Why you should care
Because we should care about the money that’s funding the money that funds the tech boom.
Josh Lerner sits somewhere in the middle of all the most powerful money on the planet. But he’s not a billionaire investor — he just knows everything there is to know about those types. Hyde Park-bred Lerner is a hotshot professor at Harvard Business School and a prominent authority on venture capital, right when VCs are some of the glammest celebs around.
The former physics-and-technology-history major is a campus favorite, teaching one of the B-school’s most popular classes, and spends his days jetting between global tech hubs, from Israel to Singapore, catching glimpses of the smartest and savviest things afoot in money. He doesn’t yet have plans to head (back) to Washington, D.C., where he’s logged time before at the Brookings Institution and Capitol Hill. For now, he’s happy teaching, convening the great and powerful investors of our time, and raising his donkeys just outside of Boston (yes, donkeys).
We chatted with Lerner about the state of venture capital today, asked him to help us follow the money and discovered that, though the U.S. is still top-shelf on VC leadership, we might take a page out of Singapore or New Zealand policymakers’ books. Our interview has been edited for clarity and length.
OZY: “Venture capital” might sound kind of jargony if you’re not in the know. Why should average people care about how it operates?
Josh Lerner: VC companies end up being very important drivers of employment in their own right. In a typical year, the share of companies starting out [that] get VC is very small. Those are also disproportionately the fastest-growing companies. And they become very significant economic actors in terms of who they employ and the quality of jobs they provide.
The other reason is that, ultimately, what we want as a society is to have growth, productivity and so forth. If people make more money in terms of wages, there are more opportunities and so forth; and we know there’s a very key impact between growth on one hand and innovation on the other. And venture capital contributes disproportionately to innovation: The saying goes something like, ‘For every one dollar of VC investment, you generate the same as three dollars of corporate R&D.’ This is very high-powered money.
OZY: What’s happening in venture capital today?
J.L.: There have been some very dramatic changes. In the last decade, we saw an extremely profound drop in terms of activity — the financing dropped off, valuations — and that’s been followed by a very dramatic recovery in the last few years. Today, compared to the first tech boom, one of those changes has been the decrease in the amount of money that businesses need to raise to get started.
A second change at play has been the quite dramatic bifurcation in the venture industry. Historically, in venture capital, if you looked at the distribution of firms, you saw a familiar-looking bell shape. Now we have a bimodal distribution: twin peaks. On the one hand, there are very small groups that have been able to raise a lot of capital in a very small realm of the industry. And then there is a whole family of funds that collectively represent a very large amount of money. Where you’ve seen the suffering has been in the middle. And many are suffering from the fact that they’re not as targeted and niche or boutique, but also don’t have the global brand and reach that the mega-funds do.
The third change has been the rise of individualized entrepreneurial finance: angel groups, the emergence of crowdfunding and the like. All that activity has been enabled by information technology. IT has impacted the process of investing itself: Look at groups like AngelList Syndicate, where you essentially have individual angel investors coordinating through IT-enabled platforms.
And then I’d point out the increased choice of companies to remain private for extended periods of time, which has several consequences: You see very large financing rounds, hundreds of millions, which traditionally would have been raised in IPO instead of in these transactions. Another change is the emergence of investors, who normally would not be investing in these kinds of companies, now playing a more important role — mutual fund companies, hedge fund companies and the like.
OZY: Startups get money from VCs, VCs are getting their money from … where exactly, these days?
J.L.: Endowments and family offices have always been important. But what’s now seen as less “du jour” is pension and sovereign wealth funds, many of whom did a lot with venture in the 1990s; they got disillusioned in the 2000s. They have jumped back into it now. And mutual funds and hedge funds are playing that important role.
OZY: And for the Chicken Littles among us, what are you scared of? How ’bout that B-word?
J.L.: With all these dramatic changes … sure, there are questions. How well does this trend of individualized investing — that individualized entrepreneurial finance — work? We have angels and angel groups jockeying. And it still remains to be seen how good they are in terms of investing in companies and so forth. It’s an important question that we don’t really know the answer to yet.
And then the fact that more and more money is concentrated at either the very, very high end or very low end of size spectrum. Will the secret sauce that makes VC so successful work as well in a multibillion-dollar firm? With this proliferation of those multibillion-dollar funds … well, this is sort of a cramped activity. And can it be industrialized and scaled out, or will it end up being a lot less successful?