Archive for July 7th, 2009

Rethinking Venture Capital

Tuesday, July 7th, 2009

The New York Times reports today that venture capital firms are rethinking their strategies due to the lower returns they’re seeing lately. Several venture capitalists quoted in the article are concerned about overfinancing in the sector and argue that VC firms need to scale back their investments and revert to strategies used decades ago.

However, Smeal’s Anthony Warren, director of the Farrell Center for Corporate Innovation and Entrepreneurship, contends that “saying the VC industry must go back to basics misses the point because the basics have changed,” due in large part to angel investors.

Warren explains:

Business angel investors have gotten more organized and wise. In the past, they worked more as individuals on a hit-and-miss basis, and when a company eventually sought venture financing, the angel’s stock ownership was wiped out by the low valuations imposed by the richer VCs. Now angels hunt in packs, and are able to take a company all the way to an exit without facing the valuation pressure from VCs.

Previously, angels were a source of deal flow for the VC funds taking the early stage risks. But the lessons have been learned; angels now avoid taking good companies to VC firms. If the VCs try to compete with angels by going down in deal size, then they will be unable to maintain their cadre of highly compensated partners. Even today, a startup rarely gets the attention of the best partners in a firm, with a junior partner being designated to the board. This will only get more prevalent. 

In addition, it costs much less to build a company now.  The growth of broadband Internet has drastically reduced the cost of marketing and distribution, which were a drain on expensive VC money in the past. Techniques like viral marketing, partnered supply chains, etc., have changed the fundamental business models for a startup. In the past, $20 million was a typical cash need for a startup; now it can be as low as $2 million. 

We now teach students how to grow a company without venture capital funds rather than how to raise venture capital. This is a much more realistic approach in today’s economy. 

Tags: Entrepreneurship, Venture Capital, Warren
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