VCs have always played a long-shot game, where the rewards from backing a few breakout winners outweigh the losses associated with the vast majority of duds. To manage risk, VCs typically cofund startups through a series of stage-gated investments, where the size and focus of each round reflects a venture’s evolving development needs. Over two-thirds of funded startups turn out to be complete busts, returning nothing to VCs. Only half of one percent monetize an exit of at least $1 billion within a decade of initial funding.
Masa launched Vision Fund to transform the rules of the game. Rather than joining shared VC funding rounds, SoftBank often decides unilaterally whether a venture is worthy of a massive cash infusion–often several times greater than the venture’s ask–at a significantly stepped up valuation. For example, the median size of late-stage VC investments worldwide in 2018 was $35 million. SoftBank led or sole-sourced 18 late-stage funding rounds of $350 million or more.
From a venture’s standpoint, such unprecedented largesse reflects both an opportunity and a threat. Those that accept SoftBank’s offer can tear up their old business plan and shift focus entirely to ramping up organic growth and acquisition. It’s hard to refuse, particularly knowing that SoftBank is prepared to make the same offer to a venture’s fiercest rival instead. As Uber’s CEO Dara Khosrowshahi remarked after accepting SoftBank’s $10 billion investment in 2017, “Rather than having their capital cannon facing me, I’d rather have their capital cannon behind me.”
Son seems to believe that the Vision Fund’s massive capital investments can be used as a weapon to convey sustainable competitive advantage, global domination, and superior returns for his chosen winners. But this thinking is profoundly flawed for three reasons.
1. The notion that one VC can exploit money to achieve sustainable competitive advantage is ludicrous on its face. In virtually every category in which SoftBank is heavily invested—real estate, ridesharing, meal delivery, freight brokerage, hotels, construction—SoftBank is facing well-capitalized and resilient competition. In a world awash in capital, none of SoftBank’s funded ventures has achieved anything close to monopoly pricing power. This marketplace reality has contributed to chronic and escalating losses across Son’s portfolio.
Bewilderingly, SoftBank itself occasionally backs direct competitors within the same business category such as Doordash and Uber Eats in the US and Didi Chuxing and Uber in Latin America. Not surprisingly, in these cases, SoftBank’s competing ventures have suffered deep losses.
2. SoftBank’s philosophy ignores the value of low-cost learning from stage-gated investing, and instead exposed blitzscaled ventures to massive risk and wasted resources. Capital constraints aren’t an inconvenient nuisance for early stage ventures. Rather, fiscal discipline encourages experimentation to optimize business performance in terms of product/market fit, technology reliability, supply chain efficiency, business process stability, and business model viability.
By often investing too much, too soon in unproven ventures, sometimes with minimal due diligence, SoftBank compels its portfolio companies to rapidly scale businesses that still have unproven or deeply flawed business models (e.g. WeWork and Uber), inadequate core business processes (e.g. Brandless, Wag) or weak defenses against competitive threats (Slack). Prematurely picking winners with massive bets heightens the risk that a company’s race for global domination winds up becoming a race to oblivion.
3. Even if weaponizing capital could promote winner-take-all outcomes, SoftBank has been investing in the wrong types of businesses to achieve its goal of profitable market dominance. Ventures in the best position to benefit from explosive global growth exhibit a specific (and rare) set of business model characteristics: a massive addressable market; compelling consumer value proposition; strong network effects and scale economies; inherently high contribution and operating margins; extremely high customer loyalty; which collectively yield a growing competitive advantage and profitable market dominance.
Companies like Alibaba, Facebook, and Google that have exhibited such characteristics didn’t need massive cash infusions to fuel rapid expansion. Their business models generated much of the requisite growth capital from operating cash flow. Alibaba raised only $50 million of VC capital before becoming cash-flow positive in its third year of operation. In 2014, the company’s $6.6 billion in operating cash flow helped Alibaba float the largest IPO in US history. Google raised only $64 million, and was highly profitable prior to going public. Facebook raised $2.3 billion in venture capital and was generating over $1.5 billion in operating cash flow before going public.
