It’s time to talk about Decision
2008, and I don’t mean who should be president. The more pertinent decision for entrepreneurs is how to fund their startups.
There’s
no simple formula to determine whether you should bootstrap, raise angel money
or take a venture capital round, and a changing landscape has complicated the decision.
Angel investors are committing larger amounts of capital in more-sophisticated financing rounds. At the same time, some venture capital firms are moving downstream, putting smaller amounts of money to work while fighting to get in earlier on the best deals. And the falling cost of starting a company has let many Internet engineers move forward with developing and launching a product even before they have to raise money.
With Web
2.0 entrepreneurs gaining more ownership, and thus more power to make
decisions, it seems big money has lost its sex appeal. It has me wondering: are
venture capitalists losing their power and prestige?
“Entrepreneurs can now dictate the terms and they’re getting multiple
term sheets,” says Bill
Rodini, Managing Partner at Revolution Partners, an investment bank
specializing in mergers and acquisitions and private capital fundraising.
Because the pendulum is swinging towards the entrepreneurs, venture
capital firms are forced to compete for fewer deals, Rodini says.
“There is a lot of money out there
and a limited number of high-quality deals, so it’s inevitable that the power
shifts. What happens over time is that this
competition reduces returns because VC’s are paying more for these deals,” he says.
Could valuations go through the
roof, just like our gas prices have lately? Given the valuations placed on companies like Ning and Slide, some would argue that they already have.
And that’s with some of the best-known VC shops sitting on the sidelines.
“The
typical big venture capital shops aren’t thriving in the interactive space,”
said Sarah Lacy, author of Once You’re Lucky, Twice You’re Good: The Rebirth
of Silicon Valley and the Rise of Web 2.0. ”Just
look at Ning, which was bootstrapped, and Slide, which used one venture capital
round and then went to work with partners on Wall Street.”
One VC sees it as the sign of a healthy marketplace.
“I don’t necessarily see a shift in
power, but rather a checks and balance between the venture capitalist and the
entrepreneur,” said Jai Choi, Principal at Partech International, which is
invested in RockYou and Spoke Software. “It’s a simple concept of supply and
demand. The options available to consumer Internet entrepreneurs have allowed a
more balanced view of capital and resources.”
Startup
founders, such as Triggit’s Susan Coelius Keplinger, are grateful for this
longer list of options. Triggit secured a seed round in the form of a
convertible note from Bay Partners, a San
Francisco venture firm.
“We decided
not to pursue a full round because of all the complexities involved in such a
decision. From valuation, to board seats and control, we realized Triggit was
not ready for that step,” said Keplinger.
“A
convertible note provided a great alternative – a smaller amount of money but
it still enabled us to get our feet wet with the venture community and begin pumping
larger sums of money into our company.”
This “pump
a little, drive a little, pump some more, drive some more” strategy is one of
the interesting trends I’ve witnessed recently. Another, likely caused by the
recession, is creative sourcing. Similar to how Internet startups are able to quickly
secure revenue from various sources, it seems they’re also learning how to
build an investment structure from different sources, thereby forcing the
venture capitalists to strengthen their offers and prove their value-add. As
long as these sources don’t conflict, this combo platter could play out in
everyone’s favor.
Hope
Schultz, founder of WebVet, an online resource for pet owners, pointed out
another trend: a huge difference in attitude between east coast investors and
west coast investors.
“It seems east
coast venture capitalists prefer more conservative, realistic projections and
west coast venture capitalists want projections of a $100 million business in
five years. East coast investors freak out when they see the ‘hockey stick’
projections,” said Schultz.
It’s up for debate what will happen
to the once-hot Silicon Valley venture funds
in the next few years. Some expect the large, reputable funds will weather the
storm because of the intellectual capacity of their team, while others believe
success depends on specific strategies, market coverage or geographies.
Partech’s
Choi thinks that the venture capitalists who are more mindful of customer
service will be the ones who survive long-term.
“My
personal belief is that this is a service-driven business. We‘re not celebrities
or rock stars; the entrepreneurs are,” said Choi. “We get a bad wrap due to the
confident nature of partners and investment professionals.”
Thank you Jai – you said it so I
didn’t have to.
