ESSAY: Welcome to the decade of venture capital

Pioneer: Sequoia Capital founder and first Apple investor Don Valentine

By Chris Chenga

You may not have heard of him before, but depending on your lifestyle, he defined how you and your loved ones spend at least eight hours of your day; regardless of whether together or in your own personal spaces.

The fun gadgets which you were so thrilled to unwrap on Boxing Day, or still have to save up for if you weren’t so lucky; laptops, mobile handsets, video games, and the digital platforms on which they function on; he propelled from idea to material.

The software on which you are soon to re-convene for collaboration with your work or school colleagues in the coming year, he had a hand in those too. Donald Valentine’s legacy permeates through almost all forms of modern human interaction, and emotion! Sadly, 2019 brought an end to the life of a man who had a more precise vision of what the world would look like today, than any other investor did decades ago.

Valentine, who died in October 2019, founded Sequoia Capital in 1972. He was a financial pioneer who became an icon of the “risk investment” field; which is now known as venture capital. Amongst some of his most notable risks are Apple, Atari, Google, Cisco Systems, Oracle, and Electronic Arts. Valentine didn’t fancy interacting much with commercial media.

So one of his few lasting sound bites is from a tape-recorded interview he reluctantly did in 2009 with Sally Hughes, of the Regional Oral History Office in California. Valentine seemed to have begrudgingly given in to being part of a series of interviews focused on how the venture capital industry began and continuously evolved in Silicon Valley. The transcribed collection of interviews is stored in The Bancroft Library at the University of California.

In what turned out to be an exceptionally enjoyable conversation, Valentine really showed up! He generously recalled as many memories as he could of a nascent industry in the 1960s to its eventual prominence by 2009; this was after a preamble of his childhood background – of Jesuit nuns beating him for writing with his left hand – as if to prime the audience into his peculiar perspective.

Valentine’s tone is wide ranged. Offhand lighthearted quips serve as antagonist banter to the interviewer who dragged him into the chat. But these are harmless gestures, purposefully serving as mental relief, in between more serious self-aware recollections that are deliberately considerate of an imagined audience that could benefit from grasping rare gems of insight as vividly as possible. By doing so, Valentine made the conversation deeply captivating, yet, an easy enough follow to isolate the most crucial insight!

Valentine responded to conventionally binary leads by presenting trade-offs that demand more thoughtfulness. For instance, asked whether he knew he was a good investor after a string of early successes, he retorts: “I don’t think I had enough companies that I had invested in in quantity, and they had not achieved enough in quality for me to be confident… As a company begins to succeed you have to put more money into the proposition and I didn’t have the more money to put in some of these companies. So their limitation was my inability to personally finance them.

Profound logic; such is the intellectual flexibility that seems necessary to manage a portfolio worth more than the size of entire sovereign economies.

Altogether, Valentine did his very best to condense, and when possible make relatable, a truly distinct lifetime of investing. The interview is an essential read – which is the best means of consuming it – as a real icon recounts half a century’s commitment that would materially influence our lifestyles, and define what modernity is!    

A controversial excerpt, however, is Valentine’s comments on the breadth of tolerance with which he would approach the founders that he backed, and how he harnessed their ingenuity.   

Don Valentine: A company we didn’t finance was up and running. It made very good software. The founder of the company understood without any help that he didn’t want to run the company; he wanted someone else to run the company. He was in Sacramento; near an air force base. He hired a retiring Colonel. Now this is the typical software company- with dogs in the building, bicycles in the building, everyone’s wearing jeans and t-shirts. I had this intuition about this Colonel. And I said, sort of in the political framework, “What are you going to do in the first hundred days?” He said “The dogs are out. These goddamn bicycles are out. Those haircuts – we’re going to look -.” I said, “Why? Why is that relevant? Who cares if there’s a dog here, or twenty-two dogs? We’re in the software business. Why do you care?

Sally Hughes: Well, it is relevant, but in the opposite way of what you’re describing.

Don Valentine: Yes, that’s why big companies fail. See if Steve Jobs went to a job interview at HP, instead of starting Apple in 1978 when we financed it, he wouldn’t have gotten a job! They’d look at him and say, “You look like Ho Chi Minh.” There are relevant things that people do, and things that are just happenings of an era.

Sally Hughes: Don’t you think that success is the background to all of this? That you can tolerate anything, or virtually anything, as long as you’re building successful companies.

