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FOUNDERS FUND

WHAT HAPPENED TO THE FUTURE?

A.INTRODUCTION

We invest in smart people solving difficult problems, often difficult scientific or engineering problems. Here’s why:

The Problem

We have two primary and related interests:

1. Finding ways to support technological development (technology is the fundamental driver of growth in the industrialized world).

2. Earning outstanding returns for our investors.

From the 1960s through the 1990s, venture capital was an excellent way to pursue these twin interests. From 1999 through the present, the industry has posted negative mean and median returns, with only a handful of funds having done very well. What happened?

VC’s Long Nightmare

To understand why VC has done so poorly, it helps to approach the future through the lens of VC portfolios during the industry’s heyday, comparing past portfolios to portfolios as they exist today. In the 1960s, venture closely associated with the emerging semiconductor industry (Intel, e.g., was one of the first – and is still one of the greatest – VC investments). In the 1970s, computer hardware and software companies received funding; the 1980s brought the first waves of biotech, mobility, and networking companies; and the 1990s added the Internet in its various guises. Although success now makes these investments seem blandly sensible, even obvious, the industries and companies backed by venture were actually extraordinarily ambitious for their eras. Although all seemed at least possible, there was no guarantee that any of these technologies could be developed successfully or turned into highly profitable businesses. When H-P developed the pocket calculator in 1967, even H-P itself had serious doubts about the product’s commercial viability and only intervention by the founders saved the calculator. Later, when the heads of major computing corporations (IBM, DEC) openly questioned whether any individual would ever want or need a computer – or even that computers themselves would be smaller than a VW – investment in companies like Microsoft and Apple in the mid-1970s seemed fairly bold. In 1976, when Genentech launched, the field of recombinant DNA technology was less than five years old and no established player expected that insulin or human growth hormone could be cloned or commercially manufactured, much less by a start-up. But VCs backed all these enterprises, in the hope of profiting from a wildly more advanced future. And in exchange for that hope of profit, VC took genuine risks on technological development.

In the late 1990s, venture portfolios began to reflect a different sort of future. Some firms still supported transformational technologies (e.g., search, mobility), but venture investing shifted away from funding transformational companies and toward companies that solved incremental problems or even fake problems (e.g., having Kozmo.com messenger Kit-Kats to the office). This model worked for a brief period, thanks to an enormous stock market bubble. Indeed, it was even economically rational for VCs to fund these ultimately worthless companies because they produced extraordinary returns – in fact, the best returns in the industry’s history. And there have been subsequent bubbles – acquisition bubbles, the secondary market, etc. – which have continued to generate excellent returns for VCs lucky enough to tap into them. But these bubbles are narrower and the general market more demanding, so VCs who continue the practices of the late 1990s (a surprising number) tend to produce very weak returns. Along the way, VC has ceased to be the funder of the future, and instead has become a funder of features, widgets, irrelevances. In large part, it also ceased making money, as the bottom half of venture produced flat to negative return for the past decade. [2]

We believe that the shift away from backing transformational technologies and toward more cynical, incrementalist investments broke venture capital. Excusing venture’s nightmare decade as a product of adverse economic conditions ignores the industry’s long history of strong, acyclical returns for its first forty years, as well as the consistently strong performance of the top 20% of the industry. What venture backed changed and that is why returns changed as well.

Not Everything With A Plug Is Technology

... et cetera