Growth5 Blog

Tuesday, April 7, 2009

Google Goes VC

I heard last summer that Google was thinking of opening a venture fund. I found out for sure last week when one of the best designers I've ever worked with, Hoby Albright, forwarded me this article from the NY Times the day before Google's official announcement.

Google Ventures, eh? I don't know. Perhaps Google should stick with acquisitions. As all you venture capitalists already know, the VC route takes a certain patience and expertise that large corporations have very little of - especially when these ventures have little affect on their bottom line over the long-term.

Last July, when Google was making noise around starting a VC fund, Union Square Ventures partner Fred Wilson wrote a post arguing that "venture investing is not the best use of a corporation's capital."

His two main points were:
  • "The best talent in the venture industry doesn't work in large companies and won't work in large companies."
  • "Corporate investors don't really share the profit motive with the entrepreneurs."
Here are Wilson's excellent arguments from that post:
  • All businesses are about talent and the best talent in the venture industry doesn't work in large companies and won't work in large companies. So corporate venture investors start with a big talent handicap and eventually face employee churn in their venture groups.
  • And to make matters worse, corporate investors don't really share the profit motive with the entrepreneurs. Let's say Google (or any other corporate VC) invests in a startup and buys 20% of it for $3mm. Let's say that startup is a huge success, sells for $1bn and Google (or any corporate VC) makes $200mm on the deal. None of the employees who made that investment get rich. The founders of Google and the CEO of Google don't get rich (they are already but that's not my point). The company "gets rich". But Google makes $1.5bn of pre-tax profits every quarter. So this big win generates another 12-13% to the bottom line, but just once. It's not a recurring gain.
  • And that's the big problem with corporate structures for venture investing. One time gains in corporations don't make anyone rich. Wall Street ignores the gain. The company can't put the gain into the pocket of its management. So it just doesn't matter very much.
  • Corporations have other motives for doing venture capital. But those motives aren't particularly well aligned with the founders, managers, and financial investors. So there's always tension in a corporate venture investment and it's not always healthy.
  • Please don't get me wrong. There are corporate investors in many of our portfolio companies. Six of our eighteen active and announced portfolio investments have corporate investors in their capital structures... We like working with corporate investors in the right situations and we'd certainly love to work with Google considering all that they bring to the table.
  • But I do think that venture investing is not the best use of a corporation's capital and that it is inevitable that it will produce sub-par returns at best and significant losses at worst. And as a Google shareholder, I'd prefer to see them do something else with all that money they are making.
It seems like it would be easier for Google to acquire a firm that has the tools/know-how developed already and just bolt it on than it would be to gamble with startups that churn thru capital and may or may not develop into anything that Google needs for itself or can make a decent profit from as an investor.

As a Google shareholder myself, I would rather they stick to acquisitions that are aligned with their growth strategy as a corporation and contribute to future earnings over the long-term. If they want to get in the VC space they should develop a fund of funds approach and hire an expert to allocate the capital to existing VC firms.

Along those lines, as a VC firm, if Google Ventures would like to invest in any of our portfolio companies, of course we'd be happy to work with them.

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