Don Valentine: Yes, and Tom (Perkins), if you ask him, turned down Apple because he met Steve, and Steve was dressed the way Steve dresses. And he said. “Pfff. This guy doesn’t look professional.” He wasn’t. He was 19.He hadn’t gone to school. He had sandals, jeans, and a t-shirt and a Ho Chi Minh beard. Atari – you go on the factory tour and the marijuana in the air would knock you to your knees – where they were manufacturing the product. We had board meetings in a hot tub, with bottles of Ripple floating around the hot tub! There are no rules that say that certain behavior produces a result that is directly related to the behavior. I think when you do that you get big companies that die, like automotive companies. They have so many rules, so many things that they do and long since forgotten why, that it takes a different attitude. Now, I don’t go around advocating marijuana – smoking in the manufacturing area, but that’s the way Nolan (Bushnell) ran the company.

Sally Hughes: You might have said something if the company wasn’t doing well.

Don Valentine: Yes, but what would I say – get a higher brand of marijuana? Get a better bottle of wine that is floating in the hot tub?

This exchange recently became reference for a modern discussion around the growing celebrity, and enablement culture, which has elevated start-up founders sometimes to heights beyond investor scrutiny and conduct stewardship.

Image result for Adam Neumann wall street journal

Recently, WeWork founder, Adam Neumann, took the company towards a dismal initial public offering (IPO). Fundamental operational deficiencies became more apparent in his business as the planned IPO drew closer. Investors grew distain for Neumann’s propensity to spend cash without the company generating comparable cash flows. In 2018, the entrepreneur had a corporate jet bought for him amongst other luxuries. And just like Sally Hughes alluded to when she pressed Valentine, as things started to go badly investors became more conscious of Neumann’s rather eccentric behavior; such as taking shots of alcohol during meetings.  

As pre-IPO valuations continuously tumbled from initial estimates that ranged between $40 billion to $80 billion, the IPO was halted altogether. One of WeWork’s biggest backers is Masayoshi Son through his SoftBank vehicle. Son is most famed for investing $20 million into Alibaba which returned $100 billion; the most lucrative risk investment to date. Nevertheless, Softbank is currently scrambling to raise a $9.5 billion rescue package for WeWork.

As the fiasco around Adam Neumann is ongoing, observers are pondering on whether venture capitalists’ continued reliability to spot and nurture entrepreneurs up to a point of entry into public markets is still warranted. It was just a few years ago that venture capitalists peaked in prominence for their uncanny ability to sniff out “unicorns”; start-ups that would enter public markets clinching at least $1 billion in market capitalization at onset.

Silicon Valley, a location that had grown synonymous with Don Valentine, remains the epicenter of the world’s venture capital industry; but, for how much longer? Has the Bay Area become too lax in its diligence? With the emergence of seemingly more vitalized start-ups such as TikTok from elsewhere in the world, has Silicon Valley lost its “edge”? This edge was never definitively quite clear.

Valentine himself could not crystallize what made Silicon Valley what it was to venture capital, and even in his passing, he still wondered, “why did it happen here? Tony Tan (Keng Yam) was here at lunch and asked the question. Tony Tan was then assistant prime minister of Singapore, and I said it was luck. Try great universities. There are lots of places with great universities; all over Europe; great universities in China. Why here? Why when it happened?” I have my own suggestions of what some of this edge probably was, and perhaps as indicative of other regions potentially over taking Silicon Valley, edge factors may not be so arcane. I will share them later on.

Africa’s no better at dealing with debt than it was 50 years ago!

In December 2019, the World Bank Group published “Global Waves of Debt: Causes and Consequences”. The book describes four waves of debt to have occurred in the global economy since 1970, with the first three invariably ending in debt overhangs that devastate nations. A highly technical and empirical read, the authors illustrate the burdens of debt dynamics in impeccable detail; for over 100 economies too. It is essentially a cautionary analysis proffering contingencies for nations to avoid these repetitious circumstances at the end of the current fourth wave of debt.

A simplified premise of the book is that debt servicing costs have often been higher than the rate of return on expenditures and investments made especially by governments. Accordingly, smart implication is for governments, and private sector debtors alike, to ensure more potent utility of accumulated debts. Fair enough. Notwithstanding, the preference of debt itself can be queried – I would suggest it should be! This particular notion falls outside of the purview of the book, but my fascination in venture capital has to a large extent been influenced by a curiosity of alternatives for debt. Justifying this curiosity is that Africa has repetitively shown little shrewdness to debt’s pitfalls.

Over the first debt wave, external debt in developing economies rose from 12 percent of GDP in 1970 to 82 percent in 1982. The infamous Highly Indebted Poor Countries (HIPC) agreements for debt forgiveness subsequently came with unpopular prescribed reforms. Even though the majority of countries were unable to fulfill these reforms, some debt was still written off and concessions made. However, today, debt has shot up again to over 60% of GDP. It shouldn’t take the World Bank to foresee yet another impending calamity.

