Xconomy Bookclub: Village Capital CEO Tackles Innovation’s “Blind Spot”

Xconomy Texas — 

Silicon Valley has written the playbook for building innovative companies that have transformed the global economy.

But it doesn’t hold the exclusive patent on the only path to innovation. That’s the view of Ross Baird, the co-founder and CEO of Village Capital, a Washington, DC-based social impact venture firm, and author of the new book “The Innovation Blind Spot.”

“The American dream has been replaced by the Silicon Valley dream, and that dream is only accessible to a tiny percentage of the population,” Baird told me in an interview.

In essence, he says that dream has increasingly become the exclusive realm of a narrow group of people—think Mark Zuckerberg-esque, Ivy League education, young, and connected.

“We must find—and promote—entrepreneurs and innovators everywhere, not just those who went to the best schools, know the right people, and live in the most developed innovation cities,” writes AOL founder Steve Case in the forward to “Blind Spot.” “We need everybody on the playing field if we’re going to remain the most innovative, entrepreneurial nation in the world.”

Take venture capital as a proxy for who are America’s innovators. Today, Baird points out that an overwhelming majority of funding goes to founders in three states: California, New York, and Massachusetts. Women founders only receive 5 percent of funding, while just 1 percent goes to African-Americans.

Money is the lifeblood of an innovation ecosystem. Without it, young companies die. But if that key ingredient fails to reach large parts of the population, Baird writes in his book, “the idea of entrepreneurship as a meritocracy is wrong.”

The problem is the practice of pattern recognition, which causes investors to make future investment decisions based on what they’ve seen succeed in the past. “There’s been very little innovation in how we find ideas,” Baird writes. The “two and twenty” compensation model for investors that is used by most venture firms hails from the need to raise capital to fund whaling expeditions in the 1830s. “The term ‘carry’ is still widely used,” he writes. “But today it’s being used to chase unicorns rather than whales.” “Carry,” or “carried interest,” is the investor’s share of profits from a venture.

Today, that system values short-term profits over the long-term success of businesses, leading to quick exits rather than building up corporate institutions that will provide solid employment and economic growth. Looking for the next Mark Zuckerberg might seem like a good idea, he says, but that strategy blinds you from seeing the other innovators who are tackling problems that someone like the Facebook founder might not see.

Baird illustrates this bias by comparing the stories of two founders: Elizabeth Holmes and Lula Luu. Holmes, the founder and CEO of Theranos, the blood testing company that, despite drawing early accolades, comparisons of Holmes to Steve Jobs, and a $9 billion-dollar valuation, never turned out to be a revolutionary game-changer. Instead, it declined under a barrage of lawsuits after its testing technology came under question in 2015.

Pattern recognition—Holmes moved in powerful circles, with people like Henry Kissinger and Oracle founder Larry Ellison on her board, and attended Stanford University—helped foster investors’ eagerness to make Holmes one of the youngest self-made millionaires in the world.

In the meantime, entrepreneurs like Luu, a Vietnamese immigrant, struggle. After earning a PhD at the University of Kentucky, Luu and her partner studied the effects of extreme poverty on rural populations. Their conversations with fisherman led to the idea for Fin Gourmet, a business that puts underemployed fishermen to work catching Asian carp, and hires rural employees to process the fish and sell it to mainstream markets. Baird writes that Fin Gourmet was profitable, grossing $1.5 million in 2015. (Village Capital invested $50,000 in Fin Gourmet.)

“Despite impressive revenue growth, they have struggled to get more resources,” Baird writes.

An interesting wrinkle that Baird notes is that crowdfunding, which operates outside of a traditional angel/VC-type funding system, shows a different demographic pattern among the entrepreneurs who receive investments. Half of founders receiving investments through crowdfunding platforms are women, at least five times the percentage of women who receive venture funding, he says.

Baird, naturally, talks about the investments Village Capital has made to illustrate the firm’s “one-pocket” approach to investing, meaning you can do well and do good in the same investment. Two-pocket investing is what typically happens, he says, where founders make their money through their companies—one pocket—and then set up foundation or invest in social enterprises from the other, second, pocket.

Like many other impact investing groups, Village Capital makes its funding decisions based on the idea that there are viable businesses that capital markets wouldn’t traditionally fund, but that have enough potential so that an investment wouldn’t be pure philanthropy. And, a lot of the time, those companies are in areas that serve the greater good, such as fintech and health IT for underserved or normally overlooked populations.

While Fin Gourmet, mentioned above, focuses on rural workers without many employment prospects, another Village Capital company, fintech startup Lendstreet, helps people reconcile their debt. Following the financial crisis in 2008, Jerry Nemorin saw a need in helping families struggling with crushing debt.

But as a Haitian immigrant based in central Virginia, Baird writes, Nemorin did not have the sorts of relationships that resulted in early-stage investment. Baird quotes Nemorin as saying: “When it comes to pattern recognition, living far away from VC funds in central Virginia, as a black guy, solving a problem for poor people, I was 0 for 3.”

Nemorin eventually did make a few key connections and did move out to the Bay Area. But, for Baird, the question is, what about similarly talented founders who can’t pick up and move to one of the most expensive places in the country?

Baird says Village Capital’s strategy is deliberately looking where others don’t: in “flyover country,” among women and minority founders, who are working on “real-world problems.” He says 40 percent of Village Capital’s portfolio companies are led by women; 20 percent are people of color. Only 10 percent of the companies are from the top venture-getting states of New York, Massachusetts, and California.

That strategy works, he says. “Ninety percent of our companies are still surviving and growing seven years in.”

Silicon Valley is instead focused on “putting billions of dollars into how to make mobile advertising and clickbait news more effective, and nudging people to buy more stuff.”

Certainly, Baird isn’t the only investor evangelizing a bigger tent for innovation. AOL founder Case is currently touring the upper Midwest with his “Rise of the Rest” tour, which is designed to highlight opportunities in non-traditional innovation hubs. (Along for the ride is JD Vance, the ex-Silicon Valley investor and “Hillbilly Elegy” author, who has also joined Case’s firm, Revolution.)

In “Blind Spot,” Baird also points out other firms such as Backstage Capital in Los Angeles, Lotus founder Mitch Kapor, and IndVC, a Mumbai-based firm that concentrates on businesses that want to stay independent. “The good news here is that there are a lot of people thinking differently,” Baird told me. “They’re too small to matter in the eyes of Wall Street, but they’re gaining a lot of momentum.”