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The Problems with Venture Capital and Entrepreneurs
Entrepreneur Joel Spolsky shares his gripes with the venture capital model in a very good article. He calls it "Fixing Venture Capital", although he actually almost only criticizes without offering solutions. But that's the only bad thing about the article, which is otherwise highly recommended reading.
There are, however, some issues I have with Joel's view (you might first want to read Joel's article before proceeding):
When venture capital is necessary, part I (product development costs before revenues): Although I agree that some businesses are better grown without venture capital and thus the founders might be much better off without it, some other businesses need immediate up-front financing to even get to the product launch stage. Unless external capital is employed, there is no way to do that for many semiconductor, electronics, or even software companies. What I don't understand is how Joel would think businesses like Amazon or Palm would have been launched without venture capital? No venture capital, no way to finance development of a larger product and a distribution system. It's a theoretically nice situation to have revenues, number of employees, public recognition, and code quality grow in the same rate. However, with many products, this is next to impossible. Employees are necessary way before revenues could even start to come in.
When venture capital is necessary, part II (risk diversification for the economy): In the afore-mentioned cases, it's in the best interest of the entrepreneur to share the risk with the venture capitalist. Look at it this way: With a bank credit (should the entrepreneur get one, which is unlikely), he might be forced into personal illiquidity should the business fail. With a venture capital investment, he is protected from that. From a whole-economy point-of-view, many risky businesses couldn't be launched without venture capital. Thus, the venture capitalist with his portfolio of businesses serves a valuable function in the business ecosystem in diversifying risks, so that the overall economy can undertake risky projects that single individuals could not.
Funneling and Rejection: Joel criticizes that many good ideas get rejected because the VCs do not have enough time to spend with the good companies because they have to spend so much time sifting through bad businesses. Point taken. However, how are you going to change that situation? Here we have a situation of a classical intransparent market with millions of small companies and even more unnurtured ideas. And the venture capitalists' role in this market ecosystem is to reduce information intransparency for themselves by whatever means they have. Thus, looking at many companies is part of the game. It's like scouting in professional sports: Most scouts only have a hit player once or twice in their career, and a decent player every year or so. Nevertheless, they look at hundreds or thousands of players in a more or less detailed way, going deeper with each individual as they eliminate the ones that prove to be not worth further scrutiny. The same applies to venture capital. Classical funneling has many faults, but it's still the best system there is.
Entrepreneurs spending time on pitching to VCs: Joel criticizes that many good companies are exempt from the venture capital model, because many good entrepreneurs often do not spend their time to pitch to VCs but rather on building their business. Well, that one is easy: If it's important for your company to get venture capital or if it is the profitable way to go, pitching to VCs is part of your job. Even if you don't like, you gotta do it. Do you not do payroll work because you don't like it? If it isn't important to your business to get venture capital, don't pursue it. All about priorities.
Devoted entrepreneurs: Joel says real entrepreneurs are single-mindedly focussed on the one company they are building right now and much prefer a higher chance to succeed with a lower payoff compared to the VC preferring a higher payoff with a lesser chance to succeed (we're talking tendencies here). Thus, he argues, the VC model attracts entrepreneurs that actually give their business a lower chance to succeed. -> My take: If you are an objective entrepreneur, you gotta know that there is a chance to fail. Entrepreneurs of course need to work their asses off and really do believe in their company. But they should also be able to step back and look at where they really stand. The romantic model of the emotional founder is a really nice one (and I am not being a cynic here), but there is a limit to how much you can will your venture to success. Each entrepreneur should understand that. Also, just because an entrepreneur realistically assesses his chances, he might not be less devoted than an entrepreneur blindingly following his chosen path. That's exactly the reason, by the way, why founders are sometimes pushed out, and should be when they are an impediment to the further success of the corporation. Call me cruel, but once you have outside investors, you are responsible to those. And this means the goal is to create financial value, not to keep a job for the entrepreneur. If you want to have "your own company" guaranteed for yourself in success or failure, though, you should probably not accept venture capital, or any outside capital for that matter.
Alignment of Interests: I don't think it's a big problem that the interests of venture capitalists and entrepreneurs are not aligned completely. Quite the contrary, I believe that this tension often serves the company very well. And in either case, whenever there are two parties involved in any game, there will be conflicts of interest to be resolved. If the entrepreneur is not ready to have that situation in his company, he shouldn't accept venture capital of course. [ Sidenote: Also, these conflicts of interest -- especially regarding the exit -- provided me with a nice topic for my thesis, which I am currently writing. So I am grateful for that, in a different way. ]
Conclusion: Joel has some important and good notions to consider when approaching venture capital from either side, but I don't agree that these issues speak against the whole model nor do they offer a solution for a better model. There are some companies fit for the model -- just look at this impressive image for really successful examples by Kleiner Perkins --, and some companies or entrepreneurs are not a good fit for venture capital. Fine with me.
More reading: A cogent response by VC Naval Ravikant. Zimran Ahmed has good points as well.