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Small Funds, Big Risks

Posted on Tuesday, May 16th 2006

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.

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I am one of those goats you are talking. VC with vision are diamonds in ruff. They are rare breed.
The quest goes on.

Good perspective

Ramana Kovi Friday, May 19, 2006 at 5:44 PM PT

Increasingly the visions are remaining as vision due to the lack of implementation and proper delivery. Though I don’t have statistics of how many great visions finally didn’t make it even after good support and investment of the VC funding due to poor implementation and the limitation of the entrepreneur to see through the complete execution process, I guess the number would be the major % of failure. We need a team of people behind all good visions to make it sucessful and I don’t blame the VCs for that. My belief is funding is still not a problem if the right kind of team is built up to make the vision true.

I have the experience of meeting people who are responsible for the delivery of great visions and I am not much hopeful looking at them and their excitement level that those visions will ever get executed. A great start at the top doesn’t always make a venture sucessful. Our industry is lacking that a lot in the current setup. Our current leaders and entrepreneurs don’t have time to build new leaders who can take forward their vision – a serious problem. I don’t complain about the investors to wait and see whether a team has proved themselves that they can deliver a good idea and then invest to take it to the next level.

Santanu Monday, May 22, 2006 at 12:08 AM PT

Santanu, The biggest issue in the venture market right now is not team, but market adoption. VCs want to see whether consumers adopt a solution or not, before they put in money. That’s the phenomenon that this article addresses. If you see the founders of Facebook, for example, I can guarantee you, they were not “fundable” in the traditional sense of the word. Nor were Steve Jobs and Steve Wozniak when they founded Apple.

Sramana Mitra Monday, May 22, 2006 at 11:48 AM PT