Startup general interest

The venture capital model – how building a company has changed

By March 2, 2010 No Comments


Ben Horrowitz of new Valley based fund Andreessen-Horowitz has a good post up today promoting an open source legal project for seed stage investments.

His discussion of how the requirements of companies have changed over the last ten years is spot on and very illustrative for the debate about the evolution of venture capital:

It turns out that building a company has changed quite a bit since the early days of venture-backed technology companies. Building a company like Twitter or Facebook is quite different from building Tandem. Specifically, the risk and cost of building the initial product is dramatically lower. I emphasize product to distinguish it from building the company. Building modern companies is not low risk or low cost: Facebook, for example, faced plenty of competitive and market risks and has raised hundreds of millions of dollars to build their business. But building the initial Facebook product cost well under $1M and did not entail hiring a head of manufacturing or building a factory.

As Brad says, the upshot of this is that funding the initial product development of a startup should be about speed, flexibility and low cost – a challenge for VCs who operate a model based on lengthy due diligence and significant capital deployment.

There is, however, still a very clear role for venture capital, and that is in helping a company move from initial product to huge scale.  This still takes significant capital (hundreds of millions of dollars for Facebook and Twitter) and also benefits from the additional value add many VCs can bring to bear, including experience in growing companies, access to senior execs who might join the team and access to corporate partners.

So, when should you raise venture? again Ben has it about right:

If you are a small team building a product with the hope of “seeing if it takes” (with the implication being that you’ll try something else if it doesn’t), then you don’t need a board or a lot of money and an angel round is likely the best option. On the other hand, if you’ve developed a strong belief in your product or your product idea and you are in a race against time to take the market, then a venture round is more appropriate. You will benefit from both the extra capital and extra support that comes with a serious and large commitment from your investors.