Monday, September 24, 2007

Startups Then and Now

A few years ago, I remarked to a friend that Microsoft Word took longer to start up on my 3GHz Pentium laptop than my DEC EDT word processor took in 1980 on a PDP-11/34 running RSX-11M. My modern laptop was hundreds of times more powerful, but I was still waiting 10 seconds. True, MS Word is much more powerful, but for the basic stuff, I was still waiting…

Nevertheless, when you read about productivity nowadays, it is apparent that in this decade we are reaping the benefits of the digital age --- all those computers and Internet linkages mean that the average information worker is much more productive today than he was just 20 years ago. In fact, according to the U.S. Department of Commerce Bureau of Labor Statistics, productivity in software publishing is up by a factor of 17x in the past 20 years. In Computer and Electronic Manufacturing, it is a factor of 9x.

So what does this mean to Venture Capital and startup financing? I submit that it simply takes less money to start a high tech company nowadays. Particularly in software development, the costs of developing a product are far lower compared to 20 years ago. And the reach of the Internet and the ease of leveraging viral marketing and messaging, means the costs of customer cultivation and product marketing and deployment are far lower as well.

I frequently see startup teams who have launched their company on less than $100K of total capital in, and only need $200-300K to get to breakeven. They can almost bootstrap it, if they use all the tools available to them, play the blogosphere right, leverage the buzz… Now it’s debatable whether trying to do it that cheap is always the best way to go, but it is certainly a viable option.

So one clear trend in my mind in seed venture capital is that deals are going to get smaller and VC funds are going to have to adjust to that. Six digit seed checks will become more common in the coming years, even with the effects of inflation. ($100K isn’t what it used to be…)

I actually believe that is healthy for the VC funds. As I’ve mentioned in my first post, I’m a big fan of Nassim Nicholas Taleb’s writings, particularly his most recent Black Swan book. He persuasively argues that a good way to invest in our inherently unpredictable world is, among other things, to expose yourself to as many positive Black Swan opportunities as possible, with a portion of your money. I think all VC funds would benefit from setting aside a portion of their funds, say 20%, and taking “fliers”, betting “hunches”, but most importantly making more, smaller bets. Yes, they can take up time, but I think it is manageable. And as Taleb says, your downside is limited to 1x, but your upside is largely unbounded.

The irony is most VC funds are going the opposite direction. They were so successful in the last decade that they have had little trouble raising gigantic new funds. When a partner group has to invest $1B, they are discouraged from making $250K investments. So they set a policy of investing no less than $5M in a first round investment, and reject deals that don’t “put that much money to work.” They say “your deal is very interesting, but it isn’t big enough for us”. In my humble opinion, this is a big mistake, and heading in the wrong direction.

VC funds, particularly those than do Early Stage investing, will necessarily have to evolve in the coming decade. This is a particular focus for me in this blog. More on this topic to come…

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