Venture capital remains a challenge for startups

Published in UT San Diego, September 18, 2012

The MIT Technology Review recently interviewed Fred Wilson, managing partner at Union Square Ventures, about the future of his industry. The most striking part of the interview?

“I don’t think there’s too much money sitting around. I think there’s too much money in too few hands. So when six white guys in suits control two-and-a-half-billion dollars, that’s not a good thing. Instead of being allocated just to one firm, it would be better if that two-and-a-half-billion dollars was allocated to 25 firms at $100 million each. It would lead to more diversity or people trying more things: data sciences, urban sciences, transportation, energy, materials science, and many others.”

Snap.

Of course, that is not the way the world really works — in part because the leading venture capitalists like to co-invest with others like themselves. Next week, one of my companies is making the trek to Sand Hill Road to get a couple of term sheets. One of the biases we have seen is this one: “We like the deal, and we would lead, but only if you get another tier 1 investor.” In other words, go find someone else like us, and then we will do the deal (meaning someone else who believes in your numbers, market size and competitive advantage etc.), and with whom we have co-invested before, and oh by the way, with the two of us together, we will probably have pretty good leverage to beat your brains in.

And what is with this “tier 1” syndrome? Who does the anointing? Is there a handbook? Is there a secret tier 1 society like the Skull and Bones at Yale? My personal mantra is pure Groucho Marx: “I wouldn’t join any club that would have me as a member.”

However, what this means for the future of startup financing is problematic. For tech companies, the classic venture round will continue to be elusive and very competitive. Angels will continue to be the first line of defense. To quote one local VC, “You will have to do a lot with very little.”

Our previous wanderings on venture capital provoked a few annoyed capitalists. So here is an apology. Venture capital partners do not “cut and run.” In fact, they are stuck with their picks for seven to 10 years.

In fact, after considering the situation more carefully, I actually find myself feeling sorry for venture capitalists. After all, they are not the CEO, they do not get to quickly start another company if the first one fails, they do not get to make the decisions, and they can only influence the direction of the company. Yet, they have fiduciary responsibility for a lot of other people’s money, and if they have to do surgery (replace the CEO), it is often difficult, expensive and bloody. So to all the venture men and women, in all the gin joints, in all the towns, I offer my condolences.

What has emerged to challenge conventional venture capital is the rise of the corporate/strategic investor, what the Harvard Business Review calls, “The New Corporate Garage.” The life science industry has been doing this kind of deal for years, and now the high tech industry is finding it profitable to dance with the corporate elephants. Here are a few things the big boys bring to the table — global infrastructure, strong brand reputation, partner relationships, scientific knowledge, experience with regulators and process excellence.

I know this to be true from personal experience. I have a small alternative fuel company. We could never get a nickel from a VC, but we got millions from two corporate partners. Financing your dream is a brutal exercise and you need to not only think outside the box, you need to look outside the box.

Rule No. 136

Do not keep looking to dive into the same swimming pool if there is no water or it is filled with alligators. The pretty ladies sitting by the pool can be friendly and often own the resort as well.

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