50 years after the internet new doors open

Speaking at November’s Web Summit, a conference for about 70,000 technology startups and investors, was a chance to reflect and appreciate the 50th anniversary since delivery of the first message across what was the beginning of the internet, the Advanced Research Projects Agency Network (Arpanet).

The first message between US scientists in Californian universities has morphed into the internet enabling billions of people to access the sort of websites and near-frictionless communications of WhatsApp, WeChat and other voice- over-internet-protocol services on mobile devices.

That message came only a dozen years after the creation of Fairchild Semiconductor in Silicon Valley, California, a venture capital-backed company that entered the Computer History Museum as the first trillion-dollar startup and spawned a generation of VCs, such as Arthur Rock, Dick Kramlich and Eugene Kleiner, and entrepreneurs, including the later creation of Intel.

The two – startups and VCs – built on chips, software and communications have gone hand in hand ever since in partnership under the third important factor: a uniqueregulatory environment of so-called permissionless innovation.

All three shibboleths are undergoing key changes as this new decade dawns.

Diversity, inclusion and globalisation

As Harvard Business School scholars Paul Gompers and Sophie Wang said in their 2017 paper, And the Children Shall Lead: Gender Diversity and Performance in Venture Capital, about four out of five VC firms have never employed a woman in a senior investment role, just one in 10 new hires are women, and less than 9% of venture capitalists are women.

This latter proportion is effectively unchanged (up three percentage points) over the past near-30 years while other perhaps-equally-skilled professions, such as doctors and lawyers, have broadly reached parity in this time.

There seems to be some correlation with this investor balance and the number of female entrepreneurs. The same analysis showed about a three percentage point increase in female-led startups in this period to 10.7%.

Corporate venturing seems to be leading the way, albeit modestly, with an estimated 16% of CVCs being women, according to our sister GCV Rising Stars 2020 supplement.

And the industry is keen to do more. In the Autumn, a GCV Leadership Society’ committee published its Diversity, Equity and Inclusion report after the latest in a series of Women In Venture lunches held before the GCV Synergize conference in New York City.

Ian Goldstein, partner at Fenwick & West, said it was “proud to have co-founded the Women In Venture networking/programming initiative in partnership with Silicon Valley Bank and Global Corporate Venturing for the purpose of supporting the success of female investors and entrepreneurs in the CVC, VC and startup communities. Together with SVB and GCV, we co-host networking/programming events for female investors in conjunction with GCV’s CVC conferences in California, New York and London.”

However, if you ask the question of diversity and inclusion outside of the US and often there are still blank glances. In some countries, such as China, this is because there are high profile female CVC leaders, such as Jean (Qing) Liu, president at ride hailing service Didi Chuxing, and Annabelle Yu Long, managing partner of Bertelsmann Asia Investments, the local corporate venturing unit of the Germany-based publisher, and plenty of talent coming through the ranks but elsewhere it is because the opposite is the case and the questions have yet to be effectively surfaced.

But as the ideas of entrepreneurship and innovation capital globalise from its Silicon Valley starting point so successes emerge in billion-dollar exits and valuations from Brazil to Bangalore and the UK to China and seemingly all points between. Latin America, led by Brazil, has at least 10 unicorns – private companies worth at least $1bn, according to inward investment agency ApexBrasil.

The UK is the single largest source of venture-backed unicorns from Europe with 29, followed by Germany (17) and France (11), according to VC firm Atomico’s latest survey.

But all other regions outside the US pale besides China, which is home to the world’s three most valuable unicorns, according to data provider Hurun: Ant Financial, a payments affiliate of Chinese tech giant Alibaba valued at $150bn, media group Bytedance, valued at $75bn, and Didi Chuxing, valued at $55bn, and more than 100 others (most of which are corporate-backed by online retailer Alibaba and gaming group Tencent).

Venture capital professionalises

What these unicorns usually have in common beyond the sort of valuations that make many public companies weep with envy is the sort of funding levels only stockmarket investors have traditionally been able to provide.

Didi Chuxing has raised more than $22bn in at least 10 rounds of $100m or more, while Ant has raised about $18.5bn.

By contrast, oil major Saudi Aramco said its flotation in December had raised $25.6bn, valuing the company at $1.7 trillion, while Alibaba raised $11.2bn the month before in a secondary listing and car hailing service Uber’s initial public offering was for $8.1bn in May.

