Is the VC model broken?

I came across a blog post today that really spoke to me. It was by Mike Masnick of Techdirt, one of the most underrated bloggers out there, for one of the most underrated tech blogs. In his blog post entitled, Venture Capitalists: Buying High, Selling Low, Mike questions whether the current strategy of venture capitalists make any sense. In his post, he states that:

  • VCs should be investing for the long-haul, the five to seven year time frame
  • What the market is doing today is meaningless
  • Investing in a downturn is a good strategy
  • Fewer institutions funding companies = Lower valuations
  • Shying away from investing today is effectively waiting until the deals are more expensive

Seeing the questionable strategies of some VC firms reminds me of the scenario outlined by Paul Graham in his post, Could VC be a Casualty of the Recession? For internet startups, it isn’t as crucial anymore to have millions on millions of dollars. It’s easier than ever to start up a company, and you can test out the validity of your concept on very little money. But there are significant problems and inefficiencies in our day-to-day lives, and their are plenty of industries that need disruption. In many ways, it can only be done through the enabling force of technology, with an opportunity to have a long-term horizon to grow and iterate. But, the fuel of innovation and disruption has all but evaporated. Some VC firms are worried about the ability of their limited partners to respond to capital calls, others are seeing their portfolio companies implode, and other cash rich VC firms are withdrawing all near-term investment  in seed stage companies. Would it kill a VC firm to invest 250k in several seed stage companies at great valuations, expecting the funding to give them some runway and proof of concept? Charles River Ventures has a convertible debt program of this kind, and I’m surprised more VC firms haven’t adopted this model.

I think this is a tragedy. In my previous post, I believe that this is still the best time to start a company. I wonder if anyone will ever look back and see the vast opportunities there are today to invest in early stage companies.  With a little capital, and by getting a great valuation, the VCs could make a killing. I guess it’s easy for me to say because I’m highly biased, and on the other side of the table, but today, you can attract quality talent, pay lower wages, get cheap office space, flexible financing opportunities for equipment (to those with cash), while not worrying about the abundance of capital and competition flowing into your space. I know it depends on the cycle and stage of the fund, but we went from a place six to eight months ago where everyone said their was too much liquidity in the market, to a place where everyone is saying that VCs are strapped for cash.

I’d love to see a case study of the VC firms that took advantage of this down time, to do what the other lemmings didn’t do, invest in a down economy. Some of the most prominent Internet companies were built during the aftermath of the first dot bomb period, and although we love stories of the emergence of internet phenomenons such as YouTube, it has taken five to seven years for a majority of our favorite sites of today to hit critical mass. Maybe it’s not a fair comparison because the rules of the game have changed because of the ecosystem supporting Internet start-ups, but at the same time, I have to believe that a great deal of value was created when others saw no reason to invest.

Who were the VC firms that raked in dough because they invested during the post-dot com bust time horizon? Does the graph below illustrate buying too high, selling too low, and investing in a super hot market, where 20% of the VC firms account for 80% of the exits?


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