We have opined before on the "
Equity Gap", that amount of money - c $0.5 to $2k- between comfortable Angel funding and comfortable "trad" VC funding that the New Techspace is increasingly spotlighting, since the New New Technology also has some New New Economics:
(i) Moore's law and Open Source software has dropped the Capex spend for any startup by 1-2 orders of magnitude
(ii) Modern hosting, bandwidth cost reductions and offshoring software development has dropped Opex costs
(iii) Much higher online penetration and higher willingness to spend - plus better transaction processing - means companies can attract customers far earlier in the lifestage, so they become self funding far earlier.
Net-net this means that the amount of funding such companies require is lower than VC's traditionally put in, and they (theoretically*) need to change their business models to reduce the cost of doing deals at these order-of-magnitude lower funding levels.
Others have already spotted the gap - Y Combinator and Charles River Ventures for example; and now comes the WSJ with an analysis of how
Peter Thiel has been operating:
Mr. Thiel, the former CEO of online-payment company PayPal, is making waves in Silicon Valley with an investment strategy that differs significantly from the traditional approach. His company invests only modest amounts of money, sometimes just a few hundred thousand dollars, and focuses on entrepreneurs Mr. Thiel and his partners often know personally. He also takes an uncharacteristically hands-off approach to company management.
Already, the gambit has yielded several potential winners like Facebook.
The venture-capital world "definitely needs to be shaken up," says the 40-year-old Mr. Thiel...
The approach of hands off is no doubt necessary so the transaction costs of bankrolling any one company do not push the deal into deficit. However, there is also a shift in power between The Money and The Talent in Small Companydom, as in many other areas when surplus cash floods in:
Most traditional VC companies want to invest larger sums, several million dollars, say, for large stakes in start-ups and then exert control over the companies' operations. Some demand "liquidation preferences," or guaranteed returns if companies are sold.
But.....
With so much money chasing deals in Silicon Valley these days, start-ups can afford to be choosy in picking their financial backers. They are increasingly turning to companies like his that offer less of a "command and control" model, he says.
Added to that is the issue of adding value in a low budget world - old models no longer work as the costs are too high:
Venture capitalists often can be too quick to fire start-up founders and replace them with professional managers, Mr. Thiel says. He blames a cultural divide: Many VCs "have these very cushy jobs, they get paid a lot," and often can't relate to founders, he says.
However, to us this is the fiddling at the edges, any moderately smart VC could adapt to this world - the real shift is in allowing Entrepreneurs to partially avoid the lousy game theory of being a founder - aka the
Founders Discount
Significantly, the fund often buys only a 5% or 10% stake in a company and sets up a special class of stock that start-up founders can sell while they are building their companies -- and before venture-capital investors see profits. That way, the thinking goes, the company founders can reap some financial reward and stay motivated to build the company before an IPO or company sale, which can take years.
Now that is revolutionary, as a prime tenet over the years has been for funders to rig the game so the Entrepreneur (and their house if possible) is lashed to the helm of the Enterprise. Shifting the game makes startups attractive to a whole new group of people - ie those very talented people who until recently could actually do better by being in employment, or were strapped to family needs etc.
This world is going to get very interesting now methinks.....
*Theoretically......our experience is the hassle for a $50k Angel deal can be as time consuming as a $500k or even a $5m deal
