Don't Be An ATM
Fraser Kelton has an excellent post on the challenges facing the venture business up on his Disruptive Thoughts blog. I don't know Fraser and have no idea how he's related to the venture business, but he makes a number of excellent observations, starting with this one:
A market is ready to be disrupted when the performance of the product overshoots the requirements of the user. Does this apply to the venture capital industry? Yes. Traditional VC’s have overshot the “needs” of start-ups. It’s interesting that this gap widened, suddenly and significantly, because of large movements in both directions. During the late 90’s venture funds raised too much money and, after the bubble popped, there was too much capital chasing too little opportunity. The performance of the product – available venture capital – snapped upwards and away from the “customers” requirement. The Economist had an interesting article on this in March of 2005 and there was an paper examining this trend released last week.
While this fund raising frenzy was occurring, the “needs” of the customer (start-up companies) fell. The cost of starting a business has collapsed. Advances in technology have had a substantial impact on the cost of starting up. Outsourcing has also had an impact on the cost. Start-ups now outsource work to highly skilled individuals, all over the world, at lower costs. The decrease in the cost of starting a business has caused the needs of start-ups to snap downwards and away from the required performance of the “product”.
These two movements happened suddenly and at approximately the same time, resulting in the equilibrium between VC needs and start-up requirements becoming unbalanced. It’s this unbalance in the market that opens the venture capital industry up to disruption.
I don't know about this "disruption" theme, I honestly don't see the venture business headed for the same kind of hurt as the telecom business or the newspaper business. But it is true that the supply of capital has increased signficantly and the demand is on the decline. Those VCs who recognize that and adjust accordingly will be better off in the long run than those who don't.
Fraser goes on to recommend five steps to take advantage of these trends:
1 - Customer Service
2 - Partial Founder Buyout
3 - Focus on a Niche
4 - Don’t Be An ATM
5 - Raise Less. Invest Less
I am not a fan of the Partial Founder Buyout. How is it in the interest of the entrepreneur to buy out his/her stock for a fraction of what the VC is going to sell it for in 3 to 5 years? I understand all the arguments about risk mitigation and alignment of interests. But the killer entrepreneurs I have met over the years would never go for that. And I love them for it. Solution number 2 is not for me.
On the other hand, I love number 4. I never want to be an ATM for an entrepreneur. That is a recipe for disaster.
I would suggest one rule and only one. Be the entrepreneur's partner. Help him or her. Be there for them. Support them. Counsel them. Share the risk with them. Have fun with them. Laugh and cry with them. And make boatloads of money with them. It's a time tested formula and it will work forever.