Venture capitalism isn’t a new idea. But it’s only been in the last three decades that its effectiveness has come into sharp focus. The most innovative technology platforms and products of recent times often have been funded by venture-capital firms. The rise of VC has been so profound that some have begun to argue that VC firms essentially are the new central planners. However, unlike governments, VC firms don’t operate in the public interest or have to report to anyone except their own shareholders and investors. There have been some spectacular lapses as a consequence of that. It is high time the sector was reformed.
But how? In fact, is it even possible to regulate – for that is what “reform” implies – a sector that often works outside home jurisdictions? Indeed, the VC sector’s effectiveness often is a function of its nimbleness in working across borders, sectors and old-fashioned notions of investment protocols. There is thus a threat of reforming the VC sector to its death – if you can even come up with a plan. The answer lies in harnessing the complex calculus of risk-taking and financial gains, married to a moral focus, that is found in sovereign wealth funds.
But first, the problems. In an article in the New Yorker magazine in November, Charles Duhigg charts the rise of venture capitalism and pulls back the curtain on some uncomfortable truths. He goes through the spectacular rise and decline of the office co-working-space company, WeWork, to highlight the challenges surrounding venture capitalism.
Because they often work in the shadows, VC firms have largely evaded public backlash for enabling reckless behavior. Duhigg begins by quoting the CEO of a WeWork competitor that was essentially put out of business because of seemingly unlimited venture capital flowing to his rival. “VCs seem like these quiet, boring guys who are good at math, encourage you to dream big and have private planes. You know who else is quiet, good at math and has private planes? Drug cartels.”
WeWork is a prime example of the danger of failure of venture capitalism, if left unchecked. Despite the buccaneering behavior of the company, VC firms kept pouring money into it. Major VC backers stayed quiet while the company engaged in questionable business strategies and plunged the company into serious difficulties. Why did these enablers escape scrutiny for this?
The answer lies in the fact that VC firms and technology companies have largely written their own rules. Technology company CEOs and founders, from Facebook’s Mark Zuckerberg to Uber’s Travis Kalanick, have (correctly) been raked over the coals for their dubious business decisions and unchecked power. VC firms have been complicit in enabling this power.
Criticism of the VC sector, however, is not meant to undermine the incredible ability of venture capitalism to propel innovation, but rather to address the hiccups that hamper the possibility of even greater success. Criticism, therefore, is meant to avoid any failure in the VC model. The latter point is especially important, because it is critical to the development of the new, tech-driven economy.
A number of governments around the world have sovereign wealth funds that function like VC firms. Temasek Holdings in Singapore and Mubadala in Abu Dhabi immediately come to mind. Like VC firms, these funds make strategic investments in emerging sectors and participate in board-level decisions. Their aim is to get in on the ground floor of emerging technological developments.
But unlike VC firms, many sovereign-wealth investments are predicated on building new industries back home, creating new jobs for their citizens. In this, sovereign wealth funds have a greater – and moral – interest in ensuring their money is safely invested in companies that won’t implode. Greater participation of sovereign wealth funds in venture capital funding will therefore function to encourage partner investors, like the VC firms, to change their modus operandi in the companies they invest in.
Beyond that, sovereign investment funds also have stakes in VC firms themselves. Saudi Arabia’s Public Investment Fund, or PIF, has a stake in SoftBank’s Vision Fund, for example. As does Mubadala from Abu Dhabi. Malaysia’s Khazanah Holdings was reported last year to have been in talks over an injection of funds into the Vision Fund. An entrenchment of sovereign wealth fund participation in VC firms could change the character of such firms – which might prevent another WeWork, in which Softbank has been invested.
It’s worth noting that aside from the debacle at WeWork, SoftBank did make a very tidy profit off the initial public offering of DoorDash earlier in December. Meanwhile, Sequoia Capital, one of the largest VC firms in Silicon Valley, is poised for an 11-fold return this year, thanks to several early bets on technology companies that have been instrumental in the remote-work pivot caused by the Covid-19 pandemic.
The caveat, however, is that, as noted earlier, the technology sector operates by its own rules, and it might prove difficult to break its habit. Consider landmark lawsuits filed against Facebook this month in the United States. The lawsuits allege that Facebook bought up rivals and “illegally squashed the competition.” The only problem is that the regulatory model used to go after Facebook is based on 20th-century notions of monopoly and anti-trust. This highlights the deeper problem of our collective lack of understanding about how the tech sector operates – and thus how difficult it is to influence behavior for the better.
Still, with their interests backed up by deep pockets, sovereign wealth funds have a chance at breaking norms at both tech and VC firms. It’s time to see forward-thinking nations start their own form of “disruption.”
Joseph Dana, based between South Africa and the Middle East, is editor-in-chief of emerge85, a lab that explores change in emerging markets and its global impact.