IT Has Grown Up - Investors Should Grow Up Too

How it all began

Once upon a time, at the beginning of the twenty-first century, people started building innovative businesses that dreamed of exploring new, unknown technologies meant to change the world for the better, and not so much to improve what already existed as to discover what nobody had seen yet. It became clear fairly quickly that researching these technologies, let alone bringing them to market, required serious capital: far more than a founder or his family and friends could put up, and far too risky for a bank accustomed to lending against collateral and a predictable cash flow.

Hence the need for a new class of investor, the venture investor, who, scorning risk, readily handed capital to the daring seekers of new horizons while also helping them with connections, accumulated experience and knowledge, and who became for young companies something between a partner, a mentor and a guide through a world whose rules the founders were still learning.

It was never charity

The motivation of these investors was far from charitable, and the romantic glow that the industry's own participants were later so eager to throw over it deserves to be stripped away right at the start. Owning even a piece of a new technology capable of changing the world in a serious way while generating serious income promises a large reward to those who managed to join its creation early, when a stake is still cheap and the future is obvious to no one, the founders included.

It was this asymmetry between a small entry and a potentially enormous exit that made venture investing so attractive: the risk never went anywhere, it simply became the price of the ticket, which the investor knowingly agreed to pay in exchange for a chance to be among the first.

When there was more capital than ideas

The first loud successes did their work, and a large share of private and institutional capital gradually flowed into venture investing, where the promise was not of modest interest but of multiples, and where merely belonging to the circle of early investors became a mark of a certain shrewdness. The need for such investment, however, did not grow as fast as the supply of capital, and at some point there was noticeably more money looking for ideas than ideas looking for money.

When supply exceeds demand the price inevitably falls, and in venture the price turned out to be the investment criteria: they slipped gradually, almost imperceptibly, replacing logic and calculation with "gut feeling" and faith in the team's potential, not because investors suddenly became less intelligent but because capital already raised on the promise of high returns had to go somewhere. And so the golden years arrived, not so much for the technologies themselves as for those who learned to convince investors of their unique ability to grow the next unicorn; pitching became a craft in its own right, and the world gradually filled up with serial entrepreneurs who had made a successful exit.

The end of the golden age

Unfortunately, those years are over, especially in information technology, and this happened not through anyone's ill will or yet another crisis but for reasons that go much deeper and that appear to be irreversible.

First, because there are fewer and fewer subjects that have not yet been explored and products that nobody has tried to build; the blank spots on the map, for the sake of which venture capital appeared in the first place, have largely disappeared, and what remains calls for heroism less and less often. Second, because the degree of risk in IT has also dropped substantially, not least thanks to artificial intelligence, which has greatly democratized building an MVP and taking it into commercial operation: what only recently required a whole team and months of work now often fits into a few weeks, and where there is no great risk there are no grounds for a great premium on it. And finally, the third reason: the knowledge and skills needed to build a startup have stopped being exclusive and have become an integral part of general education, so that what twenty years ago was passed from hand to hand in a few offices in Silicon Valley is now taught at any business school.

None of these reasons alone would have been a verdict, but together they mean that the venture model in its classic form has gradually lost the very object it was created for.

"So, what next?"

A reasonable question comes up at this point, "what next?", and with it an understandable unease, because if venture capital is no longer needed, doesn't that mean information technology as an industry has run its course and the most interesting part is already behind us?

Let me reassure you: information technology is not going anywhere. On the contrary, over the past few years it has become a key component of modern business, without which no successful company can be imagined, and an equally important part of our everyday life. IT has simply stopped being a frontier and become infrastructure, as ordinary and as necessary as electricity, plumbing or bookkeeping, in which nobody invests venture-style but without which nobody can picture a business at all.

An honest conversation

As for venture investors, this is where we have to be completely honest with ourselves.

If we are truly looking for opportunities to fund breakthrough technologies, it is time to revise our criteria, because yet another mobile dating app, a corporate finance management system or an AI assistant for young mothers is not such a technology; these may be good products and even perfectly profitable companies, but they are not a breakthrough, and calling them one means deceiving, first and foremost, ourselves.

That is why at every pitch we owe the founders of such projects some honesty, the ones asking for 100, 200, 500 or more thousand dollars for a 10% stake in a project that brings in no revenue yet but "definitely will": they are building an ordinary operating business, and the approach to it should be the same as to any operating business, with a business plan, a breakeven calculation, equity and debt as the sources of financing, cost discipline and a clear horizon for profitability. There is no humiliation in this, only respect, both for the founders, who are not being sold illusions, and for the money, which is finally being counted.

And yet, staying open

On the other hand, such honesty has a flip side: while screening out ordinary businesses, we must remain truly open to real breakthrough technologies, not confining our interest to today's standard set of industries where it is "customary" to invest, and instead looking for real breakthrough ideas, unconventional approaches and non-trivial solutions, often in fields that do not yet have a fashionable acronym of their own or an established circle of investors.

That is one possible path, and probably the most obvious one. I, however, choose a different one, and that is what the next article is about.