The Death of Risk in Silicon Valley

Here's my list of the prime suspects responsible for the Valley's nagging aversion to risk

By Sarah Lacy

I was recently at a Silicon Valley conference where one of the debates that raged into the wee hours centered on Silicon Valley's increasing aversion to risk: Is it a good thing, and who's to blame for it?

Less risk-taking by entrepreneurs means less outright failure. A lot of burned startup founders and investors see this as a plus. But any macroeconomist will tell you it's the rare home runs—successful, innovative companies yielding high returns—that create jobs and capital that keep the Valley humming.

But today I am more interested in who or what is responsible for the death of risk in Silicon Valley. Obviously, the recession has played an important role. Stock market declines and surging unemployment have done a number on everyone's appetite for risk. But other parties deserve some of the blame. Herewith, my list of prime suspects:

Angel Investors

They're not as angelic as the name implies. Angel typically refers to investors willing to park $50,000 or less of their own money in a startup. Often, angels are the first money into a company. The best ones invest based on gut feeling; and because they're investing only their own money, they don't have other investors to answer to. And most have been through it before.

But there are few substantive professional barriers to entry. So alongside savvy angels you have morons throwing around money they can't afford to lose.

This was especially true in the late 1990s, as tech companies were going public in droves and the Nasdaq was soaring. Paper millionaires saw seeding companies as a sure thing; they hung out the angel shingle and began funding deals. And why not take their money? Dumb money can buy servers and pay salaries, too. The problem with dumb angels is they have no reserves and evaporate as soon as times get tough.

Verdict: The angels have probably committed the fewest offenses against risk, but as the first money in, they can do big harm early in the life of a company.

Venture Capitalists

The VC is everyone's favorite villain. What's not to hate about a group of investors caricatured as heartless hoarders of billions of dollars who take all the returns when you win, or hang you out to dry when things founder?

In defense of VCs, no one is forcing entrepreneurs to take their money. Anyone who thinks he or she can get millions of dollars that don't have to be repaid—with no strings attached—is probably too naive to be building a company. VCs have their own pressure from investors, and it has intensified recently as endowments have sold stakes in illiquid assets like venture capital firms.

A venture capitalist's greater crime against risk isn't closing down a startup that's not going anywhere. Rather, it's not funding ambitious, risky new ideas in these slow times. Every VC will tell you the biggest hits from Silicon Valley come from downturns, when copycat companies are few and only die-hard entrepreneurs have the guts to go for it. Examples include Sun Microsystems (JAVA), Cisco Systems (CSCO), LinkedIn, and Facebook.

Verdict: The VC is only the startup's enabler. VCs don't innovate and they are hedged against several other deals. But the VC is the only part of the ecosystem that is paid to take risk. And it has the least skin in the game. There's little excuse not to tolerate a higher degree of risk than they do.

The Entrepreneur

Entrepreneurs are taking less risk partly because they have less reason to. Internet and communication technology has so reduced the costs and compressed the amount of time needed to get a new product out that entrepreneurs need less money.

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