Is venture capital becoming obsolete for Web start-ups? It’s a recurring theme as of late. Even the NY Times is jumping on the bandwagon with a resounding “Yup, they’re (almost) useless“.

I don’t know ’bout that. You got a startup? Guess what, sooner or later, you’ll need money :) Let’s dissect the Times piece, which primarily quotes Robert Hendershott:

“As the cost of starting a Web company decreases, thanks to cloud computing services and technology that entrepreneurs can rent instead of buy, many founders can finance a new company without the help of venture capitalists, using their savings, money from family and friends and credit card debt…”

Sure, you can probably go further on bootstrapped cash then you could in the past, but that’s just the beginning. Let’s say you want to build a SaaS. Bruce Cleveland mashed up some data revealing that - on average - to grow a company into a market leader, you’ll need $20-25M [sic: and an ulcer of steel]. Should you decide to brave the Sarbanes Oxley waters and go IPO, you’ll need another $20-25M to bring that SaaS public with a decent multiple. That second bit is primarily a gigantic marketing budget.

The Flip

But what about the famous flip? The times article makes it sound like you only need cash to go IPO, which, frankly, is a tad misleading.

“More often, [entrepreneurs] are choosing to sell small, immature companies instead of taking the longer, riskier path of developing a business that could one day go public. That makes venture capital less relevant.”

Wrong. Selling a small, immature company still requires capital. The BigCo’s like Google, Microsoft, and Ebay buy companies for technology and/or as a form of recruiting the best talents on the market. Which means that entrepreneurs have to build a firecracker development team of  gurus (gurus are expensive) and a breakthrough technology which continues to innovate faster than the market can catch up (you may get more for a sale if you have patents).

Attracting those BigCo’s takes a lot of time. And contacts. In the meantime, the company must keep paying the gurus, keep the technology evolving, file the patents and trademarks, and make sure the product doesn’t slip and fall out of the market by accident. All that takes money, rarely less than $2-5M.

Exceptions: I’ve heard through the lawyer grapevine that there’s been a interesting uptick in M&A’s between startups during this economic crisis — recently funded companies taking advantage of the temporarily closed VC window and buying out their cash-trapped competitors. So that’s a cheap flip… but I don’t know how attractive it actually is an an exit.

Check Your Assumptions

I think there’s essentially an outdated assumption at the basis of the article, at least for the web companies:

“One of the key roles of venture capital, Mr. Hendershott argues, is providing the money needed to prove that a new technology works and that a market for the technology exists.”

VC’s invest just to see if a market even exists? I don’t think so.

I’ve been in some form of fundraising or another for the past two years (it’s a never ending loop) and I can honestly say that no VC ever even remotely pretends to be interested in a product that doesn’t already have market traction, not to mention a revenue history with impressive growth.

I actually believe that’s a good thing. VCs need not be involved in the earliest stages of a company. A baby startup doesn’t need the administrative overhead that a VC will typically bring to the picture. You’re better off going to angels, or experienced seed funds.

Ch-ch-ch-changes

The VCs aren’t going away, though they’ll change. Even the Time article comes back around to reality in the end:

“Furthermore, some venture capitalists are tweaking the venture model to continue to take advantage of these new ideas”

Ok, these “new” ideas are already getting a little old to be called new. In fact, changes have already taken place with more and more seed funds popping up. Personally think a great tweak is heavier coinvesting with  corporate investors who have just as much interest in assuring a healthy crop of startups as the VCs do.

On the contrary, I’m less excited to see the Business Angel market so consolidated. When a group of angels starts acting more like a mini VC than a band of business mentors… watch out! they’ll be lugging along a similar administrative overhead as a VC would.

In the end. VCs need startups. And, sooner or later, startups need VCs. It’s just a matter of timing.