EarlyStageVC

Fail Fast, Fail Often

There was an article last week in the Wall Street Journal talking about an apparent change in the entrepreneurship/VC funding model.  Riya, Meebo, and others were cited as poster children for the new restraint.  The core idea was that entrepreneurs are taking advantage of the availability of capital to fund for long periods, often several years, rather than the traditional 12-18 months.  So why does this make sense? Why raise a bucket of money when a thimbleful will do?

The classic venture model has been to fund to milestones 12-18 months out.  In consumer web services, there are only two meaningful milestones --  (1) are you getting a lot of users and (2) have you figured out how to make money?  We use other metrics in other sectors (like management, product, etc.)  as proxies for real economic progress.  We also use them because (we believe) they would have residual value in an asset sale or merger. 

None of this is true in consumer web services. You're either hot or not. Second place generally sucks.

The problem is that it is hard for entrepreneurs and VCs to know a priori if something is going to be a hit. The only way to know is to try, and trying takes time and money.  So here's the real rationale for what it makes sense for these companies to raise "a lot of money" and not blow it.  They have to run lots of experiments.

By now we are all well-acquainted with the observation that software is cheaper than ever to produce.  But that is only half the story.  The other half is that it takes several iterations -- several trials -- to hit it big.   

Imagine you have a low-burn consumer internet company and you think you can do your next build for $2M (offshore, open source, etc.)  Imagine further that there is a 1 in 20 chance that you could be the next [insert fantasy outcome here]. Angels are lining up with $2M in hand.  VCs are waving $5-20M checks at you.  Everyone says this is a $10M pre-money company and you own 50% today.

Assume you have a 5% chance of Being Big on the $2M raise, and a 95% chance of nothing.  The chance of Being Big if you raise $4M is 9.75% (1-.95*.95).  This is because you can iterate twice at 5% probability each.  The chance of Being Big after raising $20M is 40.1%.

Of course, each $2M has a dilution to you as the Founder. As the graph below illustrates for this hypothetical example, the risk-adjusted ownership (diluted ownership x probability of success) increases as you raise more money.  (This conclusion is not universally true in all situations.)   

The key to this thinking is to resist the temptation to spend like a lottery winner. Raising the big VC round isn't winning the lottery; it is the purchase of a deck of weekly lottery tickets. 

This is how Munjal Shah described the move to Riya 2.0 in the WSJ article.  It was the realization that the first experiment, while a success by many measures, wasn't enough of a success relative to other options.

The larger-than-expected VC rounds in consumer internet deals are perfectly rational outcomes, for the entrepreneurs who understand the trials of consumer marketing.  Failure is baked into the calculus of the opportunity.  The key is to fail fast.  Set metrics ahead of time and be decisive. Because time is money -- literally.

Entrepreneurs who practice this discipline are just doing what VCs do every day.  Venture Capital is a hits business, too.  Companies often fail.  Time is money here, too.  Failure is part of the process.  We, too, are looking to fail fast and expect to fail often.  That's why funds are getting bigger, too.

EarlyStageVC 2.0

A bit of personal news. As of November 1, I have joined Crosslink Capital in San Francisco as a General Partner.  At one level the move is a small transition.  I move from two additional VC partners to five.  My practice has been centered on early stage, Internet services and software.  That’s exactly what Crosslink wants more of.`  So nothing major changes, except my commute.  So why the change? In a word – Relationships.

Crosslink has consistently been a top-quartile firm with its later stage investments and crossover investments.  Their ability to cross the investment spectrum is a huge advantage for limited partners. If you have read my series on Venture Capital 2.0, you know why I believe this is true. That same cross-spectrum footprint is also a huge advantage for an early stage investor like me. Let me explain why. 

Early stage companies go through predictable phases.  First, it is about the Product. Then it is about the early Customers. Then it is about the Partners. Then it is about the Investment Community.  All along the team is changing, expanding, and improving.

