1.1.6. Venture Creation’s Role in Society


In order to think about society, there’s an awful lot of actors there. What we’re going to do, is develop an extremely simple stylized model of venture creation that’s just going to include a very, very small subset of the actors who are relevant in the whole ecosystem. But this will allow us to focus on a few entities, where we can examine some statistics and really understand something about the value that is created.
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So to start, we need startups right? We need ventures to be created. And so we have entrepreneurs. Founding entities with ideas and those ideas, those founding teams, ultimately will need some funding, so Venture Capital is providing funding to many startups that have high growth potential. Likewise for established firms that are focusing on startups with particular products or services that may be complimentary to what they’re providing. In addition to this flow of money toward ideas, we also see another sort of flow. So while the money is represented by green arrows, the red arrow is used to represent the flow of people from established firms to the startup context, right? We discussed in another module how established firms can be inertial in the face of innovation. So professionals who are at these firms can feel circumscribed by these inertial pressures, they’ll want to pursue these technologies and so this winds up causing some of them to want to leave and found their own firms or join entities that are able to pursue these sorts of technologies. And certainly this happens an awful lot in tech. The traditional example here is that a Fairchild Semiconductors in Silicon Valley. Fairchild gave birth to many well known semiconductor firms as the members of their organization left and founded newer firms. So one baby from Fairchild is of course intel, which has been extraordinarily successful in that space, but there are quite a few. And that’s another history worth looking up. It’s not only that this happens in high tech firms, but much of the value that’s created in the startup context is in the tech sector, which we’ll see shortly. But there are other examples of contexts where people will leave established firms. So for example, professional services firms, legal services, accounting firms, consultancies, and the like. Again partners at these firms may leave and found additional firms, so the same sort of idea of established firms spawning offspring occurs. So, lets talk about what’s happening in this context where new products and services are being created, value is being created, investment is being made, and the like. Let’s focus first of all on the value that’s created just by the fact that new enterprises or small businesses exist. Let’s talk about the enterprises themself and the jobs that are created within these enterprises. According to the Kauffman Foundation, 0.3% of US adults were entrepreneurs in 2014. Let’s put that in context. 3 out of every 1,000 US adults were self-employed in 2014, had some sort of enterprise. So it sounds like a very small number, but there’s an awful lot of US adults. There are more than 28 million enterprises in the United States. And over 99% of these are small businesses. And small businesses are defined by the Small Business Administration as less than 250 employees. According to the Small Business Association, 67% of all private sector jobs created in the US occur in small businesses. In high tech, this number is lower. It’s not 67%, it’s 37%. And this makes sense because the overall set of ventures includes lots of self employment where there are virtually no employees or a very small number, the food trucks, the dry cleaners, and the like. In high tech, of course we have many firms that become very, very large. And so even with that, small businesses high tech start ups still account for 37% of all private sector jobs created in the US, so a lot of employment is happening as a result of venture creation.
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Let’s focus on the value created within these ventures for investors, much attention of late has been focused on what are called unicorns. Startups that have grown and been funded to receive valuations over $1 billion. So this fancy full name unicorn is meant to conjure that the rarity of such an occurrence, who’s ever seen a unicorn? But of course the number of unicorns is growing and it’s no longer so rare. That said it’s still under 100, but again, it is growing. So put that number in perspective. The number of unicorns is less than 2 out of every 1,000 venture back startups, 0.2% of all venture back startups actually become unicorns, so it is rare. Here’s a graphic that depicts the great skew in unicorn evaluation. So this is just showing for the 80 some unicorns that already exist, how much they’re currently valued at. And as you can see from that really steep curve that valuations pretty quickly stay close to $1 billion and there are only a few that are much more dramatic. Of course the outlier on the left side is Uber, which is valued at over $40 billion at this point. As you move toward the middle of the graph you’d see Blue Apron, which is between $1 and 2 billion. And then Eventbrite as you move further towards the right, it valued slightly over $1 billion. The majority of unicorns, like those three that I’ve just noted, are indeed consumer-oriented rather than more enterprise-focused. Now importantly, 65% of these valuations are just on paper. They’re based on the backing from VCs. The terms of the deals and the funding that these firms have received, these are unrealized gains at this point. But if 65% of these firms are still private with unrealized gains, we can also examine the 35% of firms that have exited. Let’s examine those statistics on exits. And when I say exit, this can be either an initial public offering to the markets, or it can be an acquisition by an established entity.
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If we look at the full set of firms that received venture capital between 2004 and 2013, so the most recent decade for which this data is fully processed and available, what we find is that there are over 800 exits that were valued at more than 100 million. Of these, 145 of these were indeed valued over 1 billion. So again getting into that unicorn territory. Importantly, of these high value exits, 75% of them were in the broad information technology sector. And so not only were the vast majority of the deals themselves in information technology, but these deals actually represented 86% of the overall value generated. So tech is really an area where much value is being created both for investors as well as on the jobs front, as we already discussed. The next biggest sector, it turns out, is actually healthcare. In this brief module we focused on venture creation’s role in society. And even with the simplest model of just start ups and established firms and investors, we could already see how the creation of jobs and opportunities creates an immense amount of value for investors as well as society.

Jim Rohn