I moved Flywheel Ventures to New Mexico back in 2000 for a variety of
reasons, but the principal motivator was simple: Fish Where Everyone
Else Isn’t.  I thought that New Mexico, in particular, was a
dramatically underserved market for venture investing and technology
entrepreneurship.  Sooner or later, I thought, that tide would turn and,
as the saying goes, the boats would start lifting.

It’s been a lot of hard work by thousands of entrepreneurs, service
professionals, politicians, investors, and other thought leaders in New
Mexico - many of whom have been at it a lot longer than myself or
Flywheel.  Now, though, it looks like the tide really is coming in - and
sure enough, it may be arriving faster than any of us expected.  Just
read this editorial by the New Mexico Business Weekly today: Albuquerque Is On Fire With Growth and Opportunity.

The late management guru Peter Drucker once said, “The entrepreneur
always searches for change, responds to it, and exploits it as an
opportunity.”  Mr. Drucker would surely be impressed by the
opportunities for entrepreneurs today in New Mexico.

Time to go fishing!

The article focuses heavily on the rapid increase in technology start-up activity, particularly in non-traditional sectors starting to draw more interest from investors, such as aviation, alternative energy, etc. Kudos are due to hundreds of people and organizations who are working together to move New Mexico forward in the global economy!

Beside an introductory paragraph that cites one of my favorite quotes from economics - “In the long-term, we are all dead” - this week features an excellent discussion of the issues surrounding globalization of human capital flow, the savings glut and its strange effect on long term interest rates, etc.  I discussed some of this in a previous post (”The SuperSizing of VC Funds”) a few weeks ago, but Jim’s treatment is (as usual) both more to the point and more entertaining to read.

For myself, I chose to get an MS in Engineering Management at Stanford (it’s now called the Management Science and Engineering department).  In part this was because it was more time-efficient (Stanford has a joint graduate program between Electrical Engineering and MS&E).  In large part it was the opportunity to work as a research assistant with Tom Byers in building the Stanford Technology Ventures Program.  In retrospect, though, the real reason I did it was that it was the path for which I had the most passion, and from which I could see myself being fulfilled for the rest of my career.  I just didn’t have the same passion for the MBA route.

Now, several of my colleagues at Flywheel have MBAs and while I rib them about its worth all the time, the truth is that they found it very helpful and fulfilling.  And, in fact, the content of all of these types of programs is fairly similar, regardless of the acronym.  So I don’t think there’s any single answer.

In fact, in my opinion…the right answer varies for each individual.  In my entrepreneurship lectures and courses, I start with the well-known definition of entrepreneurship proposed by Howard Stevenson at Harvard: “Entrepreneurship is the pursuit of opportunity without regard to the resources currently under control.”  In other words, figure out what opportunity you want to pursue, and only then, worry about what resources you need to be successful in that pursuit.

Most people who ask the question of which degree program will advance their career the most are inadvertently signaling that they don’t yet know what opportunity they want to pursue.  Deciding what degree to get, or whether any degree makes sense at all, is a pointless question until you have decided what opportunity to pursue - i.e., what path you want to follow in life.  It’s okay not to know, of course, and in that case, any path at all will get you there.  Just don’t sweat the choice so much.  The energy spent deciding which type of degree is the right one should instead be spent figuring out what path in life will be the most fulfilling.  Which gets me to my real point…

When it comes time to fund entrepreneurs, I can certainly tell you that I don’t pay attention to what advanced degrees (if any) the entrepreneur has.  I pay attention to where their passion lies, and what their past actions (e.g. career choices) tell me about that passion.  Entrepreneurship is too hard, and too risky, to pursue if one doesn’t have passion for the effort that transcends simple risk/reward economics.  Inevitably during the entrepreneurial process, a point will come when the logical, intellectual, well-reasoned decision is to go do something else.  Equally inevitably, the entrepreneurs who are successful in the long-term are those who kept going when economic logic said to stop.  Their pursuit of their passion and their seeking of fulfillment beyond the logical economic choice kept them going.

