This is the final part of a 3-part series on the major changes in the structure of the software & the venture capital industries.
The series started here if you want to read from the start.
Or the Cliff Note’s version:
Open Source & Cloud Computing (led by Amazon) drove down tech startup costs by 90%
The result was a massive increase in startups & a whole group of new funding sources: both angels & “micro VCs”
With more competition in early-stage many VCs are investing smaller amounts at earlier stages. Some are going later stage to not miss out on hot deals. I call this “stage drift.”
The opportunities for tech startups today are more immense than they’ve ever been with billions of people now connected to the Internet nearly all the time.
Downsizing Venture Capital
The venture capital business itself is going through an even more fundamental change than just the entry of a new category at the earliest stage. The industry is shrinking back to a mid-90’s level in terms of both dollars and numbers of firms.
The doubling of the industry size was caused by the euphoria of the dot-com bubble and since funds take 10 years or more to dissolve the bursting of the funding bubble has taken its time. We all know the result of the over-funding of the asset class – poor returns in aggregate for the industry. The best firms have still delivered results, though.
The Venture Capital industry has changed over the past 5 years that I would argue are a direct result of changes in the software industry, not the other way around. Specifically, Amazon has changed our entire industry in profound ways often not attributed strongly enough to them.
I believe the changes to the industry will be lasting rather than temporal change. Venture capital is in the process of its own creative destruction with new market entrants and new models of innovation at the precise moment that our industry itself is contracting.
I will argue that when the dust settles, although we will have fewer firms, each type well end up more focused on traditional stage segments that cater to the core competencies of that firm. The trend of funding anything from the first $25k to funding $50 million at a billion+ valuation is unlikely to last as the skills and style to be effective at all stages are diverse enough to warrant focus.
I will argue that LPs who invest in VC funds will also need to adjust a bit as well.
When I built my first company starting in 1999 it cost $2.5 million in infrastructure just to get started and another $2.
This article originally appeared on TechCrunch.
2 preamble issues having read the comments on TC today:
1: I know that the prices of startup companies is much great in Silicon Valley than in smaller towns / less tech focused areas in the US and the US prices higher than many foreign markets. I acknowledged this in the article. You can be pissed off, but I don’t set prices. I’m just making the commentary.
2: As expected at least one person accused me of writing this post because I want to see lower valuations. That’s stupid. I can’t control the market. When prices are too high I just pass. Simple. I wrote this because over the last decade I’ve seen a destructive cycle where otherwise interesting companies have been screwed by raising too much money at too high of prices and gotten caught in a trap when the markets correct and they got ahead of themselves.
I said both in the article but felt compelled to provide a statement up front for the skimmers.
I have conversations with entrepreneurs and other VCs on a daily basis about fund raising, the prices of deals, how much companies should raise, etc.
This is part of my series on Raising Venture Capital.
I’m sure I’ll spark the ire of some VC’s for saying so, but there is certainly such a thing as black-out days in venture capital. It’s worth you knowing this so you don’t waste your time. It’s also very important to understand so that you can properly plan when you raise money.
Let me first tell you the black-out periods and then I’ll explain why. It is very difficult to raising venture capital between November 15 – January 7th. It is also very hard to raise VC from July 15 – September 7th. (you need to have had your first meeting even earlier.) If you’re thinking about raising VC and have not yet started the process, you’ve probably already missed the boat for 2009.
If you’ve had your first partner meeting but haven’t had the full partner meeting then you had better schedule it for Monday, November 23rd. Full partner meetings are almost always on Mondays and if it isn’t already booked yet for Monday, November 16th (e.g. this coming Monday) obviously that’s not going to happen.
Montgomery & Co Projects Deal Volume to Grow by 167% in Just 2 Years with No End to Growth in Sight
On the third Wednesday of every month I co-chair a meeting called the SoCal VCA (venture capital alliance), which represents participants from all of the top venture capital firms in Southern California as well as prominent members of the Tech Coast Angels (TCA). We meet to discuss trends in the industry and to find ways to work together to help with SoCal deal syndication – somethings that happens automatically on Sand Hill Road in NorCal due to proximity.
We feature a prominent speaker at every event. This morning we heard from Jamie Montgomery, CEO of the venerable Montgomery & Co investment bank who is at the heart of what is going on in M&A for venture backed companies. They do around 7% of the total VC-backed deals in the US per year or just under 40 deals / year on average (present year excluded!)
I have to admit that I was greatly encouraged by Jamie’s outlook for venture backed companies, which if true will be a welcome relief for our industry.
In the first post in this three part series I described why I believe the VC market froze between September 2008 – April 2009. In the second post I argued that as of September 2009 the pace of VC investments has increased rapidly (at least for software / Internet investments – the only sector on which I’m competent to comment), but only for those remaining VCs who have new enough funds and aren’t plagued by “the triage problem.” This is a direct result of innovation around the iPhone / mobile computing, Facebook / Social Networks and Twitter (as distinct from Social Networks). It is also a result of pent-up demand.
In the following post I argue that this increased pace may be temporary. I obviously don’t have a crystal ball so the economy could fare better than my gut, but here’s why I’m cautious for some time in 2010 or early 2011:
Why is the future still so unpredictable?