Silicon Valley's High Octane Business Model

The article goes on to describe how the exchange’s proceeds have helped fund the locality’s public infrastructure, including hospitals and public schools, out of poverty. Yet this is not a traditional emerging markets phenomenon, the companies being traded no Apples, Googles or Goldman Sachses – described here is the Haradheere Maritime Stock Exchange, an equity market for the capitalisation of Somalian pirate ventures.

What is intriguing about this example is not that investors can contribute in the form of cash, munitions or sons – one divorcee received 75 000 USD for contributing a rocket-propelled grenade launcher for 38 days, courtesy of her ex-husband’s alimony payment – but that a functioning venture capital (VC) market, however deplorable its societal implications, has emerged in a region otherwise written off by civilised society.

Boston’s Route 128 was once considered humanity’s source of technical wunderkind. No more – today, the crown of tech capital of the world proudly and securely rests on the Silicon Valley. Vivek Wadhwa asserts that Route 128’s failure was based on its dominance “by large, vertically integrated, and secretive” companies that trapped “technology, skill and know-how...within the boundaries of large corporations”[2]. Yet how and why did Silicon Valley develop its open, serial entrepreneur paradigm where a single entrepreneur may start several successful companies in his life-time and where a single piece of IP, technical or experiential, may be levered across many companies?

A key difference between Boston and Silicon Valley VC is that Boston focuses on exits via strategic acquisition while Silicon Valley focuses on IPOs. The Boston model has the advantage in that strategic exits can be performed at an earlier stage in a company’s development, lowering the VC firm’s exposure but also reducing its exit valuation. As a result of the lower exit price and risk, Boston VC cannot afford to lose too many of its portfolio companies. Thus, it tends to invest more conservatively by entering ventures at later stages and by avoiding companies that aren’t easily acquired. The latter requirement rules out disruptive companies that don’t presently have an apparent acquisition candidate; the Boston VC partner who turned down Facebook now says that “may turn out to have been a mistake”³.

Silicon Valley, on the other hand, operates on a strategy more akin to that of, staying with our pirate theme, sea turtle reproduction – several high-risk bets of which a small fraction will succeed, but where those that succeed will do so with great magnitude. The high octane fuel for this machine is the IPO. Thus, Silicon Valley can invest in earlier and more eclectic companies than can Boston; earlier since the high return IPO exit allows for high risk, and eclectic since the IPO market isn’t constrained by possible acquisition partners.

Attempts to replicate Silicon Valley elsewhere are flawed in that they attempt to imitate one part of the system, the entrepreneurs or the VCs, without respect for the interactions that make up the entire cluster. The Silicon Valley ecosystem rivals that of biological systems in its complexity, uniqueness, and as we’ve witnessed with the recent IPO slow-down, fragility. The author isn’t suggesting that attempts to build a VC community are in vain - as the Somalian example suggests, venture markets can and do erupt organically - but that the Boston model with a heavy reliance on strategic partners and academic research institutions is a more plausible bet.

Paul Graham, a Y Combinator founder, recalls a story where he asked a Google employee why Google is better at search than Yahoo. The employee replied that there isn’t anything specific, but that Google just understands search so much better. Graham relates this to VC – Silicon Valley just understands its disruptive flavour of venture capital better than anyone else[3].