Fad and Fashion in Venture Capital

Charles River Ventures announced Quickstart- their new effort at doing seed stage deals with modest amounts of money. Bill Tai and George Zachary are seasoned venture capitalists with operating and investment banking experience, and I wish them well.  New structures, however, often have unintended consequences. I think it may be helpful to get some historical perspective on the situation.

Venture capital investing has been subject to fads and fashion for as long as I've been involved. I started in 1982 (egad - it'll be 25 years next April), and have watched many of the fads in investment areas. Been through (and made some money at) enterprise software, PC hardware, PC software, client server, internet bubble - that was fun - Web 1.0, now Web 2.0. There have also been different fashions of investing, from small fund to big fund, late stage, mezzanine and, as evidenced not only by CRV but several other attempts that other excellent long established funds are about to try, seed stage investing.

When I started, funds were much smaller than today, and there was a lot of focus on syndicating deals among many firms. Hence it was important to work collegially and collaboratively on deals, so that you'd be invited to the table on the "better" ones (as if we knew in advance).  There was also a need for several deep pockets around the table - especially when it took tens of millions to establish a new brand and its sales force. This was in a day when $100 million was a large fund.  As the fad migrated from hardware to software, where less money was needed in the development stage, syndicate sizes got smaller.

Also, as we entered the 90s, funds sizes became more disparate (i.e., the rich got richer) and very big money went to the late stages.  When we hit the internet bubble, with quick exits, funds were so successful that they grew way too large (several funds raised a billion dollars), which proved hard to deploy.  The tactics then became one of eliminating syndication, and bidding up the price of startups with "we'll put in all the money you'll ever need - but we want 30%, 40% or more."  Kleiner Perkins, Sequoia, Benchmark and others were pretty successful with this, for a time.

But as the web infrastructure really proved robust, entrepreneurs also got smarter.  Many had made some money in the bubble and could afford to fund their own startups. And during the venture nuclear winter of 2002-3, entrepreneurs had very little choice.  Even though the large firms had the money, they were not willing to invest.  Sometime in early 2004, my partner Josh Kopelman realized that there was a void in this early stage, and that much less capital was required. In setting up First Round Capital, we explicity understood that we would need to spend a lot of time with our investee companies, and that it would only generate the returns we wanted if we could interest other venture groups in joining in later. Our typical initial investment size has remained in the $250,000 range, with lots of hands on in the first few months. Whether or not it will prove successful remains to be seen.

This stage of investing, somewhere between angel and A round, requires strong diversification to succeed, and a high ratio of time to money invested. We expect a lot of money to flow into this stage in the next year, as evidenced by Quick Start. Hopefully the new players will stay smart enough not to push up prices so much that the inefficiencies go away completely.

First Round Capital has been one of the way too early investors in angel/seed stage, but we expect to be here for some time to come and wish the best of luck to the new firms and, we hope, our new coinvestors.

[See my partners reaction to the announcement at redeye.firstround.com]

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