I have written and been quoted many times before on the rise of a new layer of capital markets and the segmentation of venture capital. Venture capital certainly will continue to play an important role in years to come, but many major variations on the current model will emerge. One of the most important drivers of change is the far lower capital-intensity of web and technology businesses. With powerful development platforms, ready access to global talent, and speed to market being of the essence, many ventures can get going with minimal capital. The proliferation of less-capitalized companies has been a feature of the entrepreneurial landscape over the last year, supported by a slow drying up of capital from venture firms.
In today’s New York Times an article titled A New Kind of Venture Capitalist Makes Small Bets on Young Firms focuses on Union Square Ventures and in particular Fred Wilson, the new superstar of web VCs. The piece starts out by describing how Etsy, now the leading crafts marketplace, was delighted in Union Square Ventures to find a VC firm willing to take just a 5 percent stake in the company. Most VC firms demand at least 20%, and usually seek strong or dominant influence on the company’s strategy.
Although Etsy had a business plan when it came to Union Square Ventures, the partners are sometimes willing to take a chance on a team with a good idea but no clear path to making money — which does not seem so different from the anything-goes investing of the Internet bubble.
Twitter is one example. The service, which lets users send short messages with updates on what they are doing, is popular with a tech-savvy crowd but crashes frequently and has not figured out a way to earn significant revenue.
“People are too impatient,” Mr. Wilson said, defending his investment. “I’ve made more money in my career investing in very early-stage companies where the business model was not clear. No revenue, just a product, but it was clear people would use it.”
How early you invest in companies is a critical factor. While Union Square Ventures invests very early stage compares to its peers, as described in the article above, it also explicitly does this in order to get into later and potentially larger funding rounds, something other firms are also beginning to do.
While the article is largely a puff piece on Union Square Ventures which will inflame the current level hyperbole, it does point to how venture capital is adopting new approaches. I personally think that significantly different funding models will emerge. Coming from a capital markets background, I look at the economy largely as an exercise in capital allocation. As we are very forcibly being reminded at the moment, capital sometimes get very badly allocated. Certainly there are sectors of the entrepreneurial sector that currently deserve more capital. Those that allocate that capital effectively on a more scalable basis will create a lot of value for themselves and others.