Uber, along with office sharing service We Company and vaping company Juul, had raised the largest amounts of venture funding in the US at more than $10bn, $11bn and $12bn, respectively, even if public market investors struggled to justify their lofty private valuations in the past year.

All these unicorns had reached such high totals thanks to corporate and other more strategic investors.

Last year saw a record 1,854 active corporate venturing investors, according to GCV Analytics. They did a record 3,232 new deals last year worth $134bn and committed to the $41bn in new funds raised. Most important for the model to continue to develop, CVCs were also involved in a record 274 exits worth $56bn last year, providing financial returns and join with the strategic rationale for investing many groups have.

This CVC activity has pushed the overall industry to new heights. With more than $1 trillion of venture capital invested in the past decade, according to data provider Pitchbook, this is more than all prior decades of venture combined. Bringing greater capital and often a strategic lens can aid portfolio companies if done well but it puts pressure on the traditional VCs.

Alex Danco’s Two Truths and a Take newsletter summed up the “dark art” of VCs as trying to diversify a portfolio enough to capture the upside of the current startup cohort without being overly exposed to the failure of any individual company while, simultaneously, being fully committed and concentrated in the winners.

He said: “A venture round is not some day-to-day thing in the life of a startup; it’s a huge part of the startup’s ability to conjure its vision into reality.

“The more forcefully a VC fund can back a startup, the better are the startup’s chances. And, down the road, if that business turns out to be Uber or WhatsApp, everything else you did in your fund will pale in importance compared to how much ownership you have in that one company. Percent ownership in your biggest winner is the number one factor that makes or breaks your fund’s performance.

“VCs take what’s normally the biggest barrier in speculative finance – the inability to know in advance how much capital will actually be needed in future rounds [his emphasis] – and use it to their advantage.

“When a VC does a deal, they’re not just writing you a cheque; they’re also committing reserves in their portfolio to be invested in follow-on rounds, both to continue supporting the company and also to defend the VC’s ownership stake from dilution….

“But not every company will actually succeed and draw on their reserves, so VCs can effectively practice ‘fractional reserve investing’ and make a larger number of initial bets. In doing so, they unlock the magic free lunch of diversification: they gain the upside exposure, but with less opportunity cost. This also lets them offer initial investment terms that are more generous than they normally should be, which can be the difference maker for a cap table.

“In the modern startup ecosystem, we take for granted that this works. But it’s a genuinely impressive piece of financial alchemy, and the innovation economy is the better for it.”

The pressure on VCs comes from ever-higher initial valuations for startups as the technique becomes better known but also from differentiated support offered to the best entrepreneurs beyond capital.

A startup only has five primary needs: capital, customers, product development, hiring and, eventually, an exit. If capital becomes effectively fungible in private and public capital markets then success in either becomes about how to organise effectively to hire the right talent to develop the product and service to meet customers. Advice and a network to achieve this is useful – think of legendary VC John Doerr’s 100 or so calls over six months to attract a senior executive, Mike Long, to join Jim Clark’s Healtheon as CEO in the 1990s – but corporations can be customers and suppliers to help startups. Good VCs in the past decade, such as Andreessen Horowitz, copied the template set out by Intel Capital and others in how they tap a broad network of potential customers and helped a product scale and iterate but CVCs retain a competitive advantage if used properly allied to an understanding of VCs’ dark arts.

In addition, with usually greater understanding of public market investors and corporate development, CVCs can help on an exit even if they are not the acquirer themselves.

The winners in the next decade, therefore, will be those who most effectively scale up and manage this matrix and also who keep an eye on the often-unsaid rules underpinning the whole ecosystem.

Permissionless innovation

Unlike medicine, which is meant to have a rigorous and scientifically-validated approach to testing and approving drugs, based on clinical trials and randomised controlled tests, or even the finance and insurance industries, where new entrants must comply with rules hopefully designed to protect the consumer, capital adequacy and anti-money laundering requirements, the tech industry has had no such framework, Azeem Azhar pointed out in his Exponential View newsletter.

Technology by contrast offers an open platform so entrepreneurs can try new things without getting permission from regulators or, indeed, anyone else.

Azhar notes this is why we got streaming audio in the mid-1990s, while the traditional broadcast industry remained heavily regulated, and why we have had a flourishing ecology of remarkably large products, such as Google, Facebook, Skype or Wikipedia in the west, alongside weird, wonderful niche products. (China’s history is more complicated in regulating and allowing Baidu, Alibaba, Tencent, Xiaomi and Bytedance but, broadly, one argument goes they grew too big, too quickly before the government could effectively threaten to shut them down.)