The successful early stage companies have two fates – they either get acquired at nice prices or they go public.  Either way, these companies benefit enormously from having ‘friends’ that run in those circles. 

All VCs claim they have relationships as a core asset.  But our primary job as VCs is to have relationships that generate deals and then to help the companies in which we have invested.  Frankly, it is difficult to have a broad set of relationships with later stage private and public company executives and help my early stage companies and source new deals.  I think this is true for most VCs.  Broad and deep don’t mix.  There are only so many hours in the day, no matter how good you are.  Relationships take time. 

Crosslink invests all along the continuum, from early stage to buyouts, public investments, and even has a hedge fund.  Consequently there are professionals whose primary job day-in and day-out is to have CxO conversations with technology and media companies at all stages.  The Firm is organized (and financially structured) to maximize the collaboration across the spectrum to the benefit of the portfolio companies. 

So now I will have a fifteen very analytical professionals with up-to-the-minute rolodexes and context to help me and my companies. It’s that simple.  This is a relationship business.  I am joining one of the best, most organized, and current social networks in private equity investing.

Of course, this is the positive valence.  Every transition has a positive valence and a negative valence.  The negative valence is more complicated, less important, and consists of a set of personal and professional issues that do not need to be aired in a public forum.  I can tell you this. It wasn’t about “VC is broken” – it’s not; “Leapfrog is broken” – it’s not; “Rip got a more lucrative offer” – it’s not.  It was just a professional change I wanted to make.

The most important measure of the transition is the impact on my Leapfrog investments.  There will be none.  I will remain a Venture Partner at Leapfrog Ventures and continue to work with Radar, Riya, Teqlo, and Vast.  I will continue to represent Leapfrog and its investors to ensure these companies grow and thrive. I have a responsibility to Nova, Munjal, Jeff, and Naval, as well as to Leapfrog's investors.  Like I said, this is a relationship business.

This kind of transition is a common practice in the VC business.  It is only that my new investments will be made on the new set of books.   

All in all, perhaps the most observable change is that, after nearly 30 years in the South Bay, I will finally ride BART for the first time.  Right after my next breakfast at Bucks'. 

Venture Capital 2.0: It's All A Game

There is a report today in the New York Times (registration required, of course) that Sevin Rosen Funds has elected to not raise a tenth fund, for now.  First of all, I have to congratulate the partners at Sevin Rosen for a triumph of integrity over greed.

This withdrawal led me to think about Why? And the conclusion provides another path to the model of a crossover fund as a VC 2.0 format. 

Viewing venture capital as a distinct market, one is led to a classic Prisoner's Dilemma formulation of the business.  Excess returns (a.k.a. top quartile) are a zero-sum game.  Not everyone can be top quartile and the presence of more firms competing for the same finite set of 'top deals' leads to the lose/lose quadrant for all players.  Exiting the market marginally increases everyone else's expected returns.  So each player faces the choice of stay/exit and if everyone choose stay, everyone loses. If everyone exits, capital is scarce and returns are excessive. 

The hypothetical payoff matrix in this construction illustrated in this figure.

 

Your firm faces the same choice as all firms -- stay or exit.  If everyone exits, of course, everyone's return is 0%.  If everyone, stays, everyone else has a median return which is -20%. Since you are a top-quartile firm (isn't everyone?), you only have a -10% return.

 

 

 

Now take a multi-period view. You can decide to take the same capital each period and "play" in a different game.  Assume that everyone also decides to "play" each period, but there are multuple games.  Each game corresponds to a different equity market.  In each period, one of the games is has better payoff characteristics than the others.  Your decision now changes to which games to play.  Note that your average return from picking the right general game each period is 15%, while each player playing playing only one game has an average -10% return.  You don't have the maximum return of 20% in any period, but you do have huge spread between the average return and your return. 

This is another way to look at the crossover model of risk capital.  Whether it is achieve by evergreen funds, merchant banking, blind pools with stage- and instrument-independent strategies is a detail.  The important point is flowing capital to the more attractive risk capital market creates the highest return. 

