What a difference a year makes. In 2009, with the nation's economic storm raging with gale-force winds, most venture capitalists pulled in their horns, trimmed the size of their startup portfolios and only rarely invested in new startups, whether they were promising or not. When they did invest, it was mostly in later-stage rounds.
Some pundits contend there is sizable surplus of early-stage capital today. True or not, this belief would never have been uttered earlier this year. What has changed? Sharp professional investors in seed and early-stage startups have come to realize that building startups, especially software-based businesses, has never been cheaper. Think about it. Open source code and cloud-based hosting is ubiquitous, as is software-as-a-service, and the cost of storage and processing has plummeted. Startups can break into the market today at a tiny fraction of the cost even a decade ago.
This stunning rebound in early-stage investing is good news on two fronts. It substantially undermines the argument – still strong in some quarters – that venture capital is dying. Instead, it suggests it is simply changing. Many traditional VC firms have gotten too big and unwieldy to build innovative companies the way they once did, opening the door to a new VC business model. And in many ways, the “new” model isn't new at all but essentially a return to venture's roots in the 1970s and 1980s. That was when VC firms were small, managed mostly by people with substantial industry operating and entrepreneurial experience, and more focused than they became in succeeding decades. This “old is new” model has probably become the best model because of a continually weak ipo market
The turnaround in early-stage venture investing is also obviously good news because promising startups are no longer starved for capital at a time when the U.S. faces an unusually strong and urgent need to reignite technological innovation, along with the jobs this creates.
Here are the recent developments in early-stage venture capital, as well as two reminders that proven, time-tested approaches to investing in entrepreneurial ventures are also alive and well.
Potent super angels that have emerged or strengthened include First Round Capital, Baseline Ventures, Maples Investments and Felicis Ventures. First Round, which has become one of the nation's most active seed stage investors, invested in online personal finance site Mint.com after Sequoia Capital passed on the deal and watched the startup blossom into a rival to Intuit, which acquired the company. These and other super angels have launched sub-$100 million funds. Unlike many VC firms, the super angel model can profit by hitting singles and doubles, not homeruns, and reducing their strikeouts.
Since the start of 2009, at least a dozen first-time venture funds, almost all focused entirely on the early stage, have hit the market. These include Andreessen Horowitz, Excel Venture Management, Founder Collective, Allos Ventures, Cava Capital, Greener Capital and Harbor Pacific Capital.
A number of old-line VC firms have recently begun setting aside a specified amount of capital specifically dedicated to seed investments. The latest to announce this move is Greylock Partners, which has formed the $20 million Discovery Fund, part of the larger $575 million fund it raised in 2009. The separate allocation allows Greylock's partners to make investment decisions very quickly, rather than wait for partnership approval. Similarly, Index Ventures and FirstMark Capital this year set up formal programs that sprinkle small sums into a large number of young startups.
Other venture firms, such as Norwest Venture Partners and Adams Street Partners, have given money to angels or seed fund managers and a thumbs up to invest as they see fit.
Traditional angel investors, who unlike super angels usually invest their own money, have not moved underground in the recession. In fact, many of today's angels are younger and better. They use their LinkedIn connections to help enhance startup opportunities. In the past, many angels were so micro-oriented that they helped write code for startups in which they invested. Today's angels have stopped doing that and instead focus on addressing new product and service challenges. Unlike before, they also help build company web sites today and beta test a startup's product.
Even last year, more than 57,000 ventures received angel funding from angels with a total of $17.6 billion in committed investments, according to the Center for Venture Research at the University of New Hampshire. Angels need cash-rich venture capitalists to make substantial follow-on investments once their companies begin to mature, and there is no guarantee they will get it. Still, angels increase the number of startups that receive seed stage capital, and many venture capitalists rely on them to remove some of the risk from new startups in which they ultimately invest.
It has always been the case that a number of venture firms have regularly invested in seed and very early-stage companies, whether they have formal seed investing programs or not. Claremont Creek Ventures, for example, has a Life Cycle Venturing (LCV) program that “turbo charges” seed-stage startups by mentoring entrepreneurs with hands-on advice and strategic direction that gives them an extra edge in the marketplace. Claremont Creek often goes on to finance LCV entrepreneurs, typically with an initial investment of $50,000 to $250,000. Claremont Creek is currently working with two LCV entrepreneurs, building upon Life Cycle Venturing relationships in the past with Adura Technologies, Alphabet Energy, Arxcis LeFora, PropertyBridge and TargetCast Networks. Like other VC firms, Claremont Creek offers LCV startups office space. Unlike others, it is also willing to partner with LCV startup founders while they are still working in outside development laboratories or inside universities. The LCV program even holds “office hours' once a week at the University of California at Berkeley, which has been a steady source of entrepreneurial talent.
A year ago, almost nobody would have gone out on a limb and predicted that today's early-stage VC investment scenario would unfold. This is a reminder that it's healthy to maintain healthy skepticism about future business trends, whether they are positive or negative, such as the contention that venture capital is dying. It's particularly important to bear this in mind when times are as tough as they are today because predictions tend to be downcast. For entrepreneurs, venture investors and the economy overall, this is a happy example of the benefit of being wrong.
Randy Hawks is managing director at Claremont Creek Ventures, bringing more than 25 years of technology industry experience to the firm. He specializes in investing in sensor networks and security and also broadly in other IT sectors.
Great post, Randy.