Tech Making Traditional VCs Obsolete

Via Wired.

Bob Rice gives us his take on the VC landscape:

Well, the classic V.C.’s simply have too much money under management, and too expensive a talent pool, to waste time looking at investing anything less than $10 million in a project. Meantime, no entrepreneur wants to give up equity by taking in more money than he absolutely needs. So, when it only costs a few million to get a serious new company off the ground, how can the V.C.’s really play? They have to find places to make gigantic gambles, usually overpaying because the other big V.C.’s are also trying to invest in the few really big-dollar opportunities out there. It has become a system doomed to failure.

I think Bob hits the nail square on here. What it takes to start an online service today is quite small (I know, I’m doing it). It isn’t millions… really, to get started it isn’t even hundreds of thousands. Given that what start up is going to give up a huge share of the company to take a massive VC investment – and all that goes with it.

All too often what comes with the large investment is an over-emphasis on growth (specifically subscriber growth). That in and of itself isn’t a bad thing – provided you are ready for it. Often what is required is small amounts of cash to invest in determining how to tap massive growth – while ensuring that both the technology and the business (processes and people) scale. If they don’t scale what is the point of the rapid growth?

All too often this is what drives the fad/flash in the pan tech sector. Find something cool… publicize the heck out of it… grow really fast… disenchant users because the company isn’t mature enough to handle the growth. I refer to this growth stage as “chucking them off the back of the bus as fast as you can load them on the front”.

More after the jump…

The challenge – for those who want to create a business – is that you have to be careful about how you present yourself. If you tell an investor that you don’t want or need 3-4 million dollars they may hear “low valuation, low return”. When in fact what you mean is “to achieve a valuation of 25 million I believe we only need 400k” or “3 million today is a waste of your money, invest 400k today and we’ll take the 2.5 in 2 years”.

What that tells the investor is either:

  1. This person has the fundamentals completely wrong
  2. This opportunity has great multiple potential

The difference is how well you can tell the story.

Full Article:

Bob Rice has had many careers. He was an attorney with the U.S. Department of Justice, a partner at law firm Milbank Tweed Hadley & McCloy, C.E.O. of a tech startup, and now runs merchant bank Tangent Capital, which he founded in 2005.

In his spare time, Rice managed to write Three Moves Ahead: What Chess Can Teach You About Business, one of the more interesting business reads to come down the pike this year, in which he uses the tried-and-true strategies of chess for insight into running a business.

Today, he’s squeezing in some blogging. One day. One place: Portfolio.com.

Ah, those Sand Hill Road visionaries, the venture capital guys who finance the future and dictate the trends. It must be fun out there, getting the first glimpses of tomorrow. But suddenly there’s a wonderful irony at work: That very future is destroying their industry.

Newspapers are rife with stories about the decline of big V.C. investments, pointing to the trend as a sign of a more conservative investment environment. But I don’t think that’s really the issue.

Instead, something much more profound is going on: The basic V.C. model is broken. And new technology is driving a much more efficient system for capital allocation to startups.

In fact, technology is largely at fault both for what’s wrong with the V.C. world and for what’s replacing it. The problem with the industry is this–it’s just too cheap to start new companies these days.

Virtual offices allow talent to gather from around the country to work on a new idea without having to quit full-time jobs too early. Servers, computers, and bandwidth are essentially free, and a robust telecommunications platform can be rented for a few tens of dollars a month. Software development can be outsourced without taking on big fixed costs. There are countless programs to manage customer relations, mine contacts, handle the books, and plan and monitor projects. And of course, the internet has reduced the costs of finding customers and testing new concepts to nearly nothing.

Okay, so what? Well, the classic V.C.’s simply have too much money under management, and too expensive a talent pool, to waste time looking at investing anything less than $10 million in a project. Meantime, no entrepreneur wants to give up equity by taking in more money than he absolutely needs. So, when it only costs a few million to get a serious new company off the ground, how can the V.C.’s really play? They have to find places to make gigantic gambles, usually overpaying because the other big V.C.’s are also trying to invest in the few really big-dollar opportunities out there. It has become a system doomed to failure.

The flip side of the story is the rise of angel investor groups. These investment consortiums have always been ideally positioned to provide $500,000 to $5 million equity injections; but until recently, that wasn’t enough to get a serious effort off the ground. More fundamentally, however, they have historically not been terribly investor-friendly, largely because the individual members have other occupations.

The individual members didn’t work in the same place or even at the same times, so angels were terribly inefficient at evaluating transactions, sharing information, and negotiating and documenting deals.

Those days are over, thanks to software developed by David Rose, founder of the New York Angels (yes, I belong). Angelsoft is a wonderful collaboration platform that manages deal flow, helps match talent and expertise to projects, provides easy-to-use data rooms for potential investors, and generally drives the investment process. It combines project management and social networking in a way that, for the first time, makes the angel process efficient for both the company seeking capital and the potential investors.

The big news now is that, in a period of just a couple of years, over 400 angel groups around the globe have standardized on the platform. That means, of course, that they will also be able to share deals between themselves, vastly expanding the capital and expertise available for any given project.

And entrepreneurs can now create one submission to get access, literally, to a world of sophisticated, organized investors. It sounds like a revolution to me. Check it out at the group’s website.

And so, once again, technology is driving a paradigm shift. But this time, it’s France in 1789: The progenitors of change are becoming the victims.

[From Tech Making Traditional VCs Obsolete]

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