22. August 2013–
Serial entrepreneur and seasoned consultant Jerzy Gangi gives us his take on why it's too tough for Hyperloop to get off the ground, why investors are wimps and how Silicon Valley is killing innovation...
Recently Elon Musk announced plans for his new Hyperlooptransportation system.
If you haven’t seen it in the news: it’s basically a giant tube that you sit inside of while you’re propelled hundreds of miles an hour to your destination. It’s sort of like the tube you put your checks in at the bank… but instead of checks, it’s people.
It’s really cool, and it could easily disrupt airline and rail travel as we know it. As an entrepreneur, I began to wonder, “Why hasn’t anyone proposed this already?” In doing some research I found out that other American inventors have had similar designs and proposals for a decade. However, none of them were taken seriously or could obtain funding. Why?
Silicon Valley is killing innovation
My thesis is simple. We haven’t seen Silicon Valley develop a company like Hyperloop — even though the plans have been out there for over a decade — because there’s a systemic failure in the startup ecosystem. In short, Silicon Valley has killed major innovation.
In all of the hype around companies such as Facebook and Instagram we’ve lost sight of some real innovation opportunities, most of which occur in the offline world.
The entire culture of Silicon Valley, and entrepreneurship around the globe, has taken on a groupthink that prevents truly novel inventions, like the Hyperloop, from reaching the market.
The result is a major loss. It’s a loss to our society. It’s a loss to our capital markets. It’s a loss to private investors. And it’s a loss to entrepreneurs.
We are so many startups creating meaningless products?
The title of this article is, “Why Silicon Valley funds Instagrams, not Hyperloops". Note the plural. I’m not necessarily talking about Instagram in particular, or the Hyperloop in particular.
No, I’m asking a question: Why are we funding these internet companies and not major life-changing innovations? Why is it that all of my peers are inventing little dinky iPhone apps instead of planes, trains, and automobiles?
If as a country, America is going to continue to lead in innovation, we can’t spend our time developing toys. We have to innovate innovation itself. In fact, I’m actually not the first person to bring this up. There are a lot of thinkers surrounding the entrepreneurial space who have been asking this same question: Why are so many startups today creating such meaningless products?
I’m going to present some theories as to why we’re funding Instagrams but not Hyperloops. By no means is this an exhaustive list. It’s just a place to start a conversation...
#1 The IPO market sucks
We have an undesirable IPO market right now. It’s a bad time to take a company public. A company such as Hyperloop is too large to be an M&A exit. It’s an IPO exit. So if you are going to make the Hyperloop, an investor’s going to ask, “How are we going to exit this investment?” The answer is, “An IPO.” And, right there, a lot of investors lose interest. In parallel commentary to this, please read Mark Cuban’s post on the stock market.
Furthermore, the stock market isn’t influenced by value today like it was 30 years ago. Whenever I bring this conversation up, I always ask people, “If AOL comes out with a phenomenal new product, is the stock price guaranteed to go up?” No, of course not. “If Kaiser Permanente releases a drug that cures all cancers, is the stock price guaranteed to go up?” No, of course not. The stock price goes up or down based on supply and demand. It only responds to human action. And, therefore, the price of a stock is solely determined by how people think about the price of a stock. There’s nothing that forces a company’s actual business value to drive the ticker price.
So when an investor says, “I don’t like investing in companies that have an IPO track,” he’s not crazy. It’s actually a very reasonable thing today — as a investor or an entrepreneur — to say, “I want to make a company that’s going to get acquired.” That’s really the most intelligent and reasonable strategy.
But without a public equities market to which investors can exit early-stage investments, and where retail investors can buy stock in new companies that will continue to grow, inventions like the Hyperloop can’t go public. And if it can’t go public, it’s not exiting; and if it’s not exiting, no one is going to invest. Under these circumstances, the only way that the Hyperloop is ever developed is if someone like Elon Musk has enough capital of his own to finance it.
If we want to have innovative products, we have to repair the process of going public and make it appealing again. Right now, the only sane choice is to aim for an acquisition. But mergers and acquisitions are on average $100 million a piece. There’s no way to have a company as large as Hyperloop acquired because it’s a multi billion-dollar company. You just can’t do it. So, how are you going to exit? You can’t. And that’s one reason why it won’t get funded.
#2 Contemporary portfolio strategy is shotgun versus sniper rifle
There is a portfolio strategy in place by investors and incubators that promotes a shotgun approach as opposed to a sniper-rifle approach. It means that early-stage funds, super angels, and micro VC’s are primarily interested in investing $50,000 a piece in hundreds of different startups instead of investing $4m in a select few. The shotgun portfolio strategy speculates that a few startups will be successful, and will pay for all of the losers. When the smoke clears, there’s something on top, and that’s your investment return.