Think about this: traditionally, debt overhangs have typically brought on an assortment of undesirables, such as currency depreciations and capital outflows, of which especially African governments really have little to no control over. Hence, at points of debt distress, negotiations with creditors are often one-way instructive, straining geo-political ties and sovereignty. A greater percentage of debt is now being sourced from non-Paris Club bi-lateral lenders, but that means credit is still tilted towards politicized transactions, diminishing pure commercial under-writing. At the citizen level, a disenfranchising peril of debt is that private financial institutions continue to face distress due to competing fiscal deficits. The spiral forces governments to pursue debt monetization or nationalization, where the public further foots the bill.

Indeed, it is exactly these dynamics that familiarize debt with “bondage”; well, the kind of bondage that impedes on both national and individual liberty to pursue commercial ventures! Yet, all these instances are stubbornly familiar in Africa, right? They have been for fifty years. So conceding to an inability to manage debt, let’s suppose debt dynamics are just structurally insurmountable. (Note: debt for Africa is not a bad thing, and actually really could have utility…but that’d require a generously optimistic mood while cynicism compelled this essay)    

Kenya’s potential for venture capital

According to Fitch Solutions, Kenya’s external debt service to exports ratio in 2019 was 47%. That means for every $1 earned by exports, 47 cents goes to servicing foreign debt. The other 53 cents cannot pay for an import bill that is three times higher than export receipts. This is obviously an untenable debt cycle. The authors of Global Waves of Debt: Causes and Consequences are slightly empathetic. They lament on the elusiveness of computing an optimal debt level that an economy can handle. It is empirically difficult to calculate; even though certain approaches are more competent than others. Moreover, national budgets are especially tricky to calibrate due to their universality and conflating of interests.

For instance, weighing the trade-offs between allocating more to home affairs over welfare programs is largely a subjective exercise. Perhaps then, I would suggest, scaling national debts by pursuing projects that could otherwise use private equity guided by venture capital instead of loans. I would be dejected if this is not at least a competitive alternative to the farce of austerity.

Kenya’s president, Uhuru Kenyatta, has been strongly criticized for what is branded as the “railway to nowhere”. The Standard Guage Railway, also known as the Madaraka Express, was funded by China. The socio-economic dividends of this project have been underwhelming. In its first full year of cargo operations to May 2019, it generated $57 million in sales below operating costs of $120 million.

Operational deficiencies include inadequate passenger service runs, and poor connectivity sequencing with other ports of travel and commute. This project ideally should have been organized in a venture capital model. A normative disagreement with this suggestion would suppose that governments are mandated to provide infrastructure to their citizens, and that it is not the responsibility of private investment vehicles. The enthusiasm behind that sentiment is often before the fact, as almost nobody ever justifies legacy debt burdens with “well, at least the government pursued its mandate”; especially when the infrastructure is defunct.

Besides, Kenya has a nascent private equity industry. More private vehicles are entering sectors of socio-economic significance. Just this year, Twiga Foods, an agro-supply chain enterprise, was able to raise $23.75 million from American investment bank, Goldman Sachs. Copia Kenya, a mobile commerce platform, raised $26 million in a series B round. The private equity industry in Africa tends to be stratified, with investors keen on specific sectors. Thus, generic mandates of government providing infrastructure would be of a secondary financing market, as private entities like Twiga and Copia would attract primary infrastructure capital as they expand the nodes of their businesses to remote regions. In the instance of the “rail to nowhere”, maybe the public sector should have been limited partners to a venture fund that had more diligence in assessing the commercial viability of the project.

Reasonable skeptics may wonder on whether or not enough private finance can be raised for such huge projects that demand billions. I cannot give a definite yes; but as the industry grows it is possible over time. According to African Private Equity and Venture Capital Association (AVCA), the total value of fundraising closed by Africa focused private equity firms reached $1.7 billion in the first half of 2019.  This was on pace to match the $3.4 billion in 2016 which was the highest raise in the last five years.

Large corporations’ role to play in venture capital

Contrary to popular notions around entrepreneurship, start-ups are not just conceived by personality outliers with eccentric demeanor; nor whiz kid college drop outs neither. Very rare is it for a 19 year old hippie with a beard like Ho Chi Minh to have clarity in a sustainable business, and less so for boards that gather in a hot tub hovered by marijuana’s aroma. Those stories become folklore as they are one in a million!

A diligent society has far more start-up founders than that; thousands in a million. Most robust start-ups tend to be spin-offs from already existent corporations, often from regular professionals with a passion to pursue projects. This is common in developed economies now, though in the 1960s it wasn’t!  

Here is why this spin-off sequence has not caught on yet in Africa: our large companies pursue business models that do not have original intellectual property! Most corporations license foreign IP, or are subsidiaries of foreign entities.

