23 Aug Is the VC Model Broken? Smart Money Needs to Smarten Up
According to some experts, the traditional VC model is broken. In fact, it has gone the way of Palm Pilots and dial up. If that is true, then how are startups supposed to…well, start up? The answer is in the “sharing economy,” with models such as AirBnB, Lyft, Surf Air and