Miniaturization of Venture Capital

There have been a couple of discussions on venturewoods earlier regarding angel funding models, including Ycombinator. An excellent article on Read Write Web outlines the challenges the venture capital is facing. Amongst the salient ones include:

  • Lowering cost of doing a startup and taking it to critical level
  • Reducing role of distinctive technology in more and more (IT) startups
  • Growing openness to acquire companies relatively early by likes of Google
  • IT doesn’t matter” – its hard to build large enterprise IT companies

There seems to be an opportunity for VCs to start investing even earlier in the cycle, and be able to make money not by one or two hits, but by more consistent performance across the portfolio, each exit perhaps being relatively smaller in absolute size than what VCs are used to today.

This calls for a new model of how venture firms are run, and in my view, opens an opportunity for a technology-enabled model. In order that each partner may still run an equivalent amount of money with smaller deals, the number of deals grows. However, given the early stage nature of these deals, the involvement grows. The only way to manage this is to critically examine the process and use technology to make it as efficient as possible. Some examples of such technology intervention would include an extranet platform to keep updated on interesting prospects, regular updates from portfolio companies linked to their own reporting systems, collaboration amongst investment professionals, and perhaps even content feeds relevant to each portfolio company and including its media buzz, competitors etc.

Amongst our own angel funding activities at the Indian Angel Network, I think there are significant opportunities to create a collaboration platform for angel investors to work together and make progress towards making investments. May be something like Angelsoft ++

From entrepreneurs’ perspective, what are the biggest inefficiencies in the venture process, which can be fixed by use of technology? Without compromising their ability to make as much money as they want to make for their investors, how do you think VCs can adapt themselves to suit the new age entrepreneurs better?

10 Responses to “Miniaturization of Venture Capital”

  1. Anthony Kuhn says:

    Innovate or die applies to VCs also. I think your ideas are spot on with regards to the need for venture capitalists to embrace the very technologies they are investing in. And more at bats means more possible hits, so why not lower the bar of what’s an acceptable risk to take into account the lower cost of getting in the game? I cross-posted on your piece to http://blog.innovators-network.org The Innovators Network is a non-profit dedicated to bringing technology to startups, small businesses, non-profits, venture capitalists and intellectual property experts. Please visit us and help grow our community!

    Best wishes for continued success,

    Anthony Kuhn
    Innovators Network

  2. SunilB says:

    Alok:

    I said that VC’s do not risk their lifestyles (for the term of the fund). Even if the fund doesn’t do well, they are well compensated. I dont know if this is true for India centric funds but I presume so.

    As far as raising the next fund that is a marketing (spin) exercise. Now the phrase I see being used is – we are in the top 25% of all VC firms. That currently means that we are returning less than the DJIA, but if institutional money has a line item for VC and they are limited or shut out of the top funds the money finds it way into this top 25% and the cycle continues.

    But you are right over time the investors will not tolerate poor performance but that will be a while.

    I think a broader set of VC’s will get back to making their money through carry – I sure hope they will, but it will be in new areas with the same hit centric model rather than in the same areas with a modest hit model.

    By the way is your definaition of a modest hit $100M? Those do fit the VC model just fine.

  3. Alok Mittal says:

    Rehan, I think VC investments being less than 1% of investments is not the relevant metric for their impact. The overall wealth created or indirect effects that the silicon valley ecosystem (largely involving VCs) has had is the right metric, and I would be surprised if its not significant.

    The point, however, is that VCs’ business model is not driven by this impact, but by their ability to generate commensurate returns for their investors. And that is the metric that has been under pressure. Sunil has mentioned in his post that VCs are happy making their 2% and thats fine – the truth is thats not fine – if that is what continues to happen, they are not going to be able to raise money anymore! VCs not making carried interest implies investors not making target returns.

    Again, what I am referring to is not lifestyle entrepreneurship, which has and always will survive on non-VC sources. I am talking about being able to make reasonable money on a $100M exit (through earlier entry, higher ownership, more capital efficiency). The “hit model” of VCs was not invented and then implemented – it was what the market threw back at the investment community! Inherent risk demanded hits to balance failures off. If we do move towards moderate returns, investors will have to select lower risk profile, and work towards creating a more leveled model.

    Deepak, I like what you are saying in terms of actually involving less. At Canaan, we have a “seed portfolio” where we put in small money to see which way the cards turn up. Even in the US, with more evolved support system, these land up taking more time. In India, I would imagine far more. It seems that on a broad basis, its hard to reduce engagement intensity (some great teams will come by, will be heavily competed for, and will need little assistance from VCs). Therein lies the need to think through the entire process and perhaps use technology to make it far more efficient.

  4. SunilB says:

    Rehan:

    I am not at all suggesting that they would sabotage the project. It would be crazy for them to have the program if that was their intention. I am stating though that if they do not invest in you, for whatever reason, you will have a hard time raising capital.

    Investing is an equation between fear and greed.

    The investors know that they do not have deep knowledge of the team or the project. When they find that a institutional investor, with an insider edge, is not pulling the trigger, fear gets invoked and pushes people away from the investment.

    The reverse is also true, if highly regarded VC was to invest in your company; often other investors will flock to put money in along side. The vote of confidence from a top firm will invoke the greed factor.

    Now an investor knows this and will naturally use the advantage to help them in their negotiation. They morally justify their use of this advantage as they helped the company get to this stage.

    Non-institutional seed doesn’t come with these strings as they are not expected to invest further.

    As you point out neither really help the company beyond providing capital.

    Of course it may still make sense for a startup to take that form of investment but the entrepreneurs should be aware of the strings attached.

    P.S. It is quite unusual for a VC firm that participates in round A to not participate in Round B.

  5. RYK says:

    Sunil, Happy Dassehra. Looking forward to your post “on why VC’s shouldn’t even play the moderate exit game”.

    Your comment on CRV’s model brought a big smile to my lips. We Indians have a knack of looking at the downside in everything first and then looking at the upside. The way I see CRV is that because they have their own money invested in you, they will do everything possible to help you raise money and make your project a success. They would be crazy to sabotage your project just to make you unattractive to other investors and have probably worked out a model where they can stay neutral if not positive on your project even when not investing further.

    Also I don’t think the finance industry works the way you have projected; to cite a simple parallel, just because your own bank won’t lend you money, it does not mean that other banks will refuse. I think each institution evaluates on its own internal criteria 1st and then checks with others. In Venture Cap too there are many cases of Series B raised from institutions other than Series A investor.

    India desperately needs CRV style quick start investing. We are a emerging nation with emerging industries and thus most projects are at seed and early stage, not at VC stage. VC many not find too many $10M opportunities currently. On the flip side, there just aren’t enough angel/seed funds. I have been closely tracking the angel/seed scene in the 3 quarters past of 2007, there have only been 4 angel/seed level investments !

    I also believe that VCs high involvement in projects is over rated in terms of real value addition. In a recent survey by INSEAD, entrepreneurs rated value addition no. 3 out of 4 criteria of the benefits they received from having a VC on board. No. 1 was capital.

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