Now, however, we are in a world where the technology has gone beyond its niche and software, as venture capitalist Marc Andreessen (who in an earlier iteration developed the Netscape internet browser with Jim Clark) pointed out at the start of the decade, has eaten the world.

Business and finance, however, only function at society’s pleasure. As Young Sohn, president of Samsung, says in the World of Corporate Venturing 2020 foreword: “In the coming years, the role of technology in our everyday lives is going to come under increased scrutiny. Regulators and consumers alike are going to ask questions about privacy, data use, inclusivity, and the ability of technology to solve pressing global issues. I believe—as leaders of this industry—it is incumbent on us not only to answer those questions, but to use corporate venturing to empower entrepreneurs to make the world a better place.”

Thinking ahead of time about how people might be affected rather than asking forgiveness afterwards is the right way to think. It’s hard to argue online gambling and unfettered gaming have made the world a better place of themselves, although at least the latter enabled the creation of better graphics chips that researchers could use for artificial intelligence (AI). Tax on screen times rather revenues is one innovative suggestion raised by economists, while regulators are pursuing gambling sites and authorities can switch off gaming licences. If it can be done in these sectors, then other areas innovation, such as AI and biology, are unlikely to remain permissionless even in rogue states especially as trade shifts in unusual directions.

Economics reporters are exploring the lessons for global trade to be found in the massively popular online videogame Fortnite, published by Tencent-backed Epic Games. It finally launched in China in 2018, after struggling for years to get permission to launch there because of government fears about internet addiction, and as a result digital trade in Fortnite skins and battle packs between players around the world successfully bypasses any tariffs or trade war skirmishes. States are still backwards in regulating digital goods and the European Commission among other governmental agencies around the world is increasingly concerned about how to do so.

As Azhar notes: “The tech industry today is simply too big and has tremendous access to capital. Entrepreneurs know how to ‘blitzscale’, that is, grow their companies globally very quickly. Capital markets are willing to support them…. The biggest firms, Alphabet, Facebook, Amazon, Tencent and Baidu, are sovereign- state in scale. This actual or potential leviathanhood demands we ask them for more prudence.

“There are emergent effects from many of these innovations which, in a permissionless environment, are borne collectively by society or simply weigh on the vulnerable. For example, Uber and Lyft have increased congestion in cities while reducing driver wages. These firms’ founders and earliest investors make out like bandits.”

Innovation flows from imagination and it is easy to foresee a public backlash if CVCs are on the wrong side of a major health or security issue. So what are the most interesting sectors for the next decade?

10 sectors of disruption – 2010 winners and 2020 promises:

1. Healthcare

If the 2010s were an era of healthcare IT promise, much of the best returns came from investors targeting cancer. For the next decade, things are joining up. Andreessen Horowitz put out a new manifesto on how Biology is Eating the World.

It is a great primer and worth reading in full: “We are at the beginning of a new era, where biology has shifted from an empirical science to an engineering discipline. After a millennia of using man-made approaches for controlling or manipulating biology, we have finally begun using nature’s own machinery—through biological engineering—to design, scale, and transform biology.

“Our ability to engineer biology will fundamentally transform how we diagnose, treat, and manage disease. The first great leap forward took place in the early 1980s with recombinant DNA technology and the first biotech drug, thanks to our newfound ability to insert human genes into bacteria to produce human insulin.

Today, modern tools like Crispr and gene circuitry enable us to program biology with greater and greater precision and sophistication, from bacteria that is engineered to produce new chemicals and proteins, to cells that are engineered to attack cancer.

The explosion of ‘programmable medicines’ (in the form of genes, cells, microbes, even mobile apps and software that can improve our health itself) are today leading us closer than ever before to that holy grail of medicine, the cure…. “Biology, of course, doesn’t just impact human health and disease. With its unparalleled ability to evolve, replicate, and create, biology is one of the most advanced manufacturing technologies on earth.

We’ve already seen it transform food, agriculture, textiles, manufacturing, and—with DNA-based computers— even software itself. Bio today is where information technology was 50 years ago: on the precipice of touching all of our lives. Just like software—and because of it—biology will one day become part of ever industry.”

