The Friends-and-Family Era

Dave Winer wants to reform venture capital. His idea is to do the IPO first, then invest. That's bassakwards, because it assumes the challenge of a new capital investment approach is to find home runs. The future will be mostly singles and doubles.

Dave Winer has done a lot of smart technology development, but I'd look somewhere else for ideas about how to fix venture capital. In a much-talked about posting, Winer says the associates, partners and general partners in venture funds who sweep"Web 2.0" is the Friends-and-Family era of IT; companies will launch like small businesses in the old-fashioned economy. the world for investments and vet those opportunities need to be disintermediated in order to make venture capital more efficient.

Doc Searls believes there is no more pipeline, not even a value chain, just a new market ecosystem calling for some serious disruption. Writes Dave Winer:

In any case, I’m sure there will be startups that need capital. Let’s assume so. So let’s start a new company, with Rick Segal as the CEO (if he’ll do it) called User Internet Capital Corp or something catchier. File all the right paper with the SEC, and do an IPO. You have to, because we’re going to be selling shares to the public right at the start. This thing will be public from day one. The purpose of the company will be to invest in promising young Internet companies, chosen by the users, nurture them through startup, get them liquid through acquisition or IPO and distribute dividends to the shareholders accordingly. Retain some cash for overhead and (I insist on this) a small percentage for pure technology research and development, so there will be new ideas to base the startups of 2009 and 2011 on.

That’s it. Never stop investing. All you have to do is listen to the users, who also happen to be the owners. How about that?

some moneyThat sounds great, but it misses the reality of the problem. Winer's alternative is to inject a publicly traded company which would have millions of dollars in overhead each year just for reporting its results to the Securities and Exchange Commission and investors, not to mention the general and administrative overhead costs that a "traditional" venture capital firm have today.

It's not clear how the Dave vision is more efficient than a venture firm, which, while they make a ton of mistakes and are limited to serving wealthy investors rather than the Rest Of Us, suffers mostly from being the status quo approach to investing in a time when people are addicted to change and "disruption." Dave Winer's admirable stand is that the small investors will make better choices as a group; his solution, creating a big investing entity with a lot of regulatory overhead, only perpetuates the large-deal mentality that prevents very early-stage investing by VCs.

Tearing the ultimate paragraph of Dave's suggestion apart, it outlines exactly what "good" VCs do today, as Eric Norlin argues. VCs invest in young Internet companies—there's never any guarantee, regardless of how you find and vet deals that all companies in a portfolio will be "promising," because it is a matter of opinion and that can be wrong. Expensively wrong. VCs also promise to nurture companies through startup and, as Dave describes his public company's main activity, "get[s] them liquid through acquisition or IPO and distribute dividends to the shareholders." The Dave vision shares much with the old incubator idea that yielded almost nothing of value during the 1990s. 

WinerThere's plenty wrong with venture capital business, though the problems are almost always individual cases. Folks generalize about VCs rather than view each deal as a separate and unique blend of factors that may produce a success—remember, most businesses fail, so it's not that "small" investments will yield a much better batting average, in terms of liquidity events, than big investments. Small investments do, however, carry the chance of huge returns, because there's less money on the line in the first place. 

Dave was responding, in part, to a posting by Rick Segal that tells the apochryphal story of an entrepreneur who wants to give back his VC money. Segal continues his thoughts about a new VC approach here, as well, though his "Capital firm" sounds to me suspiciously like a PR firm with a fund.

What Dave's getting at, as Tom Foremski noted in comments on the posting, is the idea that users should be picking the companies they want to back. If the company expects to need a lot of capital, "reform" would be much better implemented through a direct public offering (DPO) marketplace, where entrepreneurs offer early users investment options. If a company were set up to be the DPO facilitator that stripped the costs out of being a public company, that would be more efficient and get rid of the middlemen and an extraneous layer of R&D spending contemplated in Dave Winer's scenario.

Companies should be doing their own R&D and users doing the due diligence about whether the company is worth investing in and if it can sustain its business.

Why, though, should we think big when the essence of new Web businesses is smallness? Add an API and charge for data, mash-up a bunch of services to create a new view of the world, or latch an ad model to a formerly fee-based product—that's a solid foundation to start something these days. And we aren't talking about the most capital-intensive undertakings, as services like Memeorandum, Digg, TailRank and MeasureMap suggest.

The reality of recent Web startups is that they are a collection of features for the most part and not often a full-fledged business, at least at the start. They'll aggregate into something bigger, but those events will be frequent and small (that is, sub-$10 million, sub-$20 million or some other traditional VC-irrelevant figure—Winer made a couple million bucks on recently, for example) or the resulting companies may never need to go public because they operate at a nice profit.

Small can be beautiful in business, after all 80 percent of the economy is really small businesses that make good livings for owners and investors.

Lemonade"Web 2.0" and other ways of describing the liminal technology market is probably just the beginning of the Friends-and-Family era of IT business, where companies are launched like small businesses in the old-fashioned economy. suggests a clever solution to the problem of linking small investors and small businesses: an eBay/Craigslist marketplace of ideas.

There are a billion small businesses to be built to take the places of the firms that are being obsoleted now, and they can be built just by talking with early customers who want to support your startup, if not your parents, friends and neighbors who believe in you. Then there's no need for any form of public offering of any kind, since management and investors look each other in the eye, ask hard questions that VCs would normally force entrepreneurs to confront, and never think of growing a company as a race for liquidity.