Why Publishers are Like Venture Capitalists

My roots are in Silicon Valley. For most of the last three decades, Silicon Valley was the world's hotbed for startup innovation. Our advantage over the rest of the world was our unique ecosystem of talent and funding, and a culture that encouraged creative risk taking, creative destruction, knowledge sharing and yes, even failure.

In Silicon Valley, our heroes are the risk-takers. We celebrate those who put their skin on the line to pursue a dream of changing the world. For much of these last 30 years, venture capital provided the entrepreneurs with the money, counsel and connections to make their dreams a reality. Earlier this decade, the Silicon Valley gravy train fell off the tracks.

Non-stop success can breed complacency and arrogance. Many in Silicon Valley thought we possessed the secret sauce to building great tech companies. Actually, we did help invent and improve the secret sauce, but like secrets that shouldn't be kept, the recipe spread around the world and was improved upon, so that today, promising tech companies sprout in every corner of the globe without a VC's assistance. Silicon Valley has eaten its share of humble pie lately, and that's a good thing for the future of our industry.

For many Silicon Valley entrepreneurs, venture capital was the oxygen that breathed life into what might have otherwise remained an idea scribbled on a napkin. After all, startup creation is expensive. In exchange for the capital, the entrepreneur usually gave the VC anywhere from 20 to 60 percent of their company, and with that ownership the entrepreneur gave up control.

VCs are usually super-intelligent people, yet they're fallible like the rest of us. They have a recurring habit of getting caught up in the greed and feeding frenzy that occurs when a startup in a hot new category hits pay dirt with an IPO. Like drunken lemmings waving fists of cash, they compete against one another to fund similar startups in the same category. The ensuing competition sparks bidding wars that inflate the valuations of the companies and lead to a glut of cookie-cutter startups in the same category. Other entrepreneurs, spellbound by the razzle dazzle of the big dollars, rush to modify their startups to fit the same mold so they too can get funded. Inevitably, consolidation comes because the market can't support so many clones.

Many entrepreneurs who've sold their souls to a VC view VCs with equal parts admiration and contempt. Key positives: VCs offer access to capital, advisors and connections that can maximize their odds of getting their company out there. Key negatives: The VCs make promises they often can't keep (such as "spend our money quickly, we'll be here to give you more when you need it"); their allegiance is fleeting (VCs are legend for losing interest at the first signs of hardship); and their interests aren't necessarily aligned with those of the entrepreneur.

The last two points are the most critical. A VC's allegiance is to their investors first and foremost, not the entrepreneur or the entrepreneur's company. At times these interests are aligned, but more often than not they diverge.

VCs play a numbers game. They understand that out of every ten companies they fund, six or seven will be outright failures, maybe two will be "base hits" or "doubles," and then maybe one will be a home run. The one home run, like the next Cisco, Netscape, Google or what have you, makes up for the other nine duds.

This desire to hit a home run will often cause a VC to manage their portfolio contrary to the best interests of the entrepreneur or their company. In other words, if you are one of the three most promising companies in a batch of ten, the VC may encourage (or force) you to take big risks and swing for the home run, even when a base hit or double is a smarter move. By forcing companies to take inappropriate risks, they do create the occasional home run, but they create many more failures along the way.

One of the reasons a thousand Silicon Valleys have sprouted up around the globe is that it no longer takes the same amount of funding to create a startup. The tools to build the company are essentially free now. With low cost or free open source software, and limitless free access to knowledge (Wikipedia and Google) and relationships (social networks) acting as equalizers, more and more entrepreneurs are turning their backs on the VCs. Some will utilize angels instead. Angels are service providers or fellow entrepreneurs who have experience in the same field, and who contribute much of the same value as a VC without exacting the same quantity of flesh.

Some of these entrepreneurs grow their business to profitability and then have the option, but not the necessity, to partner with a VC. Once an entrepreneur has proven the success of their business (i.e. they've eliminated much of the risk), they have the freedom to either forego venture funding altogether, or they can bring on the VC under more favorable terms.

Fun with Words
So now, my dear HuffPo reader, if you haven't already come to your own conclusions about why publishing is like venture capital, I invite you to play the word game below to explore the allegory. Enjoy!

Instructions: Copy and paste this post into a word processor as plain text. Carefully perform the following search and replace ("CTRL-H" in Microsoft Word) in the following order, and then re-read your creation:

replace "entrepreneurs" with "authors"

replace "entrepreneur" with "author"

replace "tech companies" and "companies" with "authors"

replace "startups" with "books"

replace "startup" and "company" with "book"

replace "VC" with "publisher"

replace "venture capital" with "publishing"

replace "funded" with "published"

replace "an IPO" with "a bestseller"

replace "service providers" with "experienced publishing professionals"

replace "business" with "writing career"

replace "open source software" with publishing tools like Smashwords and Wordclay"

replace "venture funding" with "a commercial publisher"

replace "Cisco, Netscape, Google" with "Breaking Dawn, Eragon, DaVinci Code"

replace "Silicon Valley" with "New York."

Now read it again!

In my next post, I'll share what I think all the above means for the future of publishing and authorship.

Mark Coker is founder of Smashwords, a publisher and distributor of ebooks. For the last 15 years, he has also been an angel investor for technology startups. This post originally appeared on the Smashwords blog.