Passion is not a replacement for logic, and skill, and industry experience, and all of that.  An MBA, or an MS, or any other learning experience certainly contributes to all of that.  But all of those other things are necessary but not sufficient.  Successful entrepreneurs have an additional drive that just keeps them going.  Don’t sacrifice the effort to discover, and fulfill, your passion in life because you think a few letters that signify an advanced degree will get you there instead.

So, it’s with great pride at Flywheel that we invite you to join us this Friday morning, March 24, at the Balloon Fiesta museum in Albuquerque to celebrate the nomination of the ten most prominent “Women of Influence” in the state of New Mexico.  All ten are deserving, but our pride is especially strong for two of the ten selected women:  our partner Kim Sanchez Rael here at Flywheel, and social entrepreneur Susan Matteucci with Southwest Creations Collaborative.  The entire Flywheel team will be attending the breakfast Friday morning, so stop by and congratulate Kim and Susan with us.

The breakfast is 8-9:30am, Friday March 24 2006, and additional information and signup is here.

Bill and Peter contribute to an ongoing discussion in the VC industry that has been building since the bubble burst.  Not surprisingly, at Flywheel we’ve been espousing similar views for years.

The gist of the problem in my view is that the total amount of liquidity available for the total universe of venture capital startups being funded by the total industry of venture capital firms is just plain too small for the math to work.  Others have made the economic argument so I won’t re-iterate it here.  Given this, one would expect a rational free market economy to adjust relatively quickly by decreasing the supply of capital available to VC firms, forcing smaller fund sizes, etc. until the problem is resolved.  In fact, this started to happen during 2001-2003, but it quickly leveled off.  Why?

I believe that the driver of the supply of capital for VC funds from the LP world has to do with a global savings glut being driven in part by increasing trade surpluses in emerging economies.  The central banks of China and a dozen other nations are increasingly managing large excess amounts of dollars, and a lack of domestic capacity for low-risk, long-term investments in their own markets (i.e., the capital markets and accompanying investment vehicles are still largely dominated by Western nations - at least for now).

As a result, the excess worldwide savings continue to flow into U.S. treasuries and similar markets, holding the long-term bond yield curve much flatter than a traditional USA-centric view of economics would predict.  I.e. the global demand for U.S. long-term investments exceeds the supply, which keeps yields artificially low relative to other economic activity that traditionally affects interest rates.  This, coupled with the relatively tepid performance of public equity markets in the U.S., has forced institutional investors around the world who are searching for better returns to push investments into alternative classes.  Hence, the rapid rise in private equity, hedge funds, venture capital, as well as specialty asset classes like timber.

Put another way, if the best returns that investors can expect for relatively low risk are likely to be in the 5-8% range over the next decade (a fairly consistent forecast of various economists I have talked with), then they are likely to accept the prospect of returns from alternative asset classes in the 10-15% range instead of the traditional 20%+.  (Disclaimer: I’m not an economist and so these statements merely reflect a summary of what I think I’ve heard from people who are).

All of which suggests, of course, that in some sense the capital markets are indeed working, and the larger VC fund sizes are a natural response to the needs of global institutional investors who need vehicles that promise higher yield.  (Emphasis, of course, is on the word “promise”).

Fine and dandy, except for the impact large VC fund size has on seed and early-stage VC investing.  Much research has shown that the pace of innovation (and hence the number of new viable innovations suitable for company-building) is relatively inelastic vis-a-vis macroeconomic conditions.  In other words, just because there is an excess in size and number of venture capital investors, does not mean that there will be a corresponding rise in the number of viable startup investment opportunities to absorb the excess capital.

Coupled with the length of time it takes to train and grow experienced venture capital personnel (which exceeds the time constant of most economic cycles), the industry now finds itself with a large number of medium-to-large-sized VC firms, growing rapidly in assets under management, all looking to fund essentially the same number of viable startups with essentially the same number of VC investment personnel.  No wonder deal sizes and valuations go up.

On the flip side, this is precisely why we think it is an attractive time to be a small, seed- and early-stage VC investor.  At exactly the time one would predict that more VC competitors would be arriving at the table to put down seed- and early-stage bets, instead we continue to see relatively little VC interest in deals requiring $500k-$1M in funding.  It just doesn’t “move the needle” for our increasingly larger brethen.  That’s great for us, because it means that we can focus on what we do best:  partnering with entrepreneurs using innovative technologies to build real businesses that solve real problems and generate real cash flow.  Compared to many our peers in the VC industry, I believe we spend almost none of the time they do simply jockeying for position on overcrowded deal syndicates.