This is a huge, if not the biggest, hindrance to creating an entrepreneurial ecosystem on the continent. I am not sure how Africa can encourage an entrepreneurial culture in professionals for as long as the main business model for the biggest entities in most sectors is to license foreign IP. Where will the animal spirits to aggressively pursue intellectual property come from in such as environment?

One may assume that this scenario is an opportunity for underdogs to out innovate big corporations. That is not correct! For instance, there is hardly enough credit on the continent to risk scaling underdogs to take on corporations that already have significant market share. Two sure ways to distinguish venture capital from bank lending are: 1- Scalability; venture capital chases infinite growth potential or complete market share dominance, at terminal fundraise rounds, which is beyond bank conservatism 2 – Untested innovations or business models; venture capital tolerates the greater risk proposition presented by untested innovations and/or business models over proven trials or case studies as credit conservatism.

Furthermore, while competing against large corporations is not an option, entrepreneurs even struggle to sell their products or provide their services to big corporations. The big corporations licensing foreign IP are often committed to a completely codified or standardized foreign supply chain. This is applies in multiple sectors from banking, telecoms, auto assembly, to FCMG.

My line of thought here probably leads to suggesting that Africa needs to ease off being a secondary market to multinationals, if it is to truly inspire its own entrepreneurship and in turn develop multinationals of its own. Such a proposition is probably an issue of industrial policy, and can be firmly advocated for in foreign policy.  

What made Silicon Valley the place for VC

I believe that Don Valentine did share Silicon Valley’s greatest edge. Speaking on attracting the first mutual fund to back his investing, Valentine remarked, “it was just a matter of how you organize to do business at that particular point in time in the world…” Venture capital is not just about pursuing intellectual property or attracting risk to investing in it; it is about organizing how to do the business! It is this little, but really significant detail that still is Silicon Valley’s edge fifty years on.

For decades, personality extravagance has grown to brand the investment hub; entities such as Benioff’s Salesforce or Musk’s Tesla. That could happen as long as a start-up was well organized to do business. An entrepreneur’s behavior or presentation became irrelevant. It is this detail that observers should include into their discussion around Silicon Valley’s industrial dominance.

Adam Neumann’s demeanor was secondary to a fundamentally flawed organization of how to run WeWork in the first place. This is why Valentine hardly had any noteworthy issues with his founders. How you organize to do business ensures that start-up founders are not elevated to heights beyond investor scrutiny and conduct stewardship.

Don Valentine was frustrated by his three previous employers, as he could not pursue both his own intellectual property and invest in that of other people as a side passion. Thus, he personally understood the nuance of how to organize a business to align supporting ideas with necessary risk by the investor! His own foray into business was a continuous succession of spin-offs from bigger corporations.

He once worked at Fairchild Camera and Instrument, whose owning family was at one point the largest shareholder in IBM. The person who ran Fairchild, Bob Noyce, would spin off to be involved in starting Intel. Common amongst Valentine’s other peers too at the time were the frustrations in a lack of equity participation in their most passionate ideas!

This group over time would fondly become to be referred to as “The Traitorous Eight”. This was the motivation that not only birthed venture capital in Silicon Valley, but made it the leader for decades since!  This is the common theme in the collection of interviews stored in The Bancroft Library in North California.

Venture capital was called “risk investment” for a reason

I suppose this edge was never truly understood worldwide. It may still not be. The most critical analysis that I could find on the venture capital industry was a Kauffman Foundation report titled, “Venture Capital – The Enemy Is Us”. At the time of the report, the Kauffman Foundation endowment of $1.83 billion was invested in a globally diversified portfolio. It had twenty years of experience invested in over 100 venture capital funds, with $249 million locked in at date of report. So it is hard to find a more credibly invested perspective.   

What we learn from the report is that venture capital is not a widely competent industry. The few good performers significantly raise averages to extents that conceal gross incompetence by the majority of active venture capital funds.

The report references one study by Flag Capital Management that revealed that from 1986 to 1999, 29 funds raised 14% ($21 billion) of total capital in the industry worldwide, and generated an astonishing 51% ($160 billion) of returns. This was a 3.6 multiple. The other funds in the industry raised 86% ($160 billion) of capital but only returned 49% ($85 billion) of returns; a disappointing 0.53 multiple. Kauffmann’s portfolio to 2011 was just as skewed with a few high performers, and many laggards. A majority of funds – 62 out of 100 – failed to earn returns available from public markets, but were still paid management fees.  

The report conclusively recommends an entire reconsideration of a broken venture capital model. But here I am, suggesting to you that this should be the decade Africa immerses itself in venture capital.