My friend Eric recommmended that I read some essays by Paul Graham, an “essayist, programmer, and programming language designer” for some insight on careers, start-up companies, and business. Here’s a great passage about funding new business ventures from an essay titled Inequality and Risk, where Graham shows that reducing economic inequality jeopardizes growth and progress by reducing incentives to take risks:
Why not just have the government, or some large almost-government organization like Fannie Mae, do the venture investing instead of private funds?
I’ll tell you why that wouldn’t work. Because then you’re asking government or almost-government employees to do the one thing they are least able to do: take risks.
As anyone who has worked for the government knows, the important thing is not to make the right choices, but to make choices that can be justified later if they fail. If there is a safe option, that’s the one a bureaucrat will choose. But that is exactly the wrong way to do venture investing. The nature of the business means that you want to make terribly risky choices, if the upside looks good enough.
VCs are currently paid in a way that makes them focus on the upside: they get a percentage of the fund’s gains. And that helps overcome their understandable fear of investing in a company run by nerds who look like (and perhaps are) college students.
If VCs weren’t allowed to get rich, they’d behave like bureaucrats. Without hope of gain, they’d have only fear of loss. And so they’d make the wrong choices. They’d turn down the nerds in favor of the smooth-talking MBA in a suit, because that investment would be easier to justify later if it failed.
Very nice.
Very nice.