Small Funds, Big Risks

Matt Marshall’s article Venture Capital Survey: Small Firms Make a Splash makes the case for small funds and Angels being the primary driver for entrepreneurship in Silicon Valley. This is roughly true, with a few exceptions:

– Not all deals offer leverage to the small investors. If a deal needs more money subsequently, the best way to get returns is by staying in the deal, pro rata, rather than getting forced off the Board, and worse, washed out from the deal via “restructuring” and “liquidation preferences”.

– This automatically means that capital intensive deals are not for small investors. The best deals for small investors, in fact, are micro-cap, built-to-flip deals. Google was an exception, not the rule.

The gap in the market, right now, is the funding source for big ideas that need big capital and high risk-appetite, but can open up big new markets. If small funds try to get into such deals, they will inevitably get washed out. An experienced entrepreneur, knowing the dynamics, will not try to bootstrap such a deal, as a similar level of dilution will follow, washing out the entrepreneur’s capital investment.

Investing in such ideas takes a style of vision and risk taking that John Doerr had mastered. It is the kind of investment that creates huge industries and lots of associated startup activity. It is, therefore, not viable at the moment to go for a $5-$6 Million Series A based on a powerpoint pitch & financial models. It was, however, very viable to raise substantial money on a powerpoint pitch in the late nineties. By and large, it is better this way, since the junk that got funded then was outrageous.

However, there are deals and ideas that still warrant financing in this mode. I’d like to see the next John Doerr step up to the plate. As it stands, large VCs are taking “wait-and-see” approaches to highly speculative deals, hoping that some idiot Angel investor or entrepreneur would jump in, help bootstrap, and take out the startup risks. And judging by the newly minted “Angel Investors” and their inexperienced investing, I am sure many such sitting ducks will lose their shirts in the process.