We founded Flywheel with a core strategy to “fish where everyone else wasn’t.”  At the time, in 1999, we thought of that goal primarily with respect to our geographic choice of the Southwest / Rockies.  As it turns out, while the number of VC firms has continued to grow, even in our geographic region, we continue to find ourselves largely fishing alone - only now, it is mostly the size and stage of investment that defines our little pond.  And, like all good fishermen/women, we’re happy to have visitors occasionally, but at the end of the day, we won’t argue with having our favorite fishing spots largely to ourselves.

One of the worst offenses in my opinion during the bubble days was the sense that, somehow, VCs were more important to the startup ecosystem than entrepreneurs.  VCs were rock stars who took enormous risk and were therefore deserving of magazine covers, etc.

Everyone at Flywheel has been an entrepreneur at some point prior to joining the firm, and we all think this kind of thinking is rubbish.  When was the last time a VC put a portfolio company’s payroll on his or her credit cards, or signed a second mortgage on the family home?

Simply put, entrepreneurs are the ones who take the risks, and they are the ones who ultimately deserve the rewards.  VCs are more like service providers.  The best VCs, of course, are like trusted service providers - the family doctor, high school principal, asset manager, or babysitter who provides more than a simple service-for-hire and who gradually becomes an important part of the family.  Our aspiration with each of our Flywheel portfolio entrepreneurs is to earn our way into that trusted inner circle.  We don’t believe you get there just because you write a check and take a board seat.

As somebody who’s been on both the employee and the funder side of VC-backed startups, I can attest to the value of this list personally.

RTP catapulted from an agrarian and textile-based economy in the 1950’s and 1960’s with per-capita income ranked second-to-last in the U.S.  to a contemporary rank of 5th in the nation for overall venture capital investment.  RTP’s successful development was built on the foundation of university-based research and development spending; the area’s 3 major institutions (Duke, North Carolina State, and the University of North Carolina) conduct over $400 million per year in sponsored research.  The successful commercialization of this R&D, coupled with the area’s lifestyle advantages, has led to the employment of over 40,000 technology workers in the area’s private sector companies.

In Flywheel’s view, San Diego of the mid-1980’s bears an even more striking resemblance to Flywheel’s target region, and especially the Firm’s headquarters location in New Mexico.  During a series of economic crises in the 1970’s and 1980’s, the economy of the San Diego area was dependent on tourism, real estate development, and defense spending.  At the same time, the area housed a large number of academic and non-profit research institutions.  These facilities conducted almost $2 billion/year in R&D activity. Leveraging the local technology expertise brought by government contracting, along with these academic research assets, the region has subsequently grown well beyond its dependence on defense spending.  San Diego now features over 1,500 private high-technology companies; ranks 7th in the nation for venture capital investment, and is the overall leader in wireless and ranks 3rd in biotech among all U.S. regions.

Susan is an outstanding example of a “social entrepreneur,” and if it seems a bit odd to write about social entrepreneurship on the Flywheel Ventures blog, it shouldn’t.  My partner at Flywheel, Kim Sanchez Rael, who is also a co-founder of Social Venture Partners New Mexico, likes to emphasize that we “can’t build world-class companies in mediocre communities.”  Social entrepreneurs are increasingly recognized as key contributors to building the world-class communities that we all want to live in, and which in turn attract other sorts of technology and commercial entrepreneurs and innovators.

Back when I worked with Tom Byers at the Stanford Technology Ventures Program, we used to teach that entrepreneurship was a “way of thinking, leading, and managing” that was relevant in almost any organization, context, or domain.  In those days it was still considered somewhat heretical to teach entrepreneurship to science and engineering students in addition to MBA’s.  Increasingly, now, entrepreneurs are recognized for what they are:  creative individuals and teams who doggedly pursue opportunity and value creation regardless of the current constraints they face.  Nothing about that situation is unique to business, nor should it be.