VC is dead. Long live VC.

I had the opportunity last week to speak at a Seattle Tech Startups meetup. The topic of the meeting was: “Where’s the Money in 2010?”, and I put together some slides describing how Founders’ Co-op is thinking about the early-stage landscape here in the Pacific Northwest.

John Cook, a friend and local tech journalist, was in attendance that night, and when I saw the headline of the article he posted the next day I knew I was in for it. The headline read, “Venture capital business faces ‘terminal misalignment of goals’“, and it was a more-or-less direct quote from my talk. Later that day Andy forwarded me a very short email from a mutual VC friend. It included a link to the article and the phrase, “Boy – y’all have some pretty extreme sound bites going around up in Seattle!

For the record, I *do* believe the goals and incentives of large institutional venture capital firms – those with billions of dollars under management – are hopelessly at odds with those of early-stage web entrepreneurs. And I’m hardly alone in this view (the slide in question included supporting quotes from Bill Burnham and Mike Arrington, two much more widely-read and respected voices on early-stage tech investing than I’ll ever be). But the VC landscape is not a monolith – although mega-funds like Kleiner and Sequoia are technically in the same business as Union Square, Foundry or True Ventures, their strategy, approach and fundamental economics are wildly different.

There are more threads here than I can unravel in a single blog post, but this topic is fundamental to what Andy and I are up to at Founders’ Co-op, so it won’t be the last time I write about it. As briefly as possible, the thesis we’re working with looks something like this:

  • Thanks to open source tools and cloud-based services, the capital required to start a web software company has plummeted (and continues to fall).
  • At the same time – thanks to Web 1.0 fund returns and the “Swensenification” of institutional asset allocation, the capital allocated to large VC funds has grown dramatically.
  • While the latter trend appears to be reversing itself somewhat, VC funds are long-lived animals, and it will take years for that capital oversupply to work itself out.
  • Because even large funds are run by relatively small teams, they *have* to put big chunks of capital to work (e.g., $10-$20MM per company) to correctly balance the allocation of partner time to committed capital.

The conditions above have left a huge hole in the funding marketplace for early stage web software companies. Smaller existing funds and a host of new funds have popped up to fill this gap – including the firms I mentioned above and many other besides. There isn’t (yet) a clean categorization for these new investment pools – we’re all still lumped together with the big firms as “Venture Capital” – but there is a significant difference in focus and intent, and I think the category merits its own label. Any suggestions?