I’d discussed changes in the VC business before in a few posts. Today, Fred Wilson calls it the signals of The Zero Billion Dollar Fund, inspired by this post by Bill Burnham.  Burnham points out:

The bad news for large VC funds is that if my recent conversations are
any guide it seems like more and more entrepreneurs are picking up on
the implications of these dynamics and adjusting their behavior
accordingly.  These changes could lead to a serious case of adverse
selection, wherein the best entrepreneurs with the most capital
efficient ideas either self-fund or raise money from angles while only
relatively risky ideas with large capital requirements seek capital
from large funds.

Fred foresees a disruption in the VC business.  The squeeze is playing out like this:  On one side, you have large funds like Redpoint’s latest at $400m and Kleiner’s 12that $600.  On the other, you have USV with $125m, Patricof with $50m.  I like Fred’s description of the "Zero Billion Dollar Fund":

We have this saying around our firm, the "zero billion dollar
business".  It describes a business, like Craigslist or Digg, that
enters a market, like classifieds or news, and by virtue of the amazing
efficiency of its operation can rely on a fraction of the revenue that
the market leaders need to operate profitably.  These zero billion
dollar businesses are highly disruptive and change the economics of
their industries over time.
…
Union Square Ventures was designed as a "zero billion fund" in a sense.

This thinking is similar to how I see the budding VC market in Turkey.  Even in the private equity market, the funds are not having an easy time deploying their capital.  In the earlier stage side of the market, that problem will be even more critical.  Calibration will be a key factor for the funds here.

NY Times reported today that Alan Patricof is leaving Apax Partners to start a venture capital fund, named Greycroft Partners, focusing on digital media ventures.  The key story here is this:

• Apax has over $20 billion under management.
• Patricof is as big a VC name as it gets.  He’s a co-founder of Apax (which was named, at one point, Patricof & Co. Ventures).
• Greycroft has raised only $50 million.
• Patricof has declared that:

"When you get into larger companies, you get into financial engineering
and leveraging models.  There is a market down
there at the smaller end that we shouldn’t ignore. If you happen to hit
it right, there can be an exponential growth factor."

I have shared my thoughts on Media2.0 and VC in this blog.  In a later post I speculated that we’ll see:

…smaller, more specialized VC outfits.  One example I can think of is Union Square Ventures.
Fred Wilson and Brad Burnham are experienced and reputable enough that
they could have raised a larger fund with broader ambitions, but I
think they recognize their competitive advantage well and will be more
effective in their current set up.

The creation of Greycroft Partners now gives a much stronger validation to this argument.  Patricof could have raised any size fund he’d like, and he chose to stay small and focus on earlier stages.

There has been various discussions of the smaller VC model.  One leg of the conversation was started by Stowe Boyd, where he distilled the advisory value offered by VC firms, and proposed separating it.  Even thought there were those disagreeing with Stowe, I think the launch of Greycroft emphasizes the value of attention and soft value in the early stage investment model.

A Wired article this month features a tactic being employed by Allen Morgan of Mayfield Fund.  Morgan has been analyzing Mayfield’s dealflow, as well as the tech press, from the Dotcom boom to see if there are companies or ideas that may have failed at the time, but would work well today.  It is an interesting thought.

However, the article made me think of a different issue.  Is the VC business increasingly about ideas?  There has been some high-profile discussion in the VC community regarding the changing dynamics of the business.  Some contributing factors have been identified as:

• Relative ease of fundraising due to humble returns elsewhere
• Decreasing need for capital in some startups, due to open-source, offshore outsourcing, etc.
• Competition from large companies acquiring startups earlier than usual

I have heard various prioritizations of the attributes one needs in the VC business, including corporate finance knowledge, quantitative skills, analytical strength, patience, and good gut to filter BS.  In the face of the changes described above, I suspect the ability to develop (or recognize) themes and filter ideas will gain precedence as the prime quality of a successful VC.

I see Fred Wilson and Brad Burnham’s USV as good example of a theme and idea based VC outfit (and we’ll see if it’s a successful one, as well.)  Nivi, a prolific idea generator, recently joined Bessemer Venture Partners, as Entrepreneur-in-Residence.

I root for ideas.

On Friday, I attended the IRC Ege Technology, Innovation and Venture Capital Days event.  I must say, it was an eye opening experience.  I have to give credit to the organizers:  they worked hard to attract a relevant crowd to Izmir, which remains a secondary region in terms of tech innovation in Turkey.

Entrepreneurship HAS to be RESCUED from the triangle of VC, academia and government!!!  I felt this to a point in NY, but in Turkey, partly due to the relative naivete of the entrepreneurial community, the grip is tighter. The concept of "entrepreneurship" is held hostage by the finance community (to a point including the advisor crowd of lawyers and accountants), academics and bureaucrats. 

The primary point I’d like to make is that the conference was extremely BORING.  Three or four panelists sit behind a table.  A political moderator asks pre-determined questions.  The audience is not really connected to what’s discussed.  The result is basically a waste of time.

To give an example, after a long debate on Venture Capital, one audience member, the founder of a 25-year old elevator company, stood up and asked, "So you’ve been yapping for two days now.  But who’s going to answer my question?  I have a great company.  Let’s assume that everything in my company is by the book. How much money will you give me, at what length of time, and at what interest rate?"  As absurd as the question was given the forum, it was so right on.

As could be expected, no one answered the poor chap.  He should not have been there.  Actually, the whole conference should have been programmed with him, and those like him, in mind. 

I met a remarkable person at the conference, Yigal Erlich.  He was one of the original partners at the Israeli national Venture Capital program, Yozma.  The story of Yozma presents a very critical lesson for the Turkish government, if there is the intent to kick-start this field in Turkey.

Howard Anderson, an elder statesman of the industry thinks so, in his MIT Technology Review article, which Brad Feld blogged about today.

Point by point, I would agree with every statement in his article.  However, I am not sure if those points add up to the death of the entire industry.  One of his points, the large sum of money looking for a destination, may be the reason why the industry survives.  Where else does all that money go?

The theme of the article is one of the reasons for my decision to move to Turkey.  I think the dynamics Anderson explains will increasingly make early-stage opportunities in developing markets attractive to investors world-wide.

Gordon Gekko would answer that with one word: "Greed"

Is it true?  I honestly don’t think that it is the primary factor.  However, there is one phenomenon that makes me believe that it is a significant component.

Imagine a business that would create an equity portfolio of minority shares of start-ups.  Once it identifies a promising business, it takes a minority share in exchange for participation in the fund – in effect the entrepreneurs give up equity in their ventures for participation in a "basket" of equity in a similar set of ventures (becoming "limited partners").  For this hypothetical business to be profitable, it would value the ventures at a discount, compared to the rest of the portfolio, therefore creating shareholder value.

A set up like this would make an interesting risk-management product for entrepreneurs, who are typically extremely exposed to risks associated with their ventures.

Could such a business work?

The response I get from the VC community has been negative.  A common objection is that the VC’s smartly take advantage of the drive (or "hunger") of the entrepreneurs.  If the entrepreneur is able to hedge that risk, theoretically she is less driven to succeed, therefore hurting the VC fund’s portfolio’s performance.

This does not make sense to me.  If this argument had much merit, Jim Clark (founder of Netscape and SGI), a billionaire, would have no VCs interested in backing him.

I think the real objection lies in management fees, the typically 2% fee that a VC fund charges its LPs as compensation for managing the fund.  In the hypothetical set up described above, there is no fund, hence no management fee.

As the early stage funding market gets more efficient, I predict that the management fees would be under pressure.