25
Oct
07

VCs need new models of investments

Venturewoods has a great article on miniaturization of VC investment. It talks about how its time that VCs adopt a different model, now that the startup landscape is changing rapidly. The biggest change being the number of startups coming up. With low entry barriers, to do a web  startup all you need is an idea, 2-3 more guys ready to go without salaries for six months. Thats not a lot. Once choosing to do a startup was a life changing decision, today its quickly becoming a career alternative. Low entry barriers also mean, a lot of startups will come from students, just graduates, etc.

VCs in India have a lot of adaptation to do. It is an open secret that startups which get funded have been referred to a VC partner either from a previous founder they had invested in or friends from close circles. This rules out most students, first time entrepreneurs and people with little experience dealing with startups. A few years back this was the state in the US too, but with the VC community being very active in interacting with the programmers/hackers and students community, its still simpler to at least approach a VC firm. Another important change is in the amount of investment. VCs barely look at startups requiring less than $1mn, even in India. Thats a lot of money here and with startup barriers going down, the figure of $1mn needs to be lowered to a figure of around $300k at least.

A major reason why VCs do not do deals of lower investment value is because the returns are ‘low’ on such deals. The absolute value of an investment being a success needs to be lowered as well. Today an exit to be termed a success needs to bring home at least $20mn. Ycombinator invests amount which are smaller than microfunds. They typically invest $20k and take 5% in equity. Thats a lot of equity, but its a comfortable amount for startup founders still in college. They fund startups no VC would touch, primarily because they need such low investments.

Venturewoods has another article on why VCs wouldn’t want to adapt to investing small and spreading themselves across more startups. The author blames it on their lifestyles, which depend less on their investing success and more on the number of partners in a VC firm. That’s the most interesting theory I’ve read about VCs!

A few weeks back I had read Paul Graham on Web startups becoming commodities and how there will be lots more of them to fund. I now understand it from a VCs perspective. It means lots more work for them in making of deals, while the total amount of investment they might do still remains the same.

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