I realize this is a trivial example.  But it does illustrate the point that the question of whether Venture Capital is Broken (overfunded) is different from whether Risk Capital as a whole is broken.  VC may (or may not) be broken now.  But somewhere in the world of risk capital the sun is always shining.  And it will shine again in VC land.

Venture Capital 2.0: Not So Separate, But Still Equal

A 1900 word finale in the series.  Part 1 is here. Part 2 is here.

The separation theorem is the foundation of Modern Finance.   Among other things, it is used by investors to construct optimal portfolios of investments based on underlying assumptions of risk, return, and correlation.  Limited partners (LPs) use this rationale to compute allocations of public versus private equities. Within private equity alternatives they further allocate between venture capital, LBOs, distressed debt, etc.  And within venture capital they allocate between early and late stage, market segment, national and local geographies, etc. 

Of course, each dissection introduces more random measurement variance as the analysis gets increasingly refined.  At some level, as I suggested in the prior post, the noise overwhelms the signal.  Funds of funds provide a very useful function in aggregating the volatility of individual private equity firms.  The theory is a Fund of funds can provide a lower beta than a direct VC fund investment.  The theory relies on reliable and persistent investment strategies of the underlying components – the VC funds themselves.

Many investors (pension funds, insurance companies, unions, etc.) also want to construct their own ‘optimal portfolios’ from private equity instruments.  So they overweight certain segments, such as buyouts, and underweight others, such as late stage technology venture capital funds. They, too, want the “pure plays” that portfolio theory demands.

Most VC funds, especially the newest ones, encounter an investors’ paradox.   They market themselves to LPs on a specific investment thesis (stage, sector, etc.) If they sense the original investment thesis no longer is a return-maximizing strategy, they face a difficult choice – pursue a new thesis to maximize return and become accused of ‘investment drift’ or remain a pure play and forgo top-quartile status.  Those who construct the portfolios (the LPs) want pure play strategies and top-quartile outcomes.

Some investors might consider this sturm und drang in VC ranks as part of the eternal Darwinian process of winnowing of investment managers.  But I think there is more to it.  The ballooning of the total amount of capital in private equity is changing the drivers of rates of return in venture investing.  The sheer number of practitioners is at all time high.  As a result, private equity markets are more efficient and more volatile.   This means that sustainable investment theses based on technical parameters are not as durable as they used to be.  Sometimes early is better; sometimes late.  Sometimes traditional private is better; sometimes PIPEs.  And venture capital is a long-only bet.  But while you can’t always pick the private winner, you often can pick the public losers.   The notion of a pure and enuring sector/stage theis is in jeopardy as a profit-maximizing strategy for any fund with a ten year life, or even a five year investment period.

Venture capital is evolving into two models.  One is the traditional model of the long-ball home run outcomes driving the portfolio.  For descriptive purposes, I refer to this as the Boutique Model. This is what we know as Venture Capital 1.0. It is the model practiced by most VCs today. This is becoming increasingly difficult for most, but not all, VCs.  This model relies on VC brand as a beacon to attract entrepreneurs. The brand owners rely on their networks to expose them to and validate proposals from the best entrepreneurs.  In theory, the best entrepreneurs are the tail of the distribution that can achieve that long-ball outcome. 

The 100x return has always been rare. The 10x return is becoming an endangered species, and  the  "not great, but I'll take it" feeling associated with the 5x is now a cause for celebration.  I illustrate this outcome compression in the associated graphic. These so-called "brand firms" have always operated at the right tail of the graph.  So the outcome compression from excess capital probably has minimal impact on them.  But those who pursue the traditional 'long-ball" strategy of VC and fail to attract those increasingly scarce 10X+ outcomes are likely to find themselves in that investors' paradox and scrambling to "re-define" their investment thesis.

