Its Venture Capital Jim, but not as we know it….

Business Week recently published an article on advice for start-up trying to attract venture capital and it made interesting reading on a couple of fronts.

First of all as I am sure a lot of you are aware the pool of venture funds has got smaller, a lot smaller additionally the opportunity for concept or speculative deals is near enough impossible to fund and finally on the plus side, if a business asks for less (sub 5m) and manages to succeed in a bear market, it has a very good chance of survival.

In my view there is little or no change here from how VC’s have always operated and for those unaware a short economics lesson of VC life:

Since the time when the Sex Pistols and the Clash were in the music charts and punk was a radical idea, Venture Capital firms had a model that worked. First off there was a large fund for investment – normally around 100m and then a bunch of businesses would be invested into at entry level for less than 5m each and within 3-5 years the best would be sold off or taken to market generating a 10-20 time return, which covered the failures in the pack and the investment time. Easy money, and for the next 30 odd years the industry made billions surviving the .com boom..

Then along came clean tech and the thinking was again that here was a money pit waiting for excavation only this time the deal is a bit more complex….very complex, to the point where VC’s are scrambling around desperately trying to find a model that works.

The problem is – apart from a massive decline in funding that the VC’s can smell the money and see the potential but it’s the level of risk that is making them gag. Getting a VC to buy into a start-up or early funding is a problem due to the fact that they don’t know what is working yet, so they wait for a “mature” business to come along with contracts and proven delivery. But then part of the old model is now out of kilter in that they are no longer a cheap buy and the returns are not a traded market but balance sheet. Add to the issue that the investment is normally in excess of 10mm and suddenly the model of 1976 is in pretty bad shape and the VC’s get twitchy.

So what’s the answer? The VC has a role to play and as the banks are less than interested in supporting a business needing hundreds, never mind millions they need and want to step up to the crease. I can see in the future a new wave of VC that spends more time on understanding the market and good due-diligence before making an investment decision. This means that investment business will need to be stronger and better thought out in their delivery and have a strong management team committed to delivering it. I can also see the numbers of businesses invested in reducing dramatically, with the “expected to fail” model being kicked into touch. That would mean less cash and more equity with more time and help being offered by the VC to ensure that they become a success beyond fiscal management, however the thought of VC businesses advising on sales and marketing is a scary thought!

A punk VC business? Or perhaps a fad to see the VC through a tough period of investment jitters? All I know is that any start-up looking to generate VC dosh will need to be ahead of the game, have big IPR and a team to wipe the floor with the competition – as the cash gets tighter and risk becomes more prevalent it’s the only thing a VC will take seriously.