Welcome to Silicon Valley 2014

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Welcome to Silicon Valley 2014

Venture Capital ain’t what it used to be, and they most likely never will be again.  When the bankers took over in the 2000s and began treating Venture Capital like the asset class it was, the passion for company-building began to drain out of the business, until today when it is almost gone. That passion that created iconic technology companies, was replaced with projections and valuation tables that number crunchers use to mitigate risk. 

What is the greatest risk in Venture Capital?  Startups, the very thing in which they are to invest.  How to mitigate that risk? Put less money at stake in a “capital efficient” model.  What has “capital efficient come to mean to today’s venture investors?  Do more with less, including less (or no) pay for the entrepreneur.  How venture capitalists make money?  Management fees, which come almost regardless of investment success, and carried interest delivered via preferential investment terms.

In other words, venture capital is aligned today to shift the risk to entrepreneurs and the upside gains to the investors. Your labor.  Your IP. Your sweat equity. That’s how they do it.

Back in the day, an investor was willing to roll the dice on an idea.  Today, the only person seemingly willing to do that is Elon Musk.  The rest mitigate risk by lowering labor costs while maximizing returns of a startup’s IP.  If yours fails, no problem. They haven’t put much into the company and they have spread the risk through the portfolio, for which they still get hefty management fees.  Sure, there are still a few risk takers, but make no mistake the back office is the boss.  

But wait, there’s more.  The trend is to decentralize this strategy in market.

“The thing that has really changed in the past couple of years that hasn’t been internalized by everyone is that startup costs are really very, very low,” says Cegłowski. “Even compared to 2008 it costs very little money to do stuff. You have these technologies that are pretty good at scaling up … but it’s still free, open source software. So as long as the labor is free, you’re fine.”  - Maciej Cegłowski, CEO of Pinboard

Low cost comes at a price and it is you.  The ever-building expectations is for you, dear entrepreneur, to do more with less.  Billion dollar exits on minimal capital in are the flavor of the day.  It is a distortion field that is warping legitimate investment models.  Here is how it works in a nutshell.

  • Entrepreneurs are giving up proportionally more for less, in multiple stages that result in death by a thousand cuts.

  • Limited partners hear this information and decide that startups should be funded with less to get more.

    • A average of $20B is invested by venture, a number largely unchanged over the years, except now it is invested in smaller and smaller chunks, by more and more angel and small-time investors.

  • Venture Capital is pressured to invest less in each dreal or tranche deals into oblivion

    • Only 3,700 deals per year are funded by Venture Capital on average.

  • Venture firms have raised the bar on risk assessments while trying to keep enough dry power to keep pro rata in older deals.

    • 2.7% to seed, 44% to early, 26% to scale, and 22% to late

  • Angel investors to fill in the gap funding deals that are too small or unproven

    • Angels also exhibited a decreased interest in early stage investing with 33 percent of investments in the early stage, down from 40 percent in 2011

  • Incubators and the raft of smaller workshare spaces are funding smaller and smaller deals

    • In contrast, Alejandro S. Amezcua of the Whitman School of Management, found that only 4% of his sample or 655 incubated firms managed to exit their incubator, over an 18-year period, having spent an average of 3.84 years in their incubator

    • They invest $250K and less.  The newest numbers are driving to $50K

  • Avoid the Series B Trap.  Check out this site which covers those points

In other words, Venture is no longer in the business in venture funding.  Angeles have become too risk averse given the pressures of follow-on dilution to invest in the small deals that Startup 500 and Mr. Ceglowski fund.  Angeles have to move up to larger deals leaving the numbers game to smaller and smaller players.  This pressure is constantly reducing the amount of funding available to a deal startup.  A race to the bottom if you will.

Sharing your vision, insights, or IP for a handshake, goodwill and a small check will most likely result in your first cut.  While that might help you in the short run, it’s most likely going to damage you in the long run.  Do not try this in your home industry either.  This distortion field has taken investments in legitimately costly high return businesses and chronically underfunded them.  Medical, Energy, Pharma, and a host of other untouchable industries are now facing unrealistic expectations while Founders and CEO”s of these companies are constantly being asked to do more for less.  All this while investors pour money into the latest social or camera application hoping for that cheap 20X return.  Even Nest, with it’s $3B Google acquisition had to have verciverious support from lead investors who balked at the rates.  Even in that success model, it’s now being hailed as a one off in the hallowed halls of Sand Hill.

So back to you, the doe-eyed entrepreneur.  You can look at this model and decide it’s for you.  Or, you can choose another path.  A sustainable business model that seeks to get and please real customers first.  Don’t rush to fund when sales will do.  More importantly, be with your customer base.  Don’t run off to Sand Hill expecting to score the lottery.  But if you do, be sure you understand the impact it will have on you and your vision.  More importantly how it will force you to live under expectations that most likely have nothing to do with your business or needs.

You are now expected to create the idea, sell the idea, launch the idea, get customer adoption, deliver at least a fully working product, and hopefully earn some revenue on a budget you would normally have for expenses in your 9-5.  Who has all the talents needed?  no one.  Don’t be fooled into taking any amount of money in lieu of support of your passion.

Sources:

Angel investment

Venture investment

Incubators

Great In and Great Out_GIGO
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