The influx of capital and capitalists is changing the definition of the business.  When the public and private technology equity markets were less institutionally populated, the world of risk capital was segmented into separate businesses.  Early stage venture capital was a different business from private investments in public companies (PIPES).  Late stage venture investing was different from leveraged buyouts.    Shorts and longs were as different as night and day.

I say they were different businesses because the classic tests of business definition all pointed to this conclusion.  Reaching back to my early days at Bain & Company, we relied on three tests to assess if two lines of business were indeed the same business (I knew this stuff would come in handy some day).

1. Do they serve overlapping sets of customers? (Shared Customers)
2. Do they share overlapping sets of competitors? (Shared Competitors)
3. Can you invest in one line of business and materially impact your cost position in the other?  (Shared Costs)

The more the answers to these questions were answered in the affirmative, the more likely the two initiatives were in the same business. And the VC industry is seeing more competition from other investment sources as all forms of risk capital converge.  These various forms of capital are not perfect substitutes.  Angels don’t compete mano-a-mano with hedge funds.  Seed VC funds aren’t bidding on LBOs.  But there is enough contamination at the edges in each class to cause asset inflation from increased total competition. This convergence is bidding up prices in all sectors. 

This is my core observation about venture capital.  It is no longer just a pure and separable business.  It is a feature of the overall business of providing risk capital. It is a product in a risk capital product line. Like many of my VC brethren, I am an early stage venture capitalist; I am a product line manager. As a principal in an early stage firm, I am a general manager in a single product company. Single product companies can be highly profitable or abject failures.  Lack of diversity is neither an asset nor a liability. It is simply an attribute. But the boutique segment is winnowing down to a very small handful of successful brands, representing a very small portion of the market.  The best brand-driven VC 1.0 firms will continue to succeed.  However, the sheer amount of total risk capital available will continue to make it difficult for many firms to build the very brands that drive predictable and continued success in VC 1.0.

If the basis for competition in the boutique segment is brand, what is the basis for competition in the larger business of risk capital? 

This brings me back to my  opening remarks about the separation theorem. The separation theorem assumes that individual investments have risk/return properties which are affected by the construction of the portfolio. An early stage investment's alpha and beta are not affected by the inclusion of a distressed debt instrument.  Now suppose the insight about how to price the distressed debt arose from knowledge you gleaned from the early stage investment. Or suppose a profitable public market short position arises from the insight acquired from chasing, but ultimately being outbid in pursuit of a 'hot' late stage investment.  Or suppose experience with a PIPE provides a source of market and customer diligence to generate ideas about potential new Series A companies to form and fund. I refer to this as a Crossover Model of risk capital. The crossover model is a model for Venture Capital 2.0.

It is best to illustrate with a hypothetical. Suppose I believe Apple is developing a Skype-like Ipod for release in 2007 and I believe it will successful.  I could simply communicate that to investors and let them construct portfolios of longs and shorts around this thesis (the separation theorem in action). Alternatively, I could use this to construct what I believe is a risk/return maximizing set of investments around the insight. I could place early stage bets (communication services), midstage bets (new battery technologies), and public bets (Apple) on the thesis.  If I go long on all bets, I have a better return than if I simply picked a market basket of early, midstage, and public technology companies. If I hedge my bet by shorting , instead I can perhaps construct a  better risk/return than a pure long, early stage VC position.  If I communicated the "Skype Ipod" insight to my investors, they could construct their own portfolios. But by communicating the thesis runs the risk of disclosure and loss of advantage.  The risk of disclosure is a real transaction cost. And the separation theorem assumes zero transaction costs.

The basis for competition in the Venture 2.0 Crossover model is a focus on markets, independent of stage, geography, and risk capital instrument. The Boutique model relies on a brand-generated magnet status to find outlier long-bets.  The Crossover model would rely on a full-spectrum view of private-to-public to generate an appreciation for inefficiencies in an otherwise fairly efficient market for risk capital.  Like everyone else in the industry, it faces the risk of competing for deals with marginal competitors who have excess cash burning a hole in their pockets.  However, unlike everyone else, the crossover firm can leverage the insight in multiple, non-competitive forms.