This isn’t always how it used to be. From the early days of venture capital through the 90s, there was a sniper rifle approach. Investors were more thoughtful – they picked a couple winners that they really believed in.
The prime belief behind the shotgun approach is that, “You can’t pick winners. Picking winners is a fool’s errand.” And, therefore, the only sane approach is to weed out the losers and invest in as many potential winners as possible. Incubators like Y-Combinator and Dream It have perfected this approach.
I’m not saying it’s necessarily a bad approach. But I want to point out the sniper rifle approach also works. It got us companies like HP, Kentucky Fried Chicken, and Hyundai.
A shotgun approach is predicated on a lot of small investments by angels. Instead of an angel writing a $5 million check, an angel writes a $50,000 check. A company like Hyperloop is going to take a first round from angels of at least $20 million just to produce a limited engineering proof-of-concept.
Entrepreneurs today — and maybe even Elon Musk 20 years ago, before Paypal, Tesla, and SpaceX — cannot get an angel to invest the necessary seed funds for a large company.
Shotgun investors also do not spend all of their time on any one company. A venture that seems too crazy, or too big, must be brushed aside simply because the investor is operating on a volume investing system, not a value investing system.
#3 “We don't fund ideas"
The problem is that you’re leaving out everyone who has a company that requires capital before they can build anything. In the case of Hyperloop, there is nothing that you would be able to do without initial funding. It’s simply too big of a project to make any sort of meaningful headway without cash. And so if you went to a Venture Capitalist, or an angel, or a high net worth individual who shares this belief that “we don’t fund ideas,” they would look at you and say, “All you have is an idea”.
Which leads to the next point...
#4 MVP obsession
Some of this is traced back to the book The Lean Startup, which advocates that startups make an MVP and measure it in the marketplace before proceeding further. It’s a way of validating a business model and assuring that there are users who are willing to pay for it, before too much money or time is invested.
But the obsession over MVPs has gotten out of control, to the point where anyone who doesn’t have one can’t get the attention of investors.
There's no MVP for Hyperloop. The Hyperloop requires hundreds of millions of dollars, perhaps billions, of upfront capital before any users or revenues are gained.
This is my contention: you only need an MVP if you’re trying to prove something. Hyperloop is a faster mode of transportation, if it’s a safer mode of transportation, then there’s nothing to prove. It’s not a huge leap of faith — in fact it’s not a leap of faith at all — to say that if you have a safer, faster means of transportation people are going to use it. No one likes flying in airplanes. Amtrack smells like farts. Greyhound buses are slow. You clearly don’t need an MVP for Hyperloop.
Another part of the MVP-obsessed culture is that you should launch “quickly and early”. There is no way to launch “quickly and early” with a company like Hyperloop. It's an infrastructure project.
Making the hyperloop any simpler would be a waste of time and capital. You simply need the money to build it. You don’t need to make it simpler. And you don’t need to launch it earlier. And you don’t need an MVP.
If we want to have companies like Hyperloop, we’re going to have to get rid of the MVP dogma. We’re going to have to say: “Sometimes there is a place for companies that only have a business plan, or that only have an idea and a sketch on a napkin… and that’s not a crazy thing". It can be a reckless way of investing, but to dismiss it carte blanche means you’re dismissing companies like the Hyperloop. And we’re going to have to get rid of the idea that every business needs to be scaled down to the size of a teacup before it is reasonable to fund it.
Of course, if we want more Instagrams, we can keep doing what we’re doing.
#5: The market rewards exits, not innovation and value
The way the capital markets operate today, investors earn profits from exits… not from revenue. If you build a VC-backed company with really solid revenue, but that can’t be sold, the company is worthless. I’m not saying this is good or bad, I’m just telling you what the market is today. It’s all about the exit.
And there’s a reason, that investors are investing this way. There’s a thing called time value of money. If you can sell an investment at a 10-year earnings multiple, and get out of it, you can take that money and invest in more startups. As an investor, you don’t want be tied up in investments that are illiquid and producing cash flow every month, because you would never be able to turn over your working capital.
Hyperloop is a business that will generate hundreds of millions of dollars a year in revenue, maybe more. It might be smarter to retain a privately held company, continue to earn cash flow, and never to take it public or have an exit event. The discounted cashflow might exceed the exit value.
Unfortunately, the market does not reward cashflow because the market does not reward value and innovation. The market rewards exits. So in a company like Hyperloop, if an entrepreneur said, “I think we can invest in this and simply return cashflow,” no VC would ever be interested. Why? There are other investment vehicles that do provide an exit.
To see theories #6 to #9, including how "corporate R&D sucks" and "investors are wimps", visit Jerzy's blog...