15 October 2009

"new school" venture funds

Over the last six months I've spent a fair amount of time responding to people who have made claims to me like:
"Venture Capital is broken/dead"
"Venture Capitalists are an unnecessary evil"
"VCs don't add value"

My responses can be summed up as "there is no one 'Venture Capital' anymore (if there ever was) and this sort of generalization is really problematic."

Inevitably in these conversations, I've mentioned a new type of Venture fund - a sort of "grouping" of sources of early round capital - that I'm quite positive about. When asked about this "new school" of venture I've always ended up simply listing a bunch of people and/or companies that make up a core of what I am calling "the new school." I've had a hard time actually defining what it is - beyond who is in it.

Today there are two blog posts (from two of the "leading lights" of this new school) that to me are incredibly good illustrations of some of the very big differences between this new school and the previous model of Venture - and which can be used to understand what the new school is.

First up is from Fred Wilson (a sort of eminence grise of the new school). In his "The 'We Need to Own' Baloney" post, Fred goes after Venture Funds that talk about the percentage of a portfolio company they need to own.
The VC business is not about grabbing the largest slice of the pie. It is about getting involved with very big pies. If you let your need for the biggest piece keep you out of the pie eating contest, you will lose eventually.
When I used to consult for entrepreneurs, I used to constantly run into the emotional challenge many entrepreneurs have when it comes to "giving up" percentages of their companies. With all too many investments, arguments came down to "I don't want to give up 22% of the company." I constantly tried to explain that 95% of $1MM is far less than 55% of $10MM.

I never quite put my finger on the flip side of this equation as one of the key differentiators between the old school and new school VCs. But it's a perfect illustration IMHO. Whereas the old school built models around assumed percentage ownership stakes (22%, 30%, whatever) - the new school has models that do start from this model. In part - this is because the new school VCs are not fixated on control. And yes - that's a pretty profound statement I'd say.

The second post is from Josh Kopelman (one of the VCs in this new school who is most respected by the others within this classification). In his post, "Company Math vs VC Math", Josh responds to Fred's post above - and extends it to take on the fundamental models underlying traditional Venture that require the focus on percentage ownership (and control).

Most importantly, Josh extends the logic to demonstrate not only how these models have created the problems behind many of the "Venture Capital is broken" articles, comments, etc., but also how these models have created conflict between entrepreneurs and investors.
A company's outcome should drive VC returns. When VC's required returns drive company's outcomes, it's a recipe for trouble.
The move from the original (traditional) Venture Fund model to the "mega Fund" model that arose during the dot-com era has created some significant problems all around (detailed not only in these posts but in many other bits of writing and discussion all over the place).

It has also, however, created opportunity. And this is where the "new school" of VCs fits into the equation. These new VCs have set up funds that are reactions to the issues with the mega Funds. In some cases they are returns to the traditional models of Venture. In others they are brand new models. In all cases, they seek to address the fundamental problems that have been created as a result of these mega Funds.

These new school VCs have, in common, a focus on the entrepreneur as the "customer" (rather than the LP as the "customer" or even worse the partners themselves as the "customer"). They are focused on smaller funds and smaller investments. In many cases they're focused on capital efficiency.

In most cases they are not focused on huge multiples on their wins. They usually do not require set (specific) ownership percentages. They do not have the massive minimum investment size that the mega Funds have.

What is really interesting is the implications of these changes in the model. Many of these VCs are far more active advisers than partners at the mega Funds. But a lot of the time they don't really care about (or even don't want) Board Seats. They're not control freaks. They're really likely to invest in entrepreneurs over businesses (and often in products over businesses). They often invest very early (and very quickly). They're often more open to looking at start-ups that are not perfect fits for their portfolio strategy (and are often willing to look outside the usual network/greentech/biotech/consumertech software focus area).

And... they're getting a lot of the good deals.

All I know is that if I were working at one of the large funds - especially one of the mega Funds - I'd be paying a LOT of attention to these guys, because they are looking like the mammals to the mega Funds' dinosaurs.