Tag Archives: VC

Kickstarter, Oculus Rift, and internet rabble rousing

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The internet is mad that Facebook bought the VR company Oculus Rift. We shouldn’t be surprised that someone bought this company, it was going to have an IPO or be bought. There’s no doubt about that. The problem isn’t that it was bought, but the company that bought it.

Oculus Rift was a startup. Startups need money so they launched a Kickstarter Campaign and raised $2.4 million. Startup money typically comes from three groups of people in early stages (3Fs) – Family, Friends, and Fools. The Kickstarter campaign clearly is the fools. Not because they didn’t think the company would succeed, but that they thought they’d have a say in the end result. Kickstart has had other scams, such as the feminist blogger that was going to buy a bunch of games and show how awful they were (but didn’t). Kickstarter has always said that you are donating and has no control if you ever get anything out of it.

If a startup is successful with the money provided by the 3Fs (and this is a huge IF as this is typically called the Valley of Death in startup parlance), these companies try to get Venture Capital Funding. The VCs are the people that have a boatload of money and try to make even more by getting companies to “exit.” There are three options for “Exiting” a startup – IPO, Purchase by another company, or failure. VCs prefer your startup being purchased by another company – it has the least risk (you never can tell what your stock price will be – see Facebook’s IPO. To get this money you typically have to give up control of your company. This comes in two forms ownership and members on a board of directors. In some cases the VC will take less ownership for more members on the board. Apparently one of those people that owned a large portion of Oculus Rift was Mark Zuckerberg – he reportedly made $337 Million on the Facebook purchase of Oculus Rift. That means he owned roughly 1/6 or 16% of the company ($2 Billion sale and all). Supposedly 2 other VCs made roughly the same amount of money on the deal. Which means that the founder likely owned less than 50% of the company and could have been forced into the deal.

Effectively, the moment Mark Zuckerberg invested in Oculus Rift, the company was going to be sold to Facebook – as long as it was shown to be successful. What this means to me is that if you read or see Zuckerberg personally investing in something, expect Facebook to eventually buy it. Additionally, with Zuckerberg owning that large of a percentage of the company, there’s no way it could have been sold to any other company. It was IPO, Facebook, or bust.

With this broader context, I cannot be mad at either Luckey or the other leaders of Oculus Rift. They knew the game when they got into VC – even if you aren’t into making a lot of money when you start, your VC will push for a positive exit for themselves.

One of the angriest people about this whole thing was Notch, the Minecraft guy. He finds Facebook creepy and is upset that his $10,000 facilitated that sale. Even if he had gotten stock for his investment, he would have only had 0.42% ownership share over the company (assuming Luckey sold all his stocks through the Kickstarter which is unlikely). Unfortunately, it’s likely his stocks would have been diluted and the VCs would have controlled enough of the board and stock to force the sale to Facebook despite all the people that could have owned stock if the money had been raised through a Kickstarter alternative like Fundable.

When investing in a Kickstarter, you can’t get emotionally attached, you need to look at it as if you’re gambling. You might never get anything from it, but at least you helped someone else’s dream come a step closer to reality. I’m happy for the folks at Oculus Rift because they got lucky in a very unfair game. I don’t like Facebook either – but it was unlikely for any other outcome unfortunately.

Innovation and government regulation

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Yesterday during a short twitter discussion the topic of US governmental policies killing new business starts came up. With the 140 characters I wasn’t able to property address the issue that was raised. It is extremely clear that SOPA is an innovation killer, because it effectively requires everyone to have a copyright lawyer on staff at the start of any sort of web company. If you have pictures, video, commentary or whatever on your site you’ll possibly be the target of some copyright holder. This policy isn’t in place and appears, for the moment, to be killed. I expect this law to be resurrected in a year or so. Despite the face that the EU adopted a resolution against SOPA.

Let’s look beyond SOPA though, what other policies are in place that seem to prevent job growth? One of the biggest ones right now is tax levels for people making $250,000 or more. Politifact did an analysis of Congressman Boehner’s claim that taxing millionaires hurts small businesses and prevents hiring. They found this statement to be False. Of course this does depend on the definition of a small business, which Politifact expresses is difficult to define. One metric that I’m aware of is based off the annual sales, where sales over $500,000/year moves you out of the small business area. This may not be the best amount, but let’s say your company has sales of $3,000,000 a year and has enough profit to pay you $1,000,000 of that a year. This tells me that you aren’t reinvesting and trying to continue to grow your firm, probably aren’t paying your employees very well. Additionally, at this amount of sales it is likely that as an entrepreneur you’ve had to get capital investment in one of several ways, loans or from venture capital. A bank wouldn’t care if you were getting paid a million a year, but there’s no way a VC would allow you to pay yourself that if they weren’t getting a good size chunk of money too and you were still planning on reinvesting in the future enough to get a huge IPO. Now, if you’ve built this company from the ground up to this level on your own, then you aren’t paying yourself that kind of money. You would have to be re-investing that money back into the firm to get new equipment hiring the best people, etc.

Another way for companies to get started is through spin-off from another company, bootstrapping themselves to get going or spinning-out of a university. I have an article that will come out soon in the Urban times that addresses some policies that can help with the creation of Spin-outs and start-ups. In the US, we still have the best policies for this. The EU as a collective and European countries are modeling many of their intellectual property laws and funding methods off of US policies. A few examples are a very similar law to the Dole-Bayh law from the 80’s to allow universities to own IP and to give it to their employees if they wish. The creation of technology incubators – this was a truly American innovation, innovation prize contests and national seed funds. The continual reinvention of these policies in the US allows us to create more new companies than European counterparts from a variety of sources.

Are there other policies that hurt the creation of companies? Yes, sure. I’m sure there are some pollution regulations that negatively impact the survival rate of firms. However, from a purely economic perspective this regulation is forcing the company to internalize the cost of the negative externality. Which the company should innovate to reduce the amount of pollution they are creating or buy equipment that reduces their costs in other ways. Innovation to reduce pollution should reduce the cost of raw materials, because they are being used more efficiently and in lower quantities. Every company wants to be able to reduce the amount of raw materials they use. In the next few years we will see greener companies, not because they have a desire to be sustainable, but because it’s more profitable. The regulations the EPA puts into place requires companies to internalize negative externalities, which from both a evolutionary and neo-classical economic perspective is expected from the market and when the market fails then and only then the government needs to step in.

There will be regulations that are industry specific that may slow the amount of innovation and creation of firms, but some of that is surely death by a thousand paper cuts (too much paper work) and the inability to figure out a way to acquire enough funds to get the company going. Compared to European countries the US is the leader for ease of firm creation and the EU is still playing catch up in that regard.