So Venture Capital 2.0 is increasingly about applying capital to market insights, across the continuum of private and public, early and late.  Move money where the insight-driven opportunities are.   This cuts directly against the grain of most LPs who want to combine investment products from great firms with different stage foci.  But in doing so, they give up the inherent advantage of cross-leveraging an insight with either hedges (to reduce risk) or additional longs (to increase return).  Financial and product markets are no longer independent. The hedge can be to go long in both the private upstart and the public incumbent.  The short can be to short the incumbent.  Finally, if  the startup loses to an incumbent, the lost capital may be recovered by shifting assets to the incumbent before the broader market fully appreciates the dynamic.

Venture Capital 2.0 is happening. The industry is consolidating into larger firms.  These larger firms, while still calling themselves VC funds, look nothing like the VC funds of 15 years ago.  They have multiple products (early, late, PIPE), multiple geographies, affiliate or satellite entities for distribution, etc.  Few are formally affiliated with hedge funds, but I believe that is inevitable.  The multi-year partnership structure is probably not in jeopardy -- investment managers will still need to finance private companies over several tranches.  However, the venture model of capital calls and distributions will likely give way to more evergreen or closed end funds in which capital can be recycled across investments.  This has its own valuation and liquidity issues. Nothing is perfect.

I began this series with a flippant remark about Venture Capital 2.0.  I don't think traditional venture capital is going away any time soon.  There is too much momentum, i.e., money.  But I do think there is a real alternative model for the practice of venture capital investment as a product within a larger risk capital portfolio.  It won't emerge soon.  LPs decision models are still based on a demand for venture products packaged to look like they conform to portfolio construction models. However, there is enough  "investment thesis drift" afoot these days that some private equity firms are going to realize that they can use this "drift" to their advantage and drift head-on into crossover forms of investing.

Thanks for taking the time. I hope you found it worthwhile. I don't claim to be a financial economist.  So if you are, and you think my reasoning is flawed, please let me know.

Venture Capital 2.0: The LP Conundrum

(The second in what will likely seem like an interminable series. First here.)

Limited partners (LPs) are investors in venture capital funds.  We raise money from them, just as companies raise money from us.  We tell them our credentials and, to a lesser extent, our business plan.  LPs usually have to make stronger commitments than VCs with even less data.  A VC who loses confidence or interest in a company can choose to cease new investments in that company.  The result is often that their investment gets diluted, perhaps massively, but it still remains.  A LP who loses confidence in a VC fund technically still faces a legal obligation to continue meeting their capital calls.  At best, they face losing all their capital.  At worst, they have no choice but to throw good money after (perceived) bad.

When we were last raising money in 2004, I heard two comments from potential investors that really captured the LP conundrum about venture capital – one from a major corporate LP with over 25 VC relationships and one from a pension fund manager for one of the largest public employee pension funds in the US.  The two comments were

We have no idea anymore what makes a top tier venture fund (corporate)

I think I should invest in smaller VC funds to get a high IRR, but I (1) have no staff, (2) can’t be more than 10% of any fund, and (3) get measured in the short term by how much money I put to work.  With $Xb to invest, I can’t write a check smaller than $50m and would prefer $100m.  (public)

The first LP was owning up to the fact that data-driven predictive models are neigh unto impossible in the LP business.  The second was saying that even with an intuitive model, he was optimizing multiple goals, not just pure IRR.   The second one is easier to solve than the first.  If you had a reliable predictive model, you could solve the back office and incentives problem by expanding staff to capture greater return from a larger number of smaller funds.  (That assumes smaller does generate better returns, bringing you back to the empirical question.) Neither invested in us, by the way.

