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NYT’s highlighted a report by the International Journal of Entrepreneurship Education yesterday, which claimed the lower start-up costs of l…

NYT‘s highlighted a report by the International Journal of Entrepreneurship Education yesterday, which claimed the lower start-up costs of launching a digital media company is making it less necessary for entrepreneurs to partner with venture capitalist firms when pursuing their big idea.

And they are right: with third-party services available for pretty much everything from hosting to ad-sales investing in a team is less of an upfront cost than it used to be and often entrepreneurs who have the right contacts can find very talented developers to create a product or website for them for equity at first. But I would be careful to dismiss the need for venture capitalists, especially since many like Spark Capital and Sequoia Capital now make small investments in the $250K range (Union Square Ventures also has for years), for the following reasons…

Smaller investors often are not a good fit: Stars like Ron Conway and Marc Andreessen aside, many angel investors can be helpful in providing the funding needed to get a product off the ground, but once launched, entrepreneurs may find that they are in bed with someone who doesn’t know or understand the business at all, but has a major say in its affairs (often the final say). While most intentions are good, this can lead to conflicts that actually inhibits the growth of the company.

VCs have invaluable experience and contacts: Many would argue that half of a start-up’s success comes from knowing the right partnerships to make early on and having the necessary resources to get them done. VCs that specialize in the industry an entrepreneur participates in have probably worked with similar companies in the past and know from experience what generally works and what doesn’t. What’s more they have years of relationship building under their belts and can be very helpful in getting those deals done.

Choosing the right exit is crucial: I met with the CEO of a start-up recently who said anytime he fields a call from someone about potentially buying his company, he immediately forwards them to his venture capital partner. While this is somewhat drastic, the point is well taken – VCs have the right network to get a sale of the company done, know how to navigate those negotiations, and if the exit option is limited to an IPO even the most sophisticated entrepreneur will need the valuable expertise and experience of a VC to get this done successfully.

  1. John C. Smith Friday, May 15, 2009

    Sorry guys but the significant majority of VCs add ZERO (or near zero) value on #2. And I'm including certain beknighted local investors in this count.

    Some VCs are great in this regard but (again) the majority simply are not.

    Plus there are numerous ways for an entrepreneur to skin this cat, i.e. to get advice, plug into others' networks — without handing over 20-30% of your company with preferences to an investors whose interests may well not be aligned with yours.

    Which brings us to point #3:

    VC and entrepreneurs interests are often misaligned in terms of exit. (I.e. what could be a great exit for the entrepreneur might be a less great to poor exit for the VC.)

    Saying that VCs are no longer necessary is dramatically overstating the case. Venture finance still makes sense (and will make sense for the foreseeable future) for businesses that require $5M+ to get to scale and profitability. (The $5M number is somewhat variable — maybe it's $2.5M, maybe it's $10M, depending on the nature of the biz, the quality of the entrepreneur, the entrepreneur's personal network, etc.)

    HOWEVER

    Because of S3, EC2, and everything else the original article mentioned, many businesses that 5-10 yrs ago might have required that level of funding can now get off the ground for an order of magnitude less. And for these businesses I would argue that the venture model (at least in the vast majority of cases) is not a good fit.

    I would NEVER take one of those $250k deals from CRV, USV, First Round, Spark or anyone else. Too much hair on that dog. If you need less than $1-2M there are many other sources of funding that you're goiing to be able to get on more favorable terms.

    p.s. re. #1, I would argue that the same issues/problems/risks apply to VCs as to angels, strategic individuals, etc. Certainly not an argument for VC vs other sources of funding.

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  2. elliottdahan Friday, May 15, 2009

    The Seed level of Risk Investing is not the same as the VC level.

    They are systemically, operationally and attitudinally different. They have different metrics for acceptance and success; funding, oversight, sourcing, profitability and, most importantly, infrastructure.

    VCs do not create or innovate – the provide money for growth.

    The new wave of Seed Mentoring Programs, Seed Summer Camps and Seed Auditions do not provide long term oversight for the entrepreneur. And the ventures that provide money do so as egregious rates.

    What is needed is a Public-Private For Profit dedicated effort to work with, support and compensate the Seed Infrastructure (Incubators, Economic Development Agencies, Tech Transfers). This infrastructure already exists and provides the efficient sourcing, screening and post-investment oversight needed to develop Series A worthy companies. What is needed is a dedicated effort that is not geographically constrained.

    What is needed is a thorough Virtual Incubation system that brings both Community and Collaboration to all elements of the total Investing community.

    By dedicating a private/public collaboration to increasing the value and viability of early stage companies you are also increasing their valuation for their Series A round; thereby leveling the playing field with what will be a smaller group of Traditional VC funds.

    Please review – http://www.slideshare.net/ElliottDahan/start-fund-q2-2009

    Elliott Dahan
    elliott(a)thegrowthgroup.com

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  3. Let's recap, shall we?
    Craiglist.org = bootstrapped, could be started on a shoestring, etc…market leader in classifieds.

    PlentyOfFish = bootstrapped, market leader in online dating in the US, UK and Canada.

    And…well, FunAdvice. 4.69 million visitors last month, bootstrapped, and one of the fastest growing social sites *of any kind* with 300%+ year / year growth.

    Sure, you could pull a sodahead (raise 16 million…with 1/2 the uniques that FunAdvice has) or you could pull a Mahalo (raise ~$50 million, with less US market share than FunAdvice, or these others)…

    …or, you could step back and ask yourself a very important question as noted above: what value does the investor bring? Is this a category that will only be won through venture investment (be in angel, VC or other).

    I'd argue for those businesses where network effects matter…it's the caliber of the idea, the entrepreneurial vision that counts…raising money won't polish your t_rd of an idea if it really is a piece of cr@p.

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  4. Why does it matter anyway…aren't VC's mostly out of the market? Isn't the model for VC changing as we speak due to the economic turmoil? The word these days is VC's are making few initial investments and figuring out which portfolio companies to keep alive. The other word is that in this desperate environment, certain VC's are inviting founders in to pitch so they can get ideas to offer their current portfolio companies. It doesn't get any lower than that. Beware of VC's and biased articles like these.

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  5. I would disagree with this. I think that there is a place for hard work and building a brand that does not involve VC money to start with. Granted at some point I would say it might be needed but not all the time.

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