SF and Silicon Valley: Drop the Incrementalism and Invest in True Innovation
“Just as energy is the basis of life itself and ideas the source of innovation, so is innovation the vital spark of all human change, improvement and progress”—Theodore Levitt
I have lived in the Seattle area for many years, and I spend a fair amount of time interacting with senior executives and fellow venture capitalists in San Francisco and Silicon Valley. I’ve studied what makes the Bay Area region one of the leading technological and commercial centers in the world. It has the entrepreneurial spirit and vast networks of capital and human resources that makes new company formation doable. We in the Northwest look at how Silicon Valley has managed to establish an entrepreneur-friendly ecosystem and how, compared with other regions, it appears to more easily translate discoveries from research laboratories into valuable commercial products. Thinking about how to create this environment reminds me of the quote from Theodore Levitt (a former Harvard Business School Professor), who emphasized that innovation is the key catalyst to promote sustainable change, improvement and progress.
If we want to achieve this goal, we need to foster an enduring ecosystem for innovation so that it can resist the unpredictable ups and downs of the marketplace.
Focusing on true innovation should not come as a surprise to those in Silicon Valley or San Francisco. What we think of today as Silicon Valley emerged largely through early innovations that came from developing and manufacturing advanced electronic components, microwave technology, and semiconductors. Major innovations in life sciences—like the discovery of genetic engineering techniques—resulted in the creation of an entirely new biotechnology industry (led in the Bay Area by Genentech) that revolutionized the way in which novel medicines for human diseases would be discovered and developed.
Following in the footsteps of this tradition, Bay-Area entrepreneurs and VCs should consider doing the following three things to foster a more stable and sustainable environment for innovation:
• Invest in True Innovations, Not ‘Me-too’ Products: Talented entrepreneurs need to invest their time and energy in identifying the most revolutionary technologies and building companies that will find the most capital-efficient way to commercialize these technologies to solve our most vexing problems in the IT, life science, and energy sectors. This means steering clear of “me-too” type technologies and focusing on those true technical discoveries that can make more than just incremental improvements. This also implies that entrepreneurs need to spend more time engaging with regional experts in their field of choice to understand what kinds of research will lead to true, game-changing advances.
For venture capitalists, this means backing ideas that may be more long-term (sometimes beyond the typical 3-5 year time horizon) and risky, supporting business models that may (at first) be unclear. This may go against the conventional way of how to solve a problem, but it nevertheless promises to provide a much larger payoff that will deliver the kinds of returns that the venture capital asset class needs in order to be viable. This also means that VC investors must be more patient and must be more willing to stick out their necks to back opportunities outside of what their peers seem to gravitate to (imagine that-venture capitalists that actually invest creatively!).
As I look at our own investment portfolio as an example of this investing approach, I note that our successes have come largely from seeding ideas that represent truly innovative approaches to solving unmet needs. This has been the case with our own investments in IT, like Farecast, which was acquired by Microsoft for developing an innovative airfare prediction technology. It happened in life sciences with Alder Biopharmaceuticals, which secured a $1B+ partnership with Bristol-Myers Squibb to advance therapeutics derived from a platform for uniquely identifying, developing, and manufacturing novel antibody therapeutics in the autoimmune and inflammatory disease areas. It’s happening in energy as well, with EnerG2, which has secured significant federal stimulus funding to commercially develop and manufacture high-performance, nano-engineered synthetic carbon electrode materials for ultracapacitor energy storage devices.
• Get Big Companies Involved Sooner: Entrepreneurs and VCs need to approach potential corporate partners much earlier as they seek to solve problems with innovative approaches. Many large corporations are recognizing the need to invest in innovation at an earlier stage. Witness recent activities by companies like Apple, General Motors, Google, SAP, T-Mobile, and numerous others in the last couple of years who have set up meaningful investment vehicles to help financially back innovative startup companies in their respective fields. Corporate cultures are shifting to be much more supportive of spinning out technologies that may be non-core to the larger company’s current area of focus. Public shareholders, like venture capital investors, are demanding more focus from larger companies in their ongoing quest to maximize shareholder value.
Investors and entrepreneurs should use this as an opportunity to develop new, early-stage companies that will take the best, most innovative technologies forward. Research compiled by the National Venture Capital Association, Thomson Reuters, and others have pointed out that venture capital investor exits today are coming more from trade sales (M&A) than from initial public offerings. So it would seem to be prudent to stay close to potential buyers to figure out what they plan to buy, and to craft your startup development strategy with this information in mind.
• Diversify Risk within Early-Stage Companies: Finally, VCs and entrepreneurs can maximize the potential for a successful outcome and a much smoother ride by diversifying risk within their respective companies. This means encouraging a reasonable diversification mindset, where entrepreneurs (supported by their VCs) would consider developing their core technologies to address peripheral markets. In some cases, these peripheral markets may be smaller in size or overall potential, or may be an unanticipated use of a core technology originally developed for one market but effective for use in another market. Using this kind of mindset effectively has helped us at WRF Capital in managing product development risk within our own investment portfolio, and in some cases has enabled our companies to significantly extend their financial runways by obtaining valuable, non-dilutive sources of funding (either from customers, government or non-profit institution grants, or other strategic investors). This is particularly important given the current economic climate where raising new outside capital can be challenging even for the best companies.
There’s no question that San Francisco and Silicon Valley continue to be well-positioned to make significant contributions to the 21st century economy. If VCs and entrepreneurs are willing to take this advice to heart, they will be even better positioned to ride out any ups and downs that the markets have to dish out.