Podcast: Maintaining a Robust VC Ecosystem Despite Changing Tides, With Dan Scheinman

Venture capital firms have reined in their funding for resource-intensive start-ups trying to commercialize new technologies in fields such as clean energy, advanced manufacturing, and robotics. Today, for a fraction of the costs involved in those enterprises, you can bring innovations to market in months—and be relatively capital efficient—thanks partly to the transition to cloud computing. Rob and Jackie discuss what’s needed to maintain a robust VC ecosystem in the United States with veteran angel investor Dan Scheinman.

Mentioned

• “The COVID-19 ‘Reallocation Shock,’ With Nick Bloom,” ITIF Innovation Files podcast, August 17, 2020.
• Adams Nager, et al., “The Demographics of Innovation in the United States” (ITIF, February 2016).

Related

• Robert D. Atkinson, Mark Muro, and Jacob Whiton, “The Case for Growth Centers: How to Spread Tech Innovation Across America” (ITIF and Brookings, December 9, 2019).
• “The Real History of Silicon Valley and the Lessons It Holds for Innovation Policy Today, With Margaret O’Mara” ITIF Innovation Files podcast, June 8, 2020.
• Daniel Castro and Alan McQuinn, “The Privacy Panic Cycle: A Guide to Public Fears About New Technologies” (ITIF, September 2015).

Auto-Transcript

Rob Atkinson: Welcome to Innovation Files. I’m Rob Atkinson, founder and president of the Information Technology and Innovation Foundation. We’re a DC based think tank that works on technology policy.

Jackie Whisman: And I’m Jackie Whisman. I handle outreach for ITIF, which I’m proud to say is the world’s top ranked think tank for science and technology policy.

Rob Atkinson: This podcast is about the kind of issues we cover at ITIF, from the broad economics of innovation to specific policy and regulatory questions about new technologies. Today we’re going to talk about how venture capital funding is fueling start-ups in not only Silicon Valley, but across the world. We have a great guest who’s at the center of it all.

Jackie Whisman: I’ll introduce him. Dan Scheinman became an investor in technology companies and a sought after start-up advisor after practicing law, and then serving in a range of leadership positions over 18 years at Cisco systems. He was the very first angel investor to write a check to Zoom, so you can say his instincts for picking winners is proven, to say the least. We’re really excited to talk to you today, Dan.

Dan Scheinman: Thank you, Jackie and Rob. An honor to be here.

Jackie Whisman: I think it would be great to kick things off by explaining what we mean when we say angel investing. Can you define it for our listeners so they understand?

Dan Scheinman: Sure. Angel investing really is the first check into companies. In general, in Silicon Valley, most of the famous institutions like Sequoia Capital or Andreessen Horowitz, their core spot is investing a little later when there’s more metrics and momentum in the business. Recently, in the last, certainly 10 years, there’s been a trend of individuals who have stepped in and tried to fund the first motion of companies, and so that really is what angel investing is. It’s the initial seed capital to get founders going on their journey.

Jackie Whisman: A lot of start-ups find it more appealing than other more predatory forms of funding. Is that right?

Dan Scheinman: Well, yes and no. It’s usually that start-ups turn to angel investing, because it’s the best source for early stage funding. What you hopefully get are people who’ve done it before and get know-how and access to the network of the investor, to help solve early stage problems. Usually for most people, it’s either friends and family, quite frankly, or it’s professional angel investors, where they get their first checks.

Rob Atkinson: You know, Dan, I know angel investing maybe 10 or 15 years ago was not only smaller, but it tended to be individual angels. Has the industry, if you will, if you want to call it that or a sub segment of the ... has evolved in a different way?

Dan Scheinman: It’s unbelievable. Eight years ago, or 10 years ago, when I really got started, it really was individuals. There were just people who had made money and had built companies who really wanted to give back into the ecosystem were doing it. Since then, what’s happened, there has been an institutionalization of angel funding. We have an explosion of funds, probably, well north of 500 and maybe more, targeting the early stage space. Now I would say that probably 75% of the time, I’m seeing people who have a firm, has an angel fund who are actually making the first investments, and 25% of the time it’s people like me who are using our checking account to do it.

Rob Atkinson: Yeah, that’s really interesting. I’m sure at one level that’s nice for the ecosystem, but it maybe makes it harder for you, since there’s more competition for the deals you want.

Dan Scheinman: Yes, but actually, I think it’s good for the entrepreneurs that there is more competition. Certainly what we have seen in the last five years has been a general rise in valuations, which is good for the early founders, because they take less dilution in the early rounds, and there’s a lot of capital available, which is also generally good for the early founder. Yes, it’s more competitive for people like me, but hey, it also means I got to get better, and that’s good too.

