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One of the most interesting things about Silicon Valley is that a great deal of the value created by the culture is due to a very healthy and useful misunderstanding: that venture capital is a broadly applicable funding model. One of the first, and most surprising things you learn when you first talk to experienced VCs is that "venture fundable" is actually a fairly narrow class of ideas. I am not talking here about good versus bad ideas, or whether or not a particular VC is visionary enough to see the potential in you and your idea. I am talking about some prosaic structural limits and requirements that act as almost a bureaucratic filter on what sorts of ideas can be funded. As a result of these requirements, many good ideas are not venture fundable, while many bad ideas are. So why is this a good misunderstanding, and how can you get to an understanding that does not kill the benefits of the misunderstanding?
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The varieties of "software eating the world" ideas
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1/ Something a lot of people new to the tech scene helpfully misunderstand: Only a tiny fraction of the software revolution is VC-fundable. 

2/ Venture capital is a very specialized kind of investing, one where good investors can actually make a difference and build a market-beating ability over a decade or two.

3/ Unlike many kinds of Wall Street investing, venture investing is a meaningful skill, not just a set of random walks filtered by survivorship bias of the sort Nassim Taleb talked about in Fooled by Randomness.

4/ A great introduction to what makes for "venture fundable" is Bill Janeway's book Doing Capitalism in the Innovation Economy. This talk I did (video, slides) is based on it.

5/ There are no easy tldrs of what "venture fundable" is. That's why it's a skilled job. Heuristics like "must have potential for 10-100x returns over 10-12 years" are the tip of the iceberg.

6/ But our topic is not venture-fundability, but the huge universe of things that is "not venture fundable." This means everything from writing a book in a "software eaten" way to nonprofits.

7/ The first thing to get into your head is that "venture fundable" is a taxonomic classification, not a judgment. Your business or idea has a certain "shape" than can fit into the VC funnel.

8/ The "shape" is determined by the mechanisms that VCs have perfected over a few decades for a particular kind of wealth-creation. An oven cannot deep fry, so to speak.

9/ "VC fundable" is a sufficient condition for applying a particular kind of funding and growth cookbook, with a particular kind of returns expectations curve for all parties.

10/ But software eating the world is too big a phenomenon to be limited to venture-fundable ideas. Fortunately, it isn't. The vast majority of innovation funding in the world is not VC.

11/ People fund their ideas primarily through savings, family support, angel investments, small business loans, crowdfunding, grants, bootstrap mechanisms, cost arbitraging, and so forth.

12/ There are models that bring financing and liquidity to these other activities, ranging from kickstarter and gofundme, to more specialized ones, such as crowdtilt and patreon.

13/ And of course, there's an entire universe of large institutional funding models, both conventional and unconventional, that mature companies and private equity investors use.

14/ Understanding the "shape" of your idea, and figuring out the financing model that fits that shape, can take a few rounds of trial and error. It is not a formulaic process.

15/ Some models are generic and apply across sectors. Others are peculiar and designed around the oddities of particular sector. 

16/ Some believe that VC is in fact one such (designed to exploit the oddities of computing technologies and the weirdly shaped businesses they enable).

17/ A good 2x2 on which to plot funding models is one with non-profit to for-profit on the x-axis, and growth speed (from human-speed to money-speed) on the y-axis. 

18/ VC fundable models are much closer to money-speed than human-speed (the speed of "money making money" can be considered a loose speed-of-light metaphoric limit for business).

19/ The middle is an awkward place. If your idea is neither for-profit or non-profit, and you want to move faster than humans, but not as fast as money, life is hard.

20/ This is the space occupied by an uneasy cocktail of models — lifestyle businesses, bootstrapped businesses, debt-financing, franchising, crowdfunding, and so on.

21/ The non-profit end of the spectrum is funded by goodwill, a pay-it-forward economy with no real expectation of returns. The for-profit end is driven by very concrete financial returns expectations.

22/ The "human speed" end is driven by notions of wealth and value with very deep cultural roots and strong socializing, normalizing narratives. "Coffee" is a business like this.

23/ As you get to "money speed" it becomes increasingly unclear whether you're creating or destroying wealth. The values and narratives are in flux. The wealth in play has not been socialized.

24/ It can be hard to navigate the external landscape of financial and other resources, since it changes all the time, and gets reshaped by technology. 

