Blog: Pavan Muzumdar & Neal Fairbanks

In the movie Moneyball, a pro-baseball manager isn't afraid to turn conventional recruiting practice on its head. When it comes to VC funding, shouldn't the same daring apply? This week software execs and entrepreneurs Pavan Muzumdar, CFA, and Neal Fairbanks have a friendly back-and-forth on the state of funding from the investor and entrepreneur points of view.

Post 1: Why Venture Capital Gravitates to High-Tech

Pavan:  I have got to say that I really enjoyed blogging for Concentrate's sister publication, Metromode, a couple of times and jumped at the opportunity when I was invited again.  Yours truly is also happy to report that I did get some nice comments from folks who took the time to read the posts.

But Tanya suggested I should do things a little differently this time.  She asked if I could do a co-blog with someone else who would have a different perspective than mine.  I readily agreed, and it was a no-brainer to ask Neal whom I respect very much.
You'll read about him in his bio, but what isn't necessarily obvious is that Neal is one of the sharpest technical dudes out there with a bunch of patents in his name to boot.  He will give us the entrepreneur's point of view, while I thought I would look at things from that of the investor.

We decided to talk about something that's been discussed on and off in the past few years – the dynamics of venture capital in Michigan and the Great Lakes Region. We also thought it would be nice to do this as a conversation between us.  What's cool is that we were surprised by a few things that we uncovered ourselves.  We hope you enjoy our banter!

So one of the questions I get asked sometimes is, "why does venture capital gravitate towards high-tech?".  The sub-text is, we have a lot of other kinds of technologies, but why does the money seem to disproportionately go to IT and software ventures?

I think the answer lies in the dynamics of how the technology is developed and commercialized.  When you produce a widget, it takes a lot more effort to design, prototype, and market the product.  Tangible products need to perform in the real world and have to be safe and reliable.  They also have to be moved from the place of manufacture to the place of use. 

Compare that with an IT product. Today, it can be designed, programmed, and deployed all over the Internet without any moving parts so to speak.  The marginal cost of serving an additional user is close to zero. 

The financial dynamics of an investment in the manufacturing space is that the increased complexity leads to increased operating costs, capital requirements, and longer timeframes – even if the product is successful.  That leads to a lower IRR (Internal Rate of Return) on the investment which is what venture capitalists use to measure the success of an investment.

For example, let's say we had a 10x return on an investment – nice by any assessment.  If that return takes 5 years to generate, the IRR is 58%.  But if it takes 8 years, the IRR drops to 33%.  Not to mention that the investor has 3 less years to enjoy the money.

Neal:  That's interesting.  I do agree that for most high-tech applications, we can probably set something up really quickly and see if the results make sense.  It doesn't take as much money as it would, to develop a manufactured product.  But then, that raises another question.  In my experience I have seen that Michigan has a large number of very qualified IT people.  Why then do we not attract large amounts of venture capital in this area?

Next: The State of High-Tech in Michigan