Jackie Whisman: I was reading an interview you did about your early investment in Zoom. As I mentioned in the intro, you were the first person to invest in the company nine years ago or so. You said, “We had planned that video would run the world at some point, but we didn’t plan for it to happen over a few months in 2020.” Overall, are you seeing an acceleration of start-ups that are trying to help fill these new needs we’re seeing because of COVID?

Dan Scheinman: No question. COVID has certainly changed the landscape and the rise, at a 50,000 foot level, the rise of cloud, where everything is now in the cloud and services are cloud based. Plus, the rise of this remote workforce and the rise of video have created an incredible number of opportunities. I’m starting to see just what went from, yeah, in the future this will happen, is now, the future is now, and we’ve got to move fast, and there’s fear of missing out. There’ve been just incredible investment to things like online events has become very popular. There’s a company that achieved a multi-billion-dollar valuation, really overnight, in that space. I think we’re seeing that people really do now believe that the cloud and remote work, these are all things that are going to be fundamental going forward.

Rob Atkinson: One of the things that’s strange, we interviewed Nick Bloom at Stanford, recently, or early on in the COVID crisis, and he was talking about his models and estimates of restructuring. What’s funny about that, when you talk to tech people, tech policy people, they always say, “Well, it’s the technology that drives these things, and when the technology gets mature enough, it’ll be adopted.” Here, it’s one of those things where it was much more about social factors, because the technology was there. Might not have been exactly where we wanted it, but as a chicken or anything, I wasn’t going to stay home every day and do video calls when people were downtown, even though I could, because they didn’t expect it, I didn’t expect it. Now there’s a whole new norm, so that to me is really fascinating. It’s the norms of change that then open up and allow these technologies to really gain and take off and then innovate, as you talked about, with this new firm you mentioned.

Dan Scheinman: I think this is one of the things, the founder of Zoom, the great Eric Yuan has said, is his goal is always to make a video meeting better than an in-person meeting over time. What I’ve seen is in a lot of ways, the reason we like to do in person is it gives us a chance to really get to know people and see the body language, but sometimes those meetings are artificial, because you put on your battle armor, or you got your suit on, you show up. I’ve certainly seen a more relaxed side of people around video, and sometimes I think I get to know people a little bit better, doing it video only. It certainly hasn’t slowed my investing pace. It’s been, I think quite frankly, a huge net positive for me.

Rob Atkinson: I kind of feel the same way. I mean, just even within our team at ITIF, I see people in ways I wouldn’t have seen them, because Jackie and I work together in an office, but now I see Jackie’s dog, and I see her daughter, and she sees other things about my life. I think people are able to see each other in a more full way if you will, and that I think builds and strengthens relationships.

Dan Scheinman: I completely agree, and I have seen that. It’s been, in some ways, easier for me to get to know founders in this methodology than sitting in a coffee shop and trying to figure each other out.

Jackie Whisman: I never thought of it that way, but you’re totally right. We seem to collaborate more and on a different level, which has been really productive for us at least, at ITIF.

Dan Scheinman: Actually, although it’s very hard to measure productivity inside companies, it’s an art, still not a science, but my CEO’s in general are reporting increased productivity in this era, in part because the lack of commute. In some places you are probably an hour and a half to two hours on the road, and that goes away, and that’s led to increased productivity. Particularly, I mean, if you have young children, then I think, I’m doubtful, there’s increased productivity, but if you don’t have young children, then I believe there is. There’s an opportunity for increased productivity.

Jackie Whisman: Well, there are a lot of start-ups that are occupying my five-year-old, while I do things like podcast. I’m grateful for them too.

Dan Scheinman: Amen.

Jackie Whisman: Is the Silicon Valley innovation ecosystem, is it still robust or have challenges from other countries, coupled with kind of the high cost of the Bay area, maybe the focus of VC funding, more on software and apps, or are there new challenges that you’re seeing?

Dan Scheinman: Jackie, I could go on for an hour on that question, so I’m going to try and be concise. Yes, at a thousand foot level, it’s the challenges and the opportunities. There’s new challenges and there’s new opportunities. The challenge clearly is the Bay area has become a very high cost location. The other thing has been that with the changes to the immigration stuff going on, it’s harder also to get people to come to the Bay area, which actually is a problem. Now, the opportunity is I’ve long believed, why should we in Silicon Valley have all the fun. This should be a national thing. What we really are doing here is, quite frankly, it’s the 21st century manufacturing. We’re building products, and there’s no reason it should only be done in Silicon Valley. I think increasingly we are seeing a geographic diversification, and I think that is a good thing.

