The Death of Risk in Silicon Valley

I was recently at a Silicon Valley conference where one of the debates that raged into the wee hours centered on Silicon Valley's increasing aversion to risk: Is it a good thing, and who's to blame for it?

Less risk-taking by entrepreneurs means less outright failure. A lot of burned startup founders and investors see this as a plus. But any macroeconomist will tell you it's the rare home runs—successful, innovative companies yielding high returns—that create jobs and capital that keep the Valley humming.

But today I am more interested in who or what is responsible for the death of risk in Silicon Valley. Obviously, the recession has played an important role. Stock market declines and surging unemployment have done a number on everyone's appetite for risk. But other parties deserve some of the blame. Herewith, my list of prime suspects:

Angel Investors They're not as angelic as the name implies. Angel typically refers to investors willing to park $50,000 or less of their own money in a startup. Often, angels are the first money into a company. The best ones invest based on gut feeling; and because they're investing only their own money, they don't have other investors to answer to. And most have been through it before.

But there are few substantive professional barriers to entry. So alongside savvy angels you have morons throwing around money they can't afford to lose.

This was especially true in the late 1990s, as tech companies were going public in droves and the Nasdaq was soaring. Paper millionaires saw seeding companies as a sure thing; they hung out the angel shingle and began funding deals. And why not take their money? Dumb money can buy servers and pay salaries, too. The problem with dumb angels is they have no reserves and evaporate as soon as times get tough.

Verdict: The angels have probably committed the fewest offenses against risk, but as the first money in, they can do big harm early in the life of a company.

Venture Capitalists The VC is everyone's favorite villain. What's not to hate about a group of investors caricatured as heartless hoarders of billions of dollars who take all the returns when you win, or hang you out to dry when things founder?

In defense of VCs, no one is forcing entrepreneurs to take their money. Anyone who thinks he or she can get millions of dollars that don't have to be repaid—with no strings attached—is probably too naive to be building a company. VCs have their own pressure from investors, and it has intensified recently as endowments have sold stakes in illiquid assets like venture capital firms.

A venture capitalist's greater crime against risk isn't closing down a startup that's not going anywhere. Rather, it's not funding ambitious, risky new ideas in these slow times. Every VC will tell you the biggest hits from Silicon Valley come from downturns, when copycat companies are few and only die-hard entrepreneurs have the guts to go for it. Examples include Sun Microsystems (JAVA), Cisco Systems (CSCO), LinkedIn, and Facebook.

Verdict: The VC is only the startup's enabler. VCs don't innovate and they are hedged against several other deals. But the VC is the only part of the ecosystem that is paid to take risk. And it has the least skin in the game. There's little excuse not to tolerate a higher degree of risk than they do.

The Entrepreneur Entrepreneurs are taking less risk partly because they have less reason to. Internet and communication technology has so reduced the costs and compressed the amount of time needed to get a new product out that entrepreneurs need less money. That means they're more likely to sell for $5 million, $15 million, or even $30 million. They've put less blood, sweat, tears, and years into that product. And, if they've raised less money, a much smaller deal makes them rich.

But when it comes to Silicon Valley's macroeconomy, these small deals don't create jobs or mass wealth. They don't foster that change-the-world ethos that lured smart coders to the Valley in the first place. No one gets on a magazine cover for selling a company for $5 million.

Verdict: Small deals for small exits are great. But don't fool yourself: You're not building a business here and you probably shouldn't be raising venture money in the first place.

The Blogosphere Bloggers have become supporters and champions of startups that big publications won't cover unless it's clear the company will be a "winner."

And those bloggers have been rewarded. People ask how TechCrunch gets an astounding 7 million unique visits a month. It's because TechCrunch was the only site that covered every Web startup and still covers nearly every product launch and demo.

But blogs have hurt startups and innovation, too. The speedy, seat-of-your-pants style of reporting can build a company up or tear it down—not over years but weeks, days, or even hours. Real businesses never materialize as fast as investors and the public hope. And today's round-the-clock coverage makes people fatigued with Web startups before they even have a chance to stumble.

Verdict: Blogs that cover startups need to remember what made them popular in the first place: They filled a news hole in the business market and provided sage, insider analysis of companies that may seem crazy to the mainstream, but could also be the next Google (GOOG). Nobody needs dozens of posts a day on the latest Twitter turn of the screw, or piling on about a minor product glitch.

Public Companies Yahoo (YHOO), Google, eBay (EBAY), Microsoft (MSFT)—these silent killers of risk are all the more insidious because they used to be those same scrappy startups. They know firsthand how a company that seems crazy can become a titan, so in a move of easy self-preservation, they just take these smaller companies out before they can get to that point. And don't expect it to end: Google said on Oct. 15 it plans to bulk up through acquisitions, and Microsoft executives have made similar remarks recently.

A lot of people defend the practice, saying it's a smart way to outsource R&D and give cutting-edge technologies a wider audience. That'd be great if the companies and products didn't frequently get killed in the process. Yahoo has done a great job supporting photo-sharing site Flickr, but what about the many others it's shut down, including most recently the e-mail service Zimbra, which Yahoo bought for $350 million in 2007?

Others will argue that a quick sale can encourage entrepreneurs to take more risk on their next companies. The common example is PayPal. Within a few years after eBay bought the company, PayPal founders and former executives were starting companies like Yelp, Slide, LinkedIn, and YouTube, and funding companies like Digg and Facebook. But that says more about the risk profile of a particularly talented group of entrepreneurs than it does any great move by eBay.

Verdict: Public companies have played a big role in curtailing risk. They have to. Otherwise, they're the Goliath in the crosshairs of David's slingshot.

Wall Street Wall Street hasn't played as direct a role in Silicon Valley since the late 1990s, when analysts like Mary Meeker and bankers like Frank Quattrone knew as much about new startups in the Valley as the VCs did. That's part of the problem.

Startups have to want to go public in order to go for the home run. And most entrepreneurs today just don't. Blame it on bankers and analysts who no longer care about a company with a sub-$500 million capitalization; blame it on Sarbanes-Oxley; blame it on activist hedge funds who don't give CEOs the leash to innovate; blame it on scars from companies going public in the 1990s that had no business going public and paid the price.

But too many great entrepreneurs sell early not because they're lazy, not because they want a quick buck, but because the idea of running a company all the while trying to meet quarter-by-quarter Wall Street estimates is antithetical to risk-taking.

Verdict: There's got to be a reward for all that risk, and until the public markets become a place great entrepreneurs aspire to get to, that risk-reward equation is hopelessly lopsided.

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