Most LPs are driven to partnership longevity as a proxy predictive indicator – a.k.a. Roman Numeral Bias. Why are predictive models about relative manager performance so difficult?  I think it is the interaction of several factors.

• There is a lot of noise in the causal modeling of financial outcomes (public market, business cycle, technology cycles, small sample sizes, etc.)
• The lack of transparency is a serious fog for anyone trying to assess fund manager performance
• Few VC firms have institutional business strategies that transcend the immediate principals

The net result is that the prevailing model for venture investments appears to be driven by two selection criteria: 

1. Longevity as proxy for performance and
2. Current top-quartile performance as a predictor of next fund top quartile performance.

Last year Alignment Capital published a really interesting analysis of fund managers that speaks to these two criteria.  After analyzing 645 separate venture funds, they found:

1. Longevity weakly correlates with IRR, showing continuous improvement between funds I and III, leveling off thereafter.
2. Second quartile funds were nearly as likely to have a top-quartile follow-on fund as the current top-quartile funds.

So the two criteria of longevity and current performance are directionally accurate, but don’t predict future performance with any meaningful precision.  This is probably why so much capital continues to flow into the business – half the firms are in the top half.

Historical performance can only take you so far.  One needs a theory of future drivers of returns to select among venture capital managers. Being yet-another-top-half-IT fund is not enough to be considered seriously by anyone. LPs construct portfolios of all private equity and venture capital investments based on their strategies, applying sound financial principles of predicting correlations of returns to maximize risk-adjusted return. The typical VC fund attributes are size, industry, stage, and geography.  These attributes pass for strategies in most fund raising conversations. My next post will deal with why I think this is mostly flawed, for both VCs and LPs.

Venture 2.0 - Preamble

This the first in a series of posts on the idea of "Venture Capital 2.0."  I thought it was appropriate to first set the stage of Venture Capital 1.0 as the point of contrast.  This first post is obvious stuff to those of us who have been in the business for a while, but less so for the casual observer.

Venture Capital 1.0 - The Cycle
The venture capital business has always been a ‘hits’ business.  One of my first blog posts (about a year ago) was on the "long tail of venture capital." The average venture investment generates a negative rate of return, but the outliers like Google, Microsoft, Cisco, and Apple have given information technology (IT) venture capital its superior rate of return.  The IT venture capital industry has always been cyclical.  For forty years the cycle has repeated.  Outsized rates of return attract capital, increasing valuations, and depressing returns.  The depressed rates of return created capital scarcity, laying the foundation for lower valuations, better rates of return and a repeat of the cycle.  Public markets have played an important role in the process, providing both the public appetite for new issues, as well as currency for acquisitions of venture-backed companies by public technology companies.

The IT venture capital industry today finds itself in a form of ‘stagflation.’ The absence of interest by the public market has made liquidity difficult to achieve, making the 2000-2005 period a particularly depressing one for those who are incented by capital gains.  At the same time, the interest in U.S. venture fund investment by non-U.S. firms is at an all time high, inflating the size of funds and increasing competition.  Venture capital fees remain at a premium to most other asset classes, but not the returns.

Venture Capital 1.0 - Key Success Factors
Success in IT venture capital investing has been a form of capital and information arbitrage for much of the period up to the late 1990s.  The scarcity of risk capital and the scarcity of insight about evolution of technologies and technology markets made it possible for astute venture capital firms to transform access to capital and superior technological insight into superior returns.  For example, as Moore’s Law was driving the electronics industry to the mantra of smaller, cheaper, faster, Sequoia Capital built a franchise reputation in semiconductor venture investments, based on the experience of its two founders, Don Valentine and Pierre Lamond, both early veterans of National Semiconductor.  A more recent example is ComVentures’ growth and success in the late 1990s.  Seeing the triple effect of telecommunications deregulation, global Internet growth, and ever-changing technologies and standards, the principals at ComVentures capitalized on their market and technological knowledge to raise several early successful funds.

