On Dec 29, 2007 the Wall Street Journal published an article called "VC's New Math: Does Less = More?". The article showcases the approach of Peter Thiel's Founders Fund and their recent success with Facebook. Their approach seems to make some sense. In a nutshell, the article makes the argument for smaller amounts of venture investments (less than $1 M) as opposed to apparent $2M rule of thumb.
The typical (if there is a such a thing) approach of Venture Capitalists is to invest a minimum of $2-3M in startup companies. The reasoning is that it takes so much time to evaluate and manage a startup that it is not worth the time to invest any less. This makes sense.
But, what if a venture group could invest less and spend less time. The risk would be less and the costs would be less. This makes sense too. The Founder's Fund takes just this approach: invest less and take a more hands-off approach. If the startup is successful the venture group can invest more which reduces risk of principle. If the startup does not do well the loss is minimized. Overall this seems like a much less risky approach and mimics trends in other industries like technology development (agile or extreme programming) or rational drug development-- make many, small, iterative and incremental changes or investments.
From the point of view of a startup this approach is somewhat appealing. Considering that the amount of money is less, the time to close on a venture deal will also be less thereby aiding the startup to, well, start-up sooner and spend more time developing the business and less time pitching for money. The approach also puts more control into the hands of the startup which can be good thing when coupled with appropriate managerial expertise and Venture Capitalist guidance.
This strategy appears to combine the early stage, smaller funding environment typical of Angel Investors with the operational skill and expertise of Venture Capitalists to reduce risk and setup an appropriate, staged (think Tranche) incentive structure.
Whether the Venture Capital community will change their habits and widely adopt the "New Math" remains to be seen. Considering that the number and size of Venture Capital deals have barely recovered from the late 1990's, maybe it is time for a change. Regardless, this trend is worth watching as it might spark a new wave of venture backed startups.
Comments (1)
It also means that ones team becomes critically important (even more so than before) on both the VC side and the company side. The risk is that having too much oversight might place unwanted burdens on a successful team. However, I agree with this strategy and likely would prefer it.
Posted by BWJones | January 3, 2008 6:43 AM
Posted on January 3, 2008 06:43