The VC View - funding start-ups in todays market place

Article published in The Manzella Report: http://www.manzellareport.com/index.php/economy/926-reports-of-another-dot-com-bust-are-exaggerated

Every few months news report claim we’re on the verge of another dot com bust or too much money is being pumped into too many start-ups that are destined to fail. These reports often are greatly exaggerated and demonstrate a total lack of understanding of the current startup market.
Some doomsayers’ predictions of another dot com bust actually have more to do with the changes in the world of funding over the last fifteen years. And venture capitalists (VCs) have devised a Darwinian culling process which can look to outsiders like a waste of money. But in actuality, it’s exceedingly efficient.

It is difficult for even the most experienced VC to choose early stage winners. Nevertheless, within the first year of funding it usually becomes self-evident which startups will not make it to round two.
The first big change since the dot com bust is in the internet itself. Today’s entrepreneurs have an easier time vetting an idea and accessing funders. There also are many more avenues of funding for very early startups then in the past. And today’s entrepreneurs can post their ideas to crowd funding sites and apply to incubators — organizations that work with entrepreneurs in developing business plans and executing products.

The second big change relates to who gets funded. Back in the 1990’s an entrepreneur with a well presented idea likely could get funding. Today, angel financiers and VCs want to see traction. Thus, an application needs to be available and already have a following before VCs consider funding the project. More specifically, the angels and VC’s look at user growth rates as the prime metric for funding.

What started in the dot com area now has become a way of doing business. There are a few exceptions to this model which have involved a very few lucky entrepreneurs with an idea so compelling their high rate of crowd funding has received the VC’s attention. Think Oculus Rift, the virtual reality headset company bought for $2 billion by Facebook. Entrepreneurs who have proven themselves on previous projects also can get funding for just an idea. And finally, some VC’s troll top grad schools like Stanford and MIT for graduate projects that fit their portfolios.
For most startups, funding is their first daunting hurtle. What started in the dot com area now has become a way of doing business.

For example, when VCs decide on an area of technology to build out their portfolios, they may give $10 million to ten or more different promising startups which only get scant support and direction. At the end of one year, the VC’s will review each startup and fund the top one or two that show promise.
It’s not a coincidence that some of the most successful companies in Silicon Valley started in a garage and have founders that can finish each other’s sentences. When VC’s decide which companies they’ll give the next round of funding to, they do this on the following basic criteria: they look to see if the startup has met it’s deliverables, used its money wisely, hired the right type of people, and very importantly, whether or not the principles work well together.

Too often startups internally combust when the partners have disagreements, spend too much money on fancy offices, waist funds on the wrong people, or do not have the necessary discipline to cut losses by firing employees who don’t work out.

For those few startups that make it out of their first round of funding, VC’s have a strong network of experienced managers that can provide the winners with guidance. For example, VCs appointed Eric Schmidt as President and CEO of Google.

Some startups that don’t receive a second round of funding become Zombies — startups with some money and level of traction, but not enough traction or market interest to be considered of value to a VC. These Zombie companies usually continue for a time from sheer determination of the founders. Some turn into mom and pop companies, while others eventually wither up and close down.
Regardless if the startup continues as a zombie or just closes, today’s VC’s are positioned to recoup all their expenses. In fact, some even make a profit from failure. Over the last fifteen years markets have been established to sell debt from closed startups, while intellectual property such as patents are sold on patent exchanges.

By calculating expected losses and creating markets for debt and intellectual property, VC’s have mitigated their losses while providing a Darwinian process, that in the end, can produce a few blindingly bright stars.