Less Venture Capital: The New Model

I’m a serial technology entrepreneur who has always been obsessed with intuitive user experience. So I was instantly attracted to the concept of the “ happy user peak ” and Less Software evangelized by the guys from 37signals.

In my current role as a VC (or “venturepreneur,” as we refer to ourselves at our firm), I have become an evangelist in my own right, but for the concept of Less Venture Capital and “ building value not excess.”

There have been many posts recently regarding what some are calling the Venture Capital Squeeze so I’ll try not to re-state what has already been said. The problem is not that venture capital is a bad idea; the problem is that too much venture capital too soon will hurt the startup if market forces make it clear that an early exit is the best option for the founding team.

The Fund Size Valuation Mismatch

The average venture capital fund size currently stands at $280 million, which presents a problem for VCs focused on investing in early-stage software companies. Generally speaking, the larger the fund, the more money it must invest on a deal-by-deal basis in order to justify the time commitment by the fund. But significant venture funding is not what today’s capital-efficient, Web 2.0 startups need—especially those that leverage the LAMP -stack, open-source frameworks and blog-fueled promotion. The old style of venture capital just doesn’t work for the type of company generally seen profiled on TechCrunch .

I became a VC because I believe that early VC involvement in any venture can add significant value (see: Venture Capital 2.0: Beyond the dark side). I also believe that it is a great time to be an investor. Having been the recipient of venture capital as an entrepreneur I recognize that too much venture capital too soon, is a bad idea. Too much capital too soon can create an impediment for taking advantage of potential opportunities for early liquidity – which, in most cases, is the best route for small startups to take. Om Malik sums this up nicely in a recent Business 2.0 article discussing how Google is now competing directly with VCs for certain deals:.

VCs looking to fund startups and flip them to Google are facing an unlikely rival — Google. The Mountain View, Calif., search giant has started buying companies on the cheap, before they even make the pilgrimage to Sand Hill Road.

Instead of VCs changing their model to invest smaller amounts, we are seeing an increase in Series A valuations. It’s not that startups have suddenly becoming more valuable, it’s that funds need to deploy larger amounts of capital. Considering the movement towards less capital and competition by the likes of Google, VC’s are increasing the valuations of young companies. The valuation increase enables the fund to deploy enough capital to make the investment worth their time.

Entrepreneurs giddy that their company has just been valued at a significant multiple often take the bait and raise more capital then they need.

The problem is that increased capital is always accompanied by expectations of increased return, which translates to increased time to liquidity and increased market risk. Unfortunately for the entrepreneur, additional capital seldom equals additional return. If the company is going to be sold, the acquisition price has to be significantly higher than it would be had the entrepreneur taken less venture capital to begin with. If it isn’t significantly higher, the entrepreneur stands to lose out on all or a substantial portion of their return. As many experienced during the bubble, this outcome was the norm, not the exception.

We foresaw this problem early last year when we decided to form Venturepreneur Partners. We saw it as an opportunity to change venture capital. Our model is predicated on getting involved much earlier in the process. We leverage our entrepreneurial experience and, in many cases, take on what could be considered a co-founding role in young companies. We fund prudently and roll up our sleeves early enough to add significant strategic value. We help shape the team, the product and the business model. In some cases, when we identify a need that fills a significant market opportunity that has not been pitched to us, we create the company ourselves (see: CollectiveX ).

We don’t wait for momentum to occur and then over-fund in order to gain a significant equity stake in a young company. Instead, we add value early, or create value ourselves , then let the market determine the best route for ultimate success.

This is our model… and we’re sticking to it!

Posted by Clarence Wooten on December 04, 2005
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