25/ Things can go from lifestyle to VC fundable if a new "network effect" technology is invented somewhere else, and vice versa.

26/ But why is misunderstanding this picture a good thing? The reason is that the prospect of "VC funding" attracts a huge number of talented and imaginative people to Silicon Valley.

27/ Learning that their idea doesn't fit the "VC fundable" shape can be highly disillusioning. People can end up hating the entire industry. This is a bad way to exit the misunderstanding.

28/ The better way is to recognize that "VC fundable" is the stone in the stone soup of Silicon Valley that attracts a lot of other ingredients into the pot, and triggers a lot of Plan B activity. 

29/ This is why the Bay Area has turned into a hotbed of lifestyle experiments and meta-innovation of alternative models of life, business, play, and ways to pay for it all.

30/ In a way this is why SV maintains technology leadership. Misunderstanding of the core model by smart people creates a community of people figuring out alternatives.

31/ As a result, the region is constantly developing newer models through trial and error. Things like crowdfunding emerge from this meta process of innovating on innovation.

32/ This is the spillover effect of the VC model itself. Thanks to the relatively open, public nature of VC investing (as opposed to Wall Street) adjacent investment spaces benefit.

33/ Even non-VC-fundable idea spaces figure out workable models by innovating on the basic VC model, and adapting it for different growth profiles, notions of wealth creation, and so on.

34/ Of course there are limits. One of the features of VC is that when it works, it creates vast amounts of wealth concentrated among relatively few individuals. It is a natural inequality engine.

35/ A misunderstanding, even a beneficial one, is a mistake with a cost. And in the Bay Area the cost is a very specific sort: rent. The cost of pursuing Plan B innovations in SV is high rent.

36/ Caricature example: If you imagine your novel is "VC fundable" and you stay in the Bay Area to finish and publish it, that's probably not a great Plan B unless your novel is about Silicon Valley.

37/ Silicon Valley creates non-VC-funded spillover value only to the extent that rents are affordable. A threat to this Plan B spillover zone is actually a threat to the Plan A core zone as well.

38/ The "non-VC" surplus and spillover that makes SV so special, and different from competing regions, can only exist so long as the region is hospitable to the Plan B tribe.

39/ The Plan B tribe is everybody who came to the region driven by startup dreams, and stayed to do something interesting that was not VC-fundable.

40/ This is a huge universe of things: individual creative works, open-source projects, non-profit endeavors, crowdfunded little businesses, food businesses, etc.

41/ Without this Plan B ecosystem around the Plan A core of VC-funded wealth-creation, SV would be like New York: lots of good culture, but a clear caste division between fat cats and proles.

42/ You need both. Many non-SV regions that want to compete try to create a pure "Plan B" type innovation ecosystem due to knee-jerk rejection of "Silicon Valley values."

43/ Still others recognize the need for a Plan A, but imagine it can be created at will around any sort of technology. And so you get struggling startup scenes around things like water, biotech, and energy.

44/ These are also helpful mistakes. In the process of trying to compete with Silicon Valley in a misguided way, some of these regions will figure out actual alternative playbooks.

45/ You've heard the line about startups: fake it till you make it. I have a similar line about innovation processes and investment models: fake it until you can bake it.

46/ Disciplined, repeatable investment processes at any scale, of any variety, can be thought of as a baking technology that creates wealth. SV-VC is just one of the first modern ones.

47/ Until you figure out how to bake the sorts of things that can create wealth in your neck of the woods, faking it by imitating elements of the VC-fundable Plan A core of SV is not a bad idea.

48/ What is dangerous is getting attached to your misunderstandings, and wanting your particular investment activity to work the way you think VC-fundable wealth creation does.

49/ So yes, think up the most creative ideas you can, and go ahead and test out the hypothesis that they are "VC-fundable" shaped. But don't worry if that turns out to be untrue.

50/ That misunderstanding will get you to the real action: figuring out your Plan B, whether that's in the Bay Area or somewhere else.


 

Feel free to forward this newsletter on email and share it via the social media buttons below. You can check out the archives here. First-timers can subscribe to the newsletter here. You can set up a phone call with me via my Clarity.fm profile page

Check out the 20 Breaking Smart Season 1 essays for the deeper context behind this newsletter. If you're interested in bringing the Season 1 workshop to your organization, get in touch. You can follow me on Twitter @vgr
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