it must be something unusual, outside of the usual mental model of finance.
I believe we can find answers in the history of Silicon Valley. There, we can ask the question: what was venture capital before venture capital? And when we do that, we discover that the answer is simple. It was people.
The people who helped build the Silicon Valley VC industry were like entrepreneurs themselves. After all, they had to create an industry from scratch. They had more than a bit of cowboy in them. They had a sense of adventure, they had a passion for the companies they were building, and their community was small enough that they all had to rely on one another to survive. Moreover, they were not bound by traditional structures of finance – they organized money in whatever shape, manner, and structure were needed at the time.
A recent documentary – Something Ventured (2011) – interviews many of the founders of the venture capital industry, letting them tell their stories. I highly recommend this movie. It captures a critical piece of history that is fading away quickly. To me, what is most striking is that every single one of the interviewees – including legends like Don Valentine, Tom Perkins, and Arthur Rock, among many others – has an unmistakable, mischievous gleam in their eyes as they talk about their work. These dudes were not your usual, run-of-the-mill asset managers or financial engineers. They were taking on the world, and loving it.
Based on the lessons of Silicon Valley, how does one build a venture capital industry from scratch? Here are five rules to start with:
1. Venture capitalists are not mere asset managers.
A skilled financial manager does not a great venture capitalist make. I've noticed that many governments or other institutions seeking to build their own venture capital industries often hire bankers or financial analysts to run early-stage funds. It's seemingly a safe choice on paper; they seem like competent managers of money. But in reality, they often know little about how to create new enterprise value, nor have the necessary personal qualities to partner with entrepreneurs. Instead, look for people with some "cowboy" in them, who care deeply about growing companies, who are bold enough to rewrite the rules of finance if they need to, and who know how to navigate companies through the tortuous, serendipitous path that is to come.
Coming soon: Rules 2 through 5, in the next column…
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