Jason Devitt

Apparently there is a crisis in the world of venture capital. Those who write about it see two distinct problems, one on the way in and one on the way out. Technology has so lowered the cost of starting a business that traditional VCs are no longer needed; on the way out the number of IPOs and big-ticket acquisitions has obviously dwindled, MySpace and YouTube and maybe Facebook being the exceptions. Some entrepreneurs seem quite smug about VC troubles. I think that the ‘crisis’ is largely confined to consumer Internet services, and that it is more of a crisis for entrepreneurs than it is for VCs.

True, part of the problem on the IPO side has nothing to do with technology or VCs. It’s a piece of over-zealous legislation called Sarbanes-Oxley that has raised the cost of going public. Personally I think the way to prevent corporate crimes is not to make companies swear to their accountants that they are really really not lying about their EBITDA, but to make them disclose as much information as possible to investors. SarbOx didn’t reveal that dozens of corporate executives had back-dated options; it was Erik Lie, a finance professor from the University of Iowa who crunched numbers that were publicly available.

But mostly the problem is that while the technology and the concepts behind Web 2.0 are exciting and important, the companies that embody them just aren’t very valuable. Pioneering sites like Flickr and delicious sold for less than $50 million each, and even YouTube and MySpace didn’t think that they could survive as independent companies. In total it’s just not enough money to get venture investors excited.

No problem, we are told, since cheap Intel boxes and Amazon S3 and Ruby on Rails and the rest of it mean that you can launch a company with $6,000 and a bowl of ramen.

Wait a minute. All over this country, across every sector, small business owners use an average of $10,000 to start their businesses. Even for this year’s Inc 500, a list of the 500 fastest-growing companies in America over the last four years, the median amount of start-up capital was only $75,000.

The key word is small. Like their peers in construction and retail and transportation, most of the consumer-facing Web 2.0 businesses are small today and will stay small. What is different is that most of the founders of the Web 2.0 companies believe that they are destined to be big.

VCs are adjusting to the fact that just like railroads, automobiles, fast food, bowling alleys, wall-to-wall carpet, fabless semiconductors, and personal computers in days gone by, the consumer Internet market has begun to mature and no longer presents many interesting opportunities for venture returns. (Yes, there will be exceptions; but every so often there is still an opportunity for a venture-backed retail franchise.)

A lot of the entrepreneurs that I meet have not made that adjustment. That’s the crisis.

This entry was posted on Tuesday, November 21st, 2006 at 9:38 pm and is filed under Economics, Starting Up, Web/Tech. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.