The Stalwart: Friendlier VC Money And The Endless Startup Boom

Cash in its purest form is basically a commodity. A million dollars is a million dollars is a million dollars, regardless of where it comes from. Except you don't usually get a million dollars in a briefcase with no strings attached. Instead, you get a million dollars in the form of a wire transfer with all kinds of conditions, strings, caveats and riders. So often, cash is not a commodity cause a million dollars from person A may represent a totally different proposition than cash from person B.

If it's true that there's an unprecedented influx of cash into new internet investments (and I don't know that this is necessarily true, but it seems to fit in with the overall narrative), then it makes sense that investors (ie VC firms) would have to compete more aggressively to market their cash to investors. Hence the interest in stuff like The Founder Fund, which was profiled this weekend in the WSJ. Among its differentiators: the award of "FF" shares, which allow a founder to cash out before the big liquidity event (acquisition or IPO). The fund, reflecting its name, exhibits its pro-founder stance in other ways as well, at least it does in rhetoric (WSJ: Venture capitalists often can be too quick to fire start-up founders and replace them with professional managers, Mr. Thiel says. He blames a cultural divide: Many VCs "have these very cushy jobs, they get paid a lot," and often can't relate to founders, he says.)

Besides the influx of cash, another factor that may be driving this trend (if it could be called that) is the emergence of veteran internet entrepreneurs. 7 years ago, nobody had much of a track record building successful internet ventures. At this point, there are a lot of folks who have taken several laps around the block, and they don't need to put up with any nonsense. Beggars can't be choosers but veterans can. So if you want to invest with an established winner, you're going to need to do it on their terms.

My guess is that we'll see more investors operate along the lines of The Founders Fund. A guy like Fred Wilson who can offer a company more than just cash (e.g., association with the hippest web 2.0 VC blogger) will be able to snag more hot deals and good valuations than other VCs with a similar investment profile.

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One question I keep thinking about is what happens to the VC world if the credit crunch continues to well, crunch, and appetite for risk abates. VC investors don't rely on credit the way PE funds do, but they do rely on leverage. The difference is like the difference between buying a stock on borrowed cash and buying options on a stock's movement. With the former, you can make a lot of money on a small movement, but there's a big downside risk. With the latter, you risk a small amount up front, but you may need a big movement to produce a winner. Ideally, you end up with a lot of losers, but some monster winners that make it worthwhile.

My hunch is that the VC world will do okay. Rich investors will continue to seek out folks who can deliver levered-up alpha, and it may be that as credit conditions crimp the maneuverability of PE funds, they'll look for the alternative route. This could actually exacerbate the condition of excess capital, putting VCs into deeper competition for deals, as described above. We'll see about that: I'm purely speculating here.

One other thought for now: Investors and entrepreneurs have the last recession fresh in their memories. But this doesn't mean that cautiousness will prevail. In fact it could be just the opposite. A lesson of the last bubble/bust was that the trough was a great time to start a company, as equipment and labor proved to be cheap, while a recovery was just a few years away. Here's a thought experiment. If you could get in a time machine and start a web startup, when would you go back to? 2000 or 2002? I think the answer would obviously be 2003. If we do another dip, you'll have a lot of folks licking their chops, seeing it as another opportunity to jump in during a time of weakness. Combined with what I think will be a steady flow of capital into internet investments, the web startup boom could continue for quite a while.