We’re seeing venture funds spring up outside of here. We are seeing companies all over the US. As a challenge, I do think that the immigration situation has led to some talented engineers staying home. What I think the general public doesn’t realize is we are dependent on a very, very small number of engineers. I always say, Andy Bechtolsheim, who, the founder of Arista and Sun, and was the first check in Google, he could have stayed in Germany, but he didn’t. He wanted to come here. If Andy didn’t come here, a lot of things might not have happened if he had stayed in Germany. We want the Andy Bechtolsheims to come here. In general, what is it that first attracts them here? It’s the education. We should be taking all these folks who show up and who are getting advanced degrees and scientific subjects, and I’m stealing this from John Doerr, but we should hand them a green card along with their diploma.

Dan Scheinman: The truth is, we don’t know which one is going to be Andy and which one is going to not, but we can’t miss. If you miss on the one, Andy, you’re sending entire industries back to other countries. I do think India and China have made enormous progress and are continuing to make enormous progress. Again, I think it’s good. I want technology only to be in one relatively small locale. It’s good that we have competition and we move forward, and it creates new markets as well, but from a United States perspective, it is a little bit worrisome, what’s been going on over the last several years. I do worry about overdependence or the situation in California, causing some issues.

Rob Atkinson: We did a report a few years ago for the Smith Richardson Foundation, where their board asked us if we would look at what was the demographic makeup of the most important inventors or innovators in the US, so we looked at who were the people who were filing triadic patents and also winning R&D 100 awards. We looked at, we got over a thousand to respond, what’s their gender, what’s their national background, what’s their race. Forty-four percent of them, or something like that, were first- or second-generation immigrants. Thirty-three percent were first-generation immigrants, way higher than the number or rate of first-generation immigrants. These were making the most important innovations.

These were like the best of the best, so couldn’t agree with you more that that’s a real opportunity and challenge, but at the same time, one of the reasons they come here is our universities. Now, according to the work we’ve done, we rank 24th in funding our universities as a share of GDP, university R and D, and so we we’ve got some real work to do.

Dan Scheinman: But Rob, I’m not sure that that ... I think actually what’s going to hurt us more in the short term is the immigration. If we’re not letting people in, or we make it difficult, or other countries make it easier to choose to go there, that to me is the bigger short-term problem. Look, the funding stuff, it’s always problematic for universities, is that’s the definition of universities, problematic getting funding, but there’s enough people in United States who are willing to fund innovation, it seems. That I think, that’s not the number one issue. I’m more worried about, do people choose to come to the US, and we want brilliant people choosing the US.

Rob Atkinson: I was talking to the Minister Bains, who’s the minister of commerce and innovation up in the Canadian government for Prime Minister Trudeau, and they’ve instituted a program up there, a 30 day STEM visa. You apply there, and within 30 days, you’re a permanent resident. You imagine that?

Dan Scheinman: Imagine, right? When you look at the graduate science programs in the United States, particularly in technology, they’re overwhelmingly populated with foreign born people. We have two choices. Either somehow we create demand for US technical people to go to graduate school and do that, which is, I mean, a longterm process where we have got to get more aggressive with regard to immigration, and we’ve got to incent and encourage the best and the brightest to come here. They want to come here. They believe in the brand of the US, and we need to make sure that we don’t disincent them from coming.

Rob Atkinson: Jackie and I, once, we did a project for the House architect. He was doing a project on how should the House of Congress, the House of Representatives use technology in the future. We did a number of trips around the country with some of the House leading staff, the CIO, and the like. I’ll always remember this trip to Carnegie Mellon, where we visited a lab, and it was doing facial recognition for the Army, at a distance, like 20 feet or whatever. I’m looking around, I’m looking around, I’m going, “They don’t look like they’re an American. They look like they’re a foreign student, foreign student.” Finally, this one woman there, and I asked her, she looked like she might be American. No, she’s from Eastern Europe. Not a single person in that PhD lab was an American. Nothing wrong with that, but we should be keeping those people.

Dan Scheinman: Right. The reality is, is that if you go into the top universities in the United States, you would repeat that experience. It’s in general, one number I saw was that north of 70% of PhD in engineering and computer science are born outside the US. Again, to me, this is the number one opportunity for the US to compete, is we have the better brand. We have better access to capital. We have less barriers to immigrants raising money. In fact, it’s considered cool, and so I really think we need to resolve the immigration issue.

