The Myth of Silicon Valley
Why the ‘capital, scale, exit’ model of success is ultimately bad for business — and society as a whole.
“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done…” — John Maynard Keynes
Silicon Valley seems like the center of the world, with its giant technology campuses, historic garages, Stanford University and Sand Hill Road. Success looks like Mark Zuckerberg, and nothing is more emblematic than the mythical ‘unicorn’— a company with a billion dollar valuation. This inspires tech ecosystems all around the world, and everywhere wants to be ‘the next Silicon Valley’.
In pop culture, movies like The Social Network and the HBO show Silicon Valley perpetuate an image where founders get rich with a big idea, venture capital (VC) is abundant, and geeks can earn six-figure salaries in colorful offices with celebrity chefs.
Underneath all this wealth and glamor lies a different story. Go to the San Francisco Bay Area and look around. There is extreme inequality and homelessness. Locals are angry at the tech companies for destroying their communities. Things work out well for those on the receiving end of gentrification — but if you believe Nick Hanauer’s blog post ‘The Pitchforks are Coming’, the 1% is realizing that they might soon have a riot on their hands.[1]
The Silicon Valley Model
The Silicon Valley model of business incubation consists of three stages: capital, scale, and exit.
Step 1: Capital
Capital is a big financial injection given to founders launching and growing their startups. This can take the form of seed financing, angel investment, VC rounds, convertible loans, and other forms of upfront payment. The cash is used by founders to pay for expenses like salaries, office space, and R&D costs before customer revenue would otherwise allow it.
Rather than enabling systemic ‘disruption’, capital embeds the status quo into companies.
But it comes with a downside: investors get voting control, giving them a loud voice in company operations. This compromises the integrity of companies at an early stage.
People become entrepreneurs because they want to ‘work for themselves’. But once VC money is accepted, they now have a boss. Investors’ priorities frequently diverge from those of the founders — but founders must go along with them after accepting capital. Rather than enabling systemic ‘disruption’, capital embeds the status quo into companies.
Google is an instructive example: starting out with the motto ‘don’t be evil’, Larry Page and Sergey Brin had good intentions when they decided to valorize their academic research. Once they got investors however, CEO Larry Page was replaced with Eric Schmidt. After that, Google purchased Doubleclick, and shortly after that the ‘don’t be evil’ motto disappeared. Google has gone on to become a tremendous commercial success — but their social impact is questionable. Internal unrest has caused protests and walkouts.[2] Management has clamped down, and Google’s famous culture of transparency has slowly eroded. Larry and Sergey gradually withdrew from the company. They are now among the richest men in the world — but at what societal cost?
Those with capital have the largest marketing budgets, and frame what ‘innovation’ looks like. Venture capital is over-glorified — and this subtly creeps into our language. The term ‘angel investor’ sounds charitable, but in practice founders get the worst investment terms from early-stage investors. This same marketing engine convinces us that ‘you need investment to start a company’. We need to question this ‘common sense’, and ask questions about the necessity and desirability of external capital for startups. After all, ~50 years ago, before Silicon Valley and venture capital existed, people somehow still managed to start companies, primarily due to having launching customers.
Step 2: Scale
We are told that scaling our companies will enable us to have the largest possible impact. But what exactly are we scaling? Hiring? Revenue? Profits? What exactly we are trying to achieve? To run a stable company for the long-term, profitability is the most meaningful metric. A healthy margin enables entrepreneurs to cover their costs and reinvest extra cash into building the business.
Pressure to scale is simply not working for founders.
‘Common knowledge’ dictates that a VC is an accelerator for your company. Yet while investor cash can indeed speed up employee hiring, buying physical assets (like offices and equipment), and funding R&D, this higher rate of spending makes it harder to run a profitable business. Customer acquisition can be subsidized — but this accelerates the financial bleeding when cash flow is negative per customer. The number of employees is also a vanity metric: Rapidly hiring more people makes a company look outwardly ‘successful’, but it doesn’t necessarily speed up the path to profitability. As Frederick Brooks points out in the The Mythical Man Month, “The bearing of a child takes nine months, no matter how many women are assigned”.[3] And, when paid by the hour, too many cooks can spoil the broth.
This pressure to scale is simply not working for founders — a fact evidenced most starkly by the startup ecosystem’s 90% failure rate,[4] which is harmful as bankruptcy affects founders’ lives, families, and communities.
Step 3: Exit
You know that scene in Hollywood movies where a company founder rings the opening bell, listing his company at the stock market to cheers and confetti? The exit is our definition of success in business.
There are two main kinds of exits:
- Initial Public Offerings (IPOs) / direct listings — also called ‘going public’
- Acquisitions / mergers — also known as ‘selling your company’
Exits are usually the first time that significant financial value is pulled out of companies. Scaling and exponential curves are primarily in service of the exit. Startups are treated like battery-farmed chickens: large capital injections artificially plump them up for three to five years. Once they look big, juicy, and attractive, they are ‘liquidated’ (yes, this is the term used by investors), and a barely functioning carcass of the company remains.
Exits are non-negotiable for investor funded startups — but exits are destructive.
The startup ecosystem has evolved into a casino for the rich. Investors place small bets across a number of different startups, hoping that some of those bets will pay off. The exponential curve is critical for the casino’s functioning — investors don’t want to wait long for returns. Ninety percent of startups fail, so creating a modestly successful lifestyle business is not good enough to meet a fund manager’s goals. The one successful startup must succeed so wildly that it compensates for the other nine losses, and then some. That’s why exits are non-negotiable for investor funded startups.
But exits are destructive. Founders lose control of their companies, and the culture is destroyed. Attrition of senior staff starts shortly afterwards. The companies now have one new boss (in the case of merger or acquisition) or a collection of smaller bosses (fund managers representing shareholders). All of these leverage their voting rights to force companies to maximize returns, often at the expense of the company’s mission (or social or environmental welfare). Acquired companies may be completely absorbed into larger organizations, or even disassembled, sold for parts, and taken off the market. This frequently happens with green energy startups, who are acquired by larger energy companies who have an interest in maintaining the status quo.
Inspired to do things differently? Check out Post Growth Entrepreneurship.
References1. Hanauer, N (Jul./Aug. 2014) 'The Pitchforks Are Coming… For Us Plutocrats' Politico. https://www.politico.com/magazine/story/2014/06/the-pitchforks-are-coming-for-us-plutocrats-108014/2. Bhuiyan, J (Nov. 6, 2019) 'How the Google walkout transformed tech workers into activists' LA Times. https://www.latimes.com/business/technology/story/2019-11-06/google-employee-walkout-tech-industry-activism3. Brooks, Frederick P (1975) The Mythical Man-Month: Essays on Software Engineering Addison-Wesley4. Patel, N (Jan. 16, 2015) '90% Of Startups Fail: Here’s What You Need To Know About The 10%' Forbes https://www.forbes.com/sites/neilpatel/2015/01/16/90-of-startups-will-fail-heres-what-you-need-to-know-about-the-10/
