Loading ...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?
I am neither an entrepreneur nor a VC, so my perspective may essentially be flawed, but I’ve been saying for a while now that VCs need to change the way they work and get more involved with the firms they invest in.
Technology and the cost of technology is the killer factor in it, in the sense that technology as a commodity (hardware and software) is so cheap now that I’ve seen costs of actually building a platform fall by around 90% once you know how to build what you are looking to build, in less than a quarter. Thus, the competitive edge is in the knowledge pool and expertise that an existing portfolio might represent for a VC firm.
Building and scaling websites is no great secret, but new installations and deployments essentially go through the same learning curve that costs money and time, especially in terms of getting the product out of the door ASAP. If this expertise is provided as part of a knowledge pool in a VC set up, it saves both the portfolio company and the VC a truckload of effort/money and gains a competitive advantage that is something a start up working on their own won’t have.
There are more angles to it, like the value of IP owned etc, but that is a different and long story altogether.
“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.”
I have always maintained that the flaw with the VC model is that it influences too few projects. Monish Pabrai wrote in his book Dhando Investor that VCs account for less than 1% of investments in the US and if they disappeared it would make no difference to the planet.
I know some VCs who have been commuting from the US West Coast to India last 4 years even 6 - 8 weeks (ouch !) and have nothing to their name; at best they have 1 or 2 investments. It beats me how they have been unable to find opportunity in this booming economy of ours.
I have never understood this “out the park” hit model of VCs. They claim that because of time constraints they can work on very few projects. I say:
1. Spend less time evaluating each project, do more deals. You need singles just as you need boundaries. Don’t be Sunil Gavaskar 55 not out after 5 days. Play like our T20 boys. Anyway playing more shots increases you chances of of boundaries, taking singles doesn’t mean you won’t get the boundaries, you will.
2. Invest early using Discounted Convertible Notes; way too much time is spent on equity agreements which are 60 pages long. Love the Charles River Ventures model here.
3. Ofcourse VCs and everyone else should automate. It amazes my how manual the VC business is.
4. Angels, do atleast 20 deals a year. If your group is not doing 20+ projects a year, you are not going to get good returns.
How about if VCs actually involved themselves LESS in the early stage of a project? Identify teams that can actually do things on their own, and that you can trust with the money and tell them to bugger off and get the software and real business model done and come to you when it is someplace.
I understand VCs like to have some level of control in the process but for these piddly sums you don’t want to spend too much time fine tuning the model - leave that to the entrepreneurs. Let them come and work with you when they’re more like early stage, when they have the need for the next “tranche” and they’re really thinking big. If they don’t get back to you after three-six months, you know either a) they’re clueless and have lost it or b) they’ve gone and found a business model that allows them to survive and grow with no further money. Both are bad for you.
But b) is worse than a). You can write off a) but b) is like a thorn in your side if the founders have lost sight of scale, in which case you ask for the money back with that convertible debenture you wrote and go find something else.
Either ways, you spend less time post-the-deal, and the auto-filter of three-six months tells you who’s going to win.
As RYK mentions “spend less time ,do more deals”.I take analogy of mistakes equivalent to entrepreneurship.Parameters are
1)Make MORE mistakes (intelligent ones leading to rising learning curve)
2)Make mistakes FAST (learn and unlearn fast)
3)Learn from other’s mistakes (Same mistakes should not be repeated)
This knowledge sharing would be of great worth to a budding entrepreneur.
I have compiled ,collected a lot of content regarding this.But yet looking for a marketable way.
Thanks Alok for your contri on Ycombi.
Alok:
I don’t think there is any technology that will help VC’s deal with small exits. But I will not muddy the comments in this post in case people want to post a set of collaboration ideas. But you have inspired me to post on why VC’s shouldn’t even play the moderate exit game so I will do that.
Also RYK seems to like the CRV quick start model. I wouldn’t take the deal as an entrepreneur.
CRV’s model is big hits. What they are doing with a small amount of money is buying an option to fund you if you seem like you have a big hit on your hands.
When you come back and negotiate the A round, if they don’t agree with you on the terms and don’t invest, then no one else will believe you have a big hit (as the sophisticated insiders didn’t think this was a big hit). So they have a lot of leverage. You will go blue in the face trying to explain to othe firms that it was the terms not the business.
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.
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.
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.
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.
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