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An open letter to the venture capital industry from Phillip John Watkins


The collapse of Silicon Valley Bank has sent shockwaves throughout the tech industry, causing many to take a closer look at the practices and principles that have driven its success in recent years. As one of the primary banks catering to high-risk tech startups, SVB's demise has raised concerns about the sustainability of the current Silicon Valley culture, particularly in terms of its reliance on less orthodox banking practices. With many startups now scrambling to secure funding from more traditional banks, the tech industry is facing a reckoning that could lead to a new era of innovation and growth, one that is built on a more stable and sustainable foundation.

As the tech industry continues to grow and mature, it's important to keep a critical eye on the practices and principles driving its success. In this open letter to the venture capital industry, Phillip John Watkins addresses the issue of unsustainable growth and the potential consequences of ignoring fundamental business practices such as risk management, legal compliance, and regulatory obligations. While the allure of unicorn status and IPOs may be strong, investing in not-so-sexy functions like insurance and risk management is critical to building a robust and successful company. Ignoring these foundational elements could lead to missed opportunities, chronic operational debt, and significant losses that impact long-term success. It's time for the VC industry to take a closer look at the practices driving growth and invest in building sustainable businesses for the future.

An open letter to the venture capital industry from Phillip John Watkins

We get it, VC capital loves growth, indeed for some of you it might be the only thing you are inclined to track. It’s easily quantifiable, tracks with profitability (at least traditionally), looks great in board meetings and can generate the hype around a company that might just see it on the path to unicorn status and IPO. What is not to love about growth?

But, what if the growth being reported is based on a flawed business model that could lead to missed opportunities and, ultimately, result in your portfolio companies’ competitors gaining an advantage? It's important to consider whether the growth being reported is sustainable while adhering to fundamental business practices, such as managing risk, trust & safety, legal compliance, and regulatory obligations. Ignoring these practices could result in incurring chronic operational debt and/or retaining significant unreserved losses, which could ultimately impact the long-term success of the business. It's crucial to keep a close eye on these factors, as they may not be reflected in the financial accounts of the business or its growth.

You are aiming to invest in unicorns, but what if you are unwittingly buying into a donkey wearing a party hat?

In my view, to build a business, let alone a unicorn, it is critical to invest in the not-so-sexy functions that will facilitate a robust company evolution over the long haul. These functions serve an important role in maturing earnest founders and early-stage companies into mature, sophisticated businesses and owners. Whether absent, poorly resourced or broadly ignored at the board and investor level, the effect is the same, and companies built in such conditions are on foundations made of sand.

Take for instance risk management and insurance, often toxic subjects for startups given that the "pay-off" only comes good when a major incident occurs. Many seem to believe that this is something that should be addressed properly post-factum, after listing and presumably exiting for both founders and VCs, if at all. Prior to that, it is simply too substantive a drain on the resources of the company, yet:

  1. Most corporate lines of insurance would tend toward a 0.5-2% rate on the policy limit. Meaning that a full limit claim within a period of 50 years fully repays the premiums deployed, or more, under any given policy.

  2. The equivalent hit to the balance sheet of most startups would almost certainly result in an immediate funding crisis. Moreover, in the absence of insurance to support a response to the underlying incident, additional indirect losses and damages could readily precipitate.

  3. Engagement with insurance practitioners and insurers often elucidates a myriad of other structural and operational issues which present excess or unnecessary risk to the business and are easily managed out of the organisation, at little to no cost, if addressed early enough.

  4. Early engagement with insurers typically supports stronger relationships and better pricing over the lifetime of the business since they are able to familiarise themselves with your portfolio companies as they grow and support and guide best practices through that evolution.

Sure insurance, like other control functions, isn't "sexy" and it isn't "fun," but just like other control functions it is absolutely critical to building a robust business. Engaging early with practitioners in these specialist areas can manifestly improve the chances of a startup “making it” and secure the value that is being created within the company for you, the investors.

These functions and their resourcing in your portfolio companies deserve your attention, as they are by default hedges against the risk posed to your investment. When adequately resourced and with appropriate board engagement, they can ensure that more of the golden gooses in your portfolio achieve their potential rather than buckling under the weight of their hidden inefficiencies, liabilities and debts.

Oh, and don’t just take my word for the importance of these functions, to paraphrase Willem Jonker, CEO EIT Digital, startups mostly fail due to an inability to access capital, whilst scaleups mostly fail due to a lack of expertise.


Phillip John Watkins

Closing remarks

It's time for the VC industry to take a step back and consider whether the pursuit of growth at all costs is truly sustainable. As Phillip John Watkins notes in his open letter, investing in the less-sexy functions that facilitate a robust company evolution over the long haul is critical to building a successful unicorn. The success of a company depends not only on its growth but also on its ability to manage risks, ensure compliance, and build trust with stakeholders. By prioritizing these functions and engaging with practitioners early on, VCs can increase the chances of their portfolio companies' long-term success and secure the value they have created. As the industry moves forward, let us remember that building a sustainable and resilient business requires more than just a high valuation and impressive growth metrics. In uncertain times, it's more important than ever to stay connected with professionals and experts that can help you stay on track. For more resources, and to connect with hundreds of VC-backed portfolio companies focusing on risk management, trust & safety, compliance and regulatory issues, check out Marketplace Risk and the upcoming Marketplace Risk Management Conference (San Francisco, May 16-18).

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