The phenomenon of technology companies around the world multiplying their valuations five to 10 times year-on- year is akin to the swelling of marshmallows inside a microwave oven. The infusion of hot air that causes marshmallows to expand is a fitting representation of the injection of venture capital and private equity funds into startups. Just as analogous is the microwave oven to the modern-day ecosystem of capitalism that fuels the growth of new ideas and innovation.
Rise of Microwave Capitalism
In the old days before venture capital accelerators and incubators, the venture funding landscape was limited to a few institutions and companies with deep pockets. Sometimes, these companies would make big bets on new innovations, such as Rockefeller's investment in Fairchild Semiconductor. But more often it was the case of large corporates allocating money for research and development. In this way, innovations were incremental, had to make good business sense, and had to synergize with the core business.
This is in stark contrast with the spirit of venture capital that relies on predicting the future value of new, independent ideas. Management influencer Gary Hamel rightly observes that we have "reached the end of incrementalism. Only those companies that are capable of creating industry revolutions will prosper in the new."
Undeniably, we are facing an economic shift. As the nature of venture financing evolves from being highly centralized to becoming increasingly decentralized, there are market inefficiencies that lead to "microwave capitalism".
In the same way a marshmallow swells up when heated, new and disruptive companies are under immense pressure from venture capitalists and their investors, many of whom require entrepreneurs to promise them massive scale and thus, returns, within a short time.
There are several reasons for the phenomenon of microwave capitalism. Startups (new, lean, and highly scalable companies) are particularly prone to microwave capitalism because new ventures need validation from not only the market, but also from investors. For innovation, be it market innovation or product innovation, to be truly useful to society, someone other than the founder's immediate family or friends must be willing to share the risk of the venture.
Institutional investors that are willing to back new ideas without any historical cash flows are called venture capitalists. Venture capital is a high-touch form of financing that is used primarily by early-stage startups.
Venture capitalists provide not only financing, but also invest their time and other resources through mentorship, strategic guidance, network access, due diligence support and subsequent fundraising advisory. These investments by venture capitalists are highly speculative – most of the companies that receive venture funding will fail, even as some become unicorns (companies valued over $1 billion through multiple rounds of private funding).
The importance of venture capital funding is clear to the extent that the largest companies that emerged in our lifetime have received funding from such investors. But successful venture-capital-backed companies may have been successful even without such financing. Of course, the fact that so many successful entrepreneurs choose venture capital financing suggests that this form of financing plays an important role in the entrepreneurial ecosystem.
Three of the five largest companies in the world received most of their early external financing in the form of venture capital. These companies are successful, not because of the"extra shopping money" but because the biggest companies in the world will be those that naturally use innovation and new technology to stay ahead of their competitors. Clearly, Apple, Google and Microsoft are among the most innovative and most important companies in our lifetime.
In the instance where a startup has secured institutional capital, it has achieved the highest form of validation, one that supersedes validation from initial consumers.
Firstly, they validate the team and founder behind the business plan. In the due diligence phase, venture capitalists have multiple interactions and opportunities to understand the founder's mission and vision, as well as see first-hand the operational mechanics of the business.
It is often the team and the founder that determine the long-term success of a fledgling company, with which consumers have limited interaction and access in comparison with shareholders and investors.
Secondly, venture capital also validates the technology and the product. Often, startup entrepreneurs are engrossed in building their product and forget what competition is like in the market.
It is the job of the venture capital investor to keep up with the latest trends in technology and stay atop of market currents, validating that the company's course of action is in line with favorable market conditions. In this way, venture capital fuels the new economy of innovation.
It certainly adds to the equation of microwave capitalism when venture capitalists demand a startup to scale as quickly as possible, giving way to the rise of incubators and accelerators. Accelerators and startup incubators that promise entrepreneurs rapid scale through introductions to more business partners and clients.
The difference between incubators and accelerators is the stage at which they aid new companies. Incubators support startups in their ideation stage, when entrepreneurs need time to develop their business plans, tweak their products and validate their markets. Accelerators guide entrepreneurs from adolescence to adulthood.
Caution in the New Economy
There are dangers to microwave capitalism. By choosing to move fast without building stable infrastructure, one could expose a startup to risks. In a keynote presentation to his Facebook developers, chief executive Mark Zuckerberg explained that "move fast, break things " is no longer the company mantra because "over time, it wasn't helping us to move faster because we had to slow down to fix these bugs and it wasn't improving our speed."
Among the things that count as "infrastructure" is a culture of operational excellence. It is never too early to establish your company's culture. Netflix for example, began building its culture, putting it down in writing, even when it only had three employees.
Establishing a culture where everyone is open to innovation is truly challenging, but it will ensure that your company continues to grow even when it is large. Research conducted by the University of Minnesota in 2008 showed that culture is in fact the most important factor in driving innovation in larger companies.
Microwave capitalism arises from the friction caused by the movement of tectonic plates that make up the economy of innovation as venture financing becomes more decentralized.
Beneath our feet, the plates will stabilize once venture funding becomes truly decentralized and crowdfunding takes off. As a result, market efficiencies will begin to pan out and microwave capitalism will soon subside.
Gitta Amelia is a general partner at a venture capital firm EverHaüs