The Wannabe Venture Capitalist

Friday, January 20, 2006

New Home for The Wannabe VC

-------------------- The Switch is Official --------------------

New blog URL:
Feed URL (same as before):


So sorry for those who receive my feed. I am working on setting up The Wannabe VC as a WordPress blog on my VentureWeek server and have, therefore, been playing with the feed redirects. I will let you know know when everything is all clear and I appreciate your patience in the meantime. I believe that the WordPress blog will be better for all of you readers out there since I will be able to categorize posts, etc. No worries for all of you that read me via RSS: I will be setting up redirects which means you don't have to do a thing to keep receiving my content as soon as its published!

Sunday, January 15, 2006

Fixing the Venture Capital Model

There has been a lot of talk for a while now about fixing the venture capital model. As it stands now, there are things about the model that do not align the wants and needs of VCs with entrepreneurs. For example, VCs need exits at certain time intervals because their funds only last 10 years (for the most part) and entrepreneurs are sometimes forced to grow too quickly or be acquired too soon because of this. While the structure of VC funds probably isn't going to change any time soon (after all, the people that invest in VC funds need their money back to pay pensions and do charitable work) the question is: What can be changed? The answer: deal structure.

The way VC deals are structured is something that, with a little creativity, can make the system much better for both parties. There is a fundamental problem between VCs and entrepreneurs. VCs want entrepreneurs to shoot for the stars and to be the next Google. Sure, entrepreneurs want that too. If they didn't, they wouldn't be in the game and taking the risks that they are. However, if someone comes along and offers an entrepreneur $25mm for a company he built in his spare time and for little of his own money he is going to take the cash or at least be very tempted to especially if it is his first company. However, that $25mm offer looks paltry to a VC who, lets say, put $7mm into the deal at a $22mm post money valuation (and sees the company eventually being worth $500mm). The return on investment for the VC does not line up with the return on investment for the entrepreneur.

Partial founder buyout can change this dynamic by giving the entrepreneur a little liquidity early on. Let's say that, in the above scenario, the VC actually put $10mm into the deal but $3mm was actually paid in cash to the entrepreneur and $7mm went into the company. Now, the entrepreneur has $3mm in the bank. This is not enough to make him too comfortable but it is enough to reduce, if not eliminate, his urge to sell out quickly for $25mm. Now, the entrepreneur is more likely to take the plunge with the VC and try to become the next Google knowing that his house and his childrens' college educations are taken care of.

If this type of situation was in practice today I think we would have already seen its effects. Let's take Flickr for example. The founders of Flickr built the company on a shoe sting in their spare time. Network effects began taking hold and before they knew it they had an incredible company on their hands. At that point the founders needed to make a decision: do they take capital from a VC and scale the business like crazy possibly gaining nothing or do they take the "sure thing" offer on the table from Yahoo! and cash out early possibly leaving money on the table but also taking in enough money to live comfortably forever? In this case the founders took the Yahoo! deal and probably regret it today but can you blame them? They were looking at a lot of guaranteed cash or getting their ownership diluted possibly for $0 return. The same situation could be applied to a number of other companies including

With partial founder buyout a lot of entrepreneurs would be still out there building their companies and VCs would be left with more quality investments. Everybody wins (except maybe Yahoo! and Google since they wouldn't be seeing any more inexpensive acquisitions). To make things clear, this is not an original idea. I have seen others write about it and have been surprised that there hasn't been much take up. I thought I would write about it to get it back into the discussion so please tell your friends (especially if they are VCs and entrepreneurs) about this blog entry so they can add to the discussion in the comments and on their own blogs. This is something that needs to be looked at because it could change the start-up game forever and in a positive way for all involved parties.