Success begat success in the venture business.  Since venture investments have had payoff characteristics like options, i.e. limited downside and infinite upside, the key to the business has been "deal flow."  Deal flow is about seeing as much of the total distribution of deals, to generate a larger set of 'long tail outcome' candidates.  Success made IT venture capital business a first-order Markov process, where the probability of the getting the next hit was enhanced by having a previous hit, precisely because of the desire of all entrepreneurs to affiliate with "known winners."  The two masters of this phenomenon have been Kleiner, Perkins, Caulfield & Byers and Sequoia Capital.  Both parlayed early successes into institutional franchises. Other firms, many as old or older, have been less effective at sustaining the self-reinforcing dynamic of brand and success.  The sequential evolution of the IT "food chain" from semiconductor (Intel, National) to systems (Apple, Sun, Dell) to software (Microsoft, Oracle) to services (Yahoo, Google) has been the underlying order.

As the U.S. venture capital industry posted record rates of return in the late 1990s, the industry attracted record levels of committed capital that remains in place today.  Despite the abysmal performance of the industry from 2000 to 2005, many firms have been able to attract investors and avoid the re-equilibration and shakeout that has been predicted for the past five years.  It seems that limited partners have become inured to the venture capital cycle, expecting a repeat of the historic boom/bust experiences of old, and to average their rates of return over the next few cycles. 

A belief in forward-averaging the returns assumes that history will repeat.  The thesis of these essays is that the venture cycle has fundamentally changed for Information Technology and that formulae that worked over the past 20-30 years no longer broadly apply. 

• Globalization is both a risk and an opportunity with venture branding.
• Capital is no longer scarce, nor is access to venture capitalists.
• Information technology is no longer rarified and, in many cases, it is inexpensive.
• Global 2000 Enterprises, once the 'go to' customer for any fledgling IT startups, no longer have the risk profile they once had for IT innovation.

As I said, these observations are not new, nor are they particularly insightful.  And some firms are already responding.  The move to Cleantech is a move to exit IT (or diversify) to find alternative industries.  The move to build Indian and Chinese outposts are brand extensions.   

Presumably the Limited Partners who invest in venture funds have more incentive than anyone to develop an investment thesis about Venture Capital 2.0.  The next post will concentrate on the barriers to doing this effectively.

Venture Capital 2.0

My prior post was a tongue-in-cheek lexical rant about the use of “2.0” in everyday parlance.  I published it, went upstairs to make some nachos, and it hit me.  Why not Venture Capital 2.0 as a serious piece? So I sat down to write (and re- write and re-write) it, violating my own ethic about  2.0 being a silly shorthand.

Venture Capital 2.0
Lots of people in and around the VC business talk about how the VC model is broken including yours truly.  That assertion passes for insight in most conversations, but the real question is how and where to fix it? Since only the market fixes industries, the even bigger question is how will the market re-equilibrate to fix it and why hasn't it?

A large measure of the problem is structural.  It used to be that venture capital was scarce and a specialized product because of its risk profile.  Today private financial markets are more efficient (relatively) at trading off risk and return, assessing risk, and very effective at attracting capital.  There are some judgment biases by limited partner investors that arise from outliers like Google, but that’s a psychological issue, not a structural one.

In my opinion, at least five structural factors contribute to the lack of re-equilibration.  Normally I drone on at length on a topic, often making reading my blog  a commitment to what seems like a long-term relationship.  Not this time.  I am going to partition this discussion into more consummable chunks because, even I began to wander while re-reading my drafts.  So the next several posts will try to make each analysis more digestable. (Disclaimer: Like most things bloggy, these observations will be opinions.  I am sure there are more rigorous thinkers and researchers in the academic and investment communities who can and will have the time to be more thorough. I am just a humble, working stiff of a VC, trying to put term sheets on the table for my little companies.) 

To give you a peak at the conclusion, this will not be an advertisement for Small as the new Big or Early as the Real venture capital.  I will try to be more intellectually honest than that.