2. Industrial

As A16Z said in its Biology is Eating the World primer, the industrial sector is undergoing plenty of change. Manufacturing in the physical world in the 2010s has been disrupted through three-dimension printing and understanding at the nanometre and quantum level. For the 2020s, using these techniques to redesign not just buildings but whole cities will become possible where the will is found to tackle zoning and property laws. With this, imagination becomes a defining criteria and accessing the raw materials will then become important.

3. Transport

The trinity of disruption affected transport in the 2010s with electric vehicles, the promise of autonomous vehicles and ride- hailing and micro-mobility from scooters and bikes affecting car ownership and manufacturers.

However, while the space industry started to open up for travel and mining asteroids among other opportunities beyond the atmosphere could have its turn in the 2020s – along with threats for those with a weather eye on security issues as power usually goes to those with the longest reach.

4. Telecoms

The launch of the iPhone in 2007 ushered in a long decade of spectacular venture capital returns for the applications targeting them, especially voice-over- internet-protocol services, even if the hardware remained mainly in the hands of large manufacturers such as Apple and Samsung and phone operators faced becoming dumb pipes. Now, the amount of data is about to explode again in the 2020s with 5G and the internet-of-things to the transfer of information through from machines to machines and edge as well as cloud computing.

5. Media

The booming success of media platforms, such as Facebook, Rakuten, Tencent, and Google made the 2010s a more social age. With better internet speeds, as well as improvements in haptics, the 1990 promises of virtual and augmented reality could finally be delivered and enabling digital doubles as virtual homes for our data and gatekeepers.

6. IT

Moore’s law continued to deliver more processing power for computers but the real excitement was around machine learning and artificial intelligence. Added in advances in human- machine interfaces and neuratech and the 2020s could see greater possibilities for an internet of brains and decoding people’s private thoughts, especially with the power of AI.

7. Services

Co-working platforms, such as WeWork, grabbed the attention in the 2010s but out of software-as-a-service could come AI-as-a-service in the 2020s creating the future ofwork – if any is required of course.

8. Energy

The 2010s was a watershed for renewables, especially solar, becoming cheaper than fossil fuels but the disruption went beyond generation into the grid and around storage. The long-term nature of energy means these transitions will take another decade to play out even with generational anxiety about hitting the 2030 climate emission goals but a wild card for the 2020s venture excitement will be nuclear fusion.

9. Financial

The past decade has seen disruption in areas ranging from digital banking and mobile payment to real estate and insurance but the blockchain, cryptocurrencies and initial coin offerings and tokens could shake up the financial system and venture capital in the 2020s.

10. Consumer

The direct-to-consumer trends offered through ecommerce meant fantastic returns for smart investors but, playing into the wider concerns around food quality and the environment, will see attention on water and plants. Cheap energy will enabledesalination while agtech will shakeup logistics and growing food.

However, perhaps most important for human health will be a shift from animal husbandry and the pernicious use of antibiotics to keep them alive to alternatives. Beyond Meat, a US-based maker of plant- based alternative meat products, floated in May and, by late July, had seen the price of its stock rise by more than 800%. Even though its stock declined two-thirds from a high of nearly $240 per share it still had a $4.7bn market capitalisation ithas shown the potential.

Conclusion

From a few thousand semiconductor engineers in Silicon Valley at the 60 semiconductor companies established in the area from 1961 to 1972 – almost all founded by formerFairchild workers – a small cottageindustry of financiers was able to generate unimaginable wealth off entrepreneurial sweat in the 1980s and 1990s. Together has come the ideas and tools to change the entire world.

Back in 1982, Blade Runner film director Ridley Scott imagined the world at the end of 2019 as being in a state of urban decay, where the population has dwindled, and humans face a new threat from manufactured biological robots gone rogue. The worst aspects of this dystopia have yet to come to pass but the holy trinity of capital, entrepreneurs and lack of regulation seems at an inflection point for the first time in a generation as societies question what sort of world people want to live in.

One answer emerging is the use of the United Nations’ sustainable development goals and impact investing to create the challenges people can tackle and form of capitalism that goes beyond measuring revenues and profits to explore the social and environmental consequences of opening the door to the new future.

These views are perhaps nothing new. Eighty years ago, Charlie Chaplin in The Great Dictator film said: “Machinery that gives abundance has left us in want. Our knowledge has made us cynical. Our cleverness, hard and unkind. We think too much and feel too little. More than machinery we need humanity. More than cleverness we need kindness and gentleness.”

Download the World of Corporate Venturing 2020 PDF here