INC.: What are the characteristics of the 99.2% that failed?
HOFF: In most cases, it's just another company, a clone of what's already out there, or it's in a slow-growth market, or it doesn't fit our start-up investment focus.
INC.: Not to make a moral judgment, but doesn't it bother you to some degree that so many fail to get capital?
MATHIAS: The sheer number of companies that do get started speaks for the vibrancy and efficiency of the system. Most new businesses are local situations that never come to the attention of the venture capital community.
AVIS: Well, some do -- companies that have been initially financed by sweat equity or credit cards or rich uncles. By the time we see them, their founders have been toiling at it for two or three years and have achieved $2 million, $3 million, $4 million in revenues and haven't even paid themselves along the way.
WENDELL: You can take what appears to be an everyday, mundane business, give it some venture capital, and dramatically boost its fortunes. It becomes supercharged within its industry because the capital differentiates it so much.
For instance, we did a deal for a technical temporary-help company. Now, temporary help is not an industry venture capitalists have been all over, but our substantial capital markedly changed the company's growth rate. Corporate America is downsizing, trying to outsource everything it can, and contract labor is becoming much more popular. Suddenly here is one well-financed source of technical temporary help among a whole bunch of ma-and-pa companies, and the ma-and-pas were left way behind. That company has since gone very far and has yet to face a major competitor.
MATHIAS: A venture round would also dramatically change the way a company is managed. And that has a lot of implications, some potentially negative for the entrepreneur or sole proprietor.
Loss of control is at the top of the list. When you accept sophisticated venture money, in one way or another you lose some control over your company and give a role to active, forceful people. Entrepreneurs are often surprised that they have to make this trade-off to attract capital.
WENDELL: But it's not an unreasonable trade-off. The way we make deals, the founder owns a chunk of the company and wants it to be valuable as much as we do. In the case of the temporary-employment company, we worked with the founder, first to identify good people to put on the board, then, over a two- or three-year period, to bring in some senior management under him. Finally, we decided with the founder that he would become chairman, and we got a top guy out of Kelly Services to come in and run the thing.
INC.: The founder was eased out.
WENDELL: Not at all. In fact, our original understanding with this particular founder was that he would serve as CEO for a shorter time than he actually did.
DOERR: Here's how lots of entrepreneurs can get their businesses started without professional venture capital: equity funding from angels. A study from the SBA just came out that says there's another $55 billion flowing from individuals into start-up companies. That's a staggering number: 13 times our $4-billion-a-year rate of investment!
INC.: Then is professionally managed capital losing its importance?
DOERR: I doubt it. There's often a lack of understanding of how much money it takes to grow a substantial business. In that $55 billion, you have neighbors funding neighbors, thinking they can do the next Apple Computer for $300,000. We often run into companies that have started with individuals' monies, and they get to the point where they're at a stage of product development but the angels have no more capital to invest.
MATHIAS: And a lot of this has happened at a time when the tax laws have not been conducive to starting companies. The '86 tax act really said debt is better than equity.
INC.: Will lowering capital gains really do anything to spur capital growth? Doesn't $55 billion from wealthy individuals suggest it doesn't matter, that they'd have invested anyway?
HOFF: You can't tell me that the billions that came from individuals wouldn't be much, much larger if they weren't looking at putting out an illiquid, long-term investment at no tax advantage over keeping it in a bank at the CD rate.
MATHIAS: It's incontrovertible: money follows tax policies. The elimination of the capital gains differential has clearly been detrimental to venture-related activity.
DOERR: We desperately need more capital formation. Until very recently, this country has been relying on an influx of foreign capital -- which I welcome. But we have to reduce -- I mean, eliminate -- the deficit. Stop spending and use the peace dividend to balance the budget. And we have to encourage savings. The interest you get in a savings account in Japan up to 5 million yen is tax-free. If you look at America's global competitiveness, it's a bleak picture.
INC.: In the end, maybe all this is a tempest in a teapot. Just how significant an economic force is a few billion dollars of venture capital, anyway?
WENDELL: To put it in humble perspective, the entire venture industry's total annual investment in new and existing portfolio companies is less than a single year of IBM's R&D budget!
DOERR: When you consider that $4 billion per year of venture capital is not even one-tenth of a percent of the $5-trillion U.S. economy, it's hardly worth a mention. But think of it as a pilot light under that economy, and the balance changes: less than $100 million in total was required to ignite Apple, Genentech, Lotus, Sun, and Compaq.