Rob Atkinson: Yeah, absolutely. I think, not to be partisan, because we’re not, but I do think the odds of that are better under a Biden administration. I think there’ll be a push for some immigration reform, and I think high skill will likely be a strong component of that. Dan, I want to switch gears a little bit, and going back to the issue of VC funding, for awhile there, I don’t know, like 10 years ago, you’d seen this decline in early stage. It was much more later mezzanine, third stage, and it was kind of troubling. Then in recent years, we just had a piece, a thing in our program, we call monopoly myths, and one of the myths is that there are all these firms out there with what are called kill zones, and the big Googles of the world killing all this innovation.

Rob Atkinson: One of the graphs we had, and there was just the really rapid growth of angels, zero, first stage, amazing growth over the last 10 years. You compare it to the 10 years before that, which suggests there’s a lot of, maybe they’re not in search, but there’s a lot of opportunities there. Can you sort of say a little bit more about that? What does that imply? Why is it happening? Going to keep going?

Dan Scheinman: Yes. Again, at a 50,000-foot level, what’s happened is the cost of innovation and doing a start-up has gone down radically in this age. Back when I started, in the Dark Ages of the last century, when we were still in horse and buggies, most of the innovation was around hardware products. Quite frankly, it was around semiconductors, and semiconductors are hard to build, expensive to build, tricky to build, and you have to wait two years to know if you’ve actually built it correctly. Today, for a fraction of those costs, you’re able to get in market, in months, and to be relatively capital efficient. Plus, the second thing is, we are in the largest transition since client server happened in the last century, in the transition to cloud.

Primarily that’s impacting a lot of things that companies used to build themselves, and now are willing to outsource to vendors who are able to do it, and not only help the companies save money, but also have better access to data. The ability to have cheaper start-ups that can scale much faster, it has attracted a lot of capital. Again, we can argue whether now the pendulum has swung too far, and there’s too much capital in early stage, but it has definitely, there’s a lot of capital in early stage. The other thing I think is quite frankly, I mean, it’s unbelievably impressive what the [A round 00:00:18:02] institutions in Silicon Valley have done.

I mean, quite frankly, the fact that Sequoia has been a market leader for 30 or 40 years, in a partnership of people and the people have changed, it’s an amazing feat of management. Similarly, there’s other funds that have done incredible things. I think a lot of folks have been leery that there’s a market opportunity in those places, because competing with those funds who have built these systems and institutions and products, it’s hard, but at early stage it was chaotic.

It was Andy Bechtolsheim running around writing checks, like he wrote the first check to Google. It was me, it was somebody, it was other people, [Rahm Sharon 00:18:41] and others. When people started to realize, hey, in a world where you don’t need that much capital, you don’t get diluted as much as you used to when you were building semiconductors. Early is a place where you could make a lot of money, if you’re prepared to wait for a long time. There has now become a lot of interest in early stage.

Jackie Whisman: A lot of folks in Silicon Valley tend to discount the role of the federal government in the US innovation system, but historically it’s really played a big role, including in Silicon Valley. Would you agree with that?

Dan Scheinman: I would. I’m a veteran at this point in my career, and I saw the federal government have a couple of very positive impacts on Silicon Valley, first as a funder through DARPA and other things, where the government was actually an early pioneer in funding innovation, but equally important has been the role of the government as a customer. When I first started in Silicon Valley, the government was one of the most important early customers for start-up businesses. That allowed the government to have early access to technology, but also to have a lot of ability to comment and control the roadmap of these companies going forward. Now, of course, over time, what happens is the commercial sector comes in, and the government has less of a role, even when it’s just a customer, but I think the government still has an important role to play, particularly where it’s aggressive on earlier new technologies, and it can help make markets.

Jackie Whisman: One final fun question. What’s the technology you’re most excited about right now?

Dan Scheinman: I think 2021, and beyond, the big issue is going to be security and how we become more secure, and we move from installing bits and pieces of software to attempt to solve little problems, to creating more secure platforms, and of course all the issues around security and privacy. I think that we as an industry are hopefully going to make you and enterprise customers much more secure going forward, and I think that’s one of the more important things going forward.

Jackie Whisman: Well, thank you, Dan, for being here. We appreciate all your patience with our technical issues. We’ll talk to you soon, I hope.

Dan Scheinman: An honor to be here. Thank you very much, Jackie. I really appreciate it.

Jackie Whisman: Well, that’s it for this week. If you liked it, please be sure to rate us and subscribe. Feel free to email show ideas or questions to [email protected]. You can find the show notes, and sign up for our weekly email newsletter on our website, which is itif.org, and follow us on Twitter, Facebook and LinkedIn @ITIFdc.

Rob Atkinson: We have more episodes and great guests lined up. New episodes will drop every other Monday, so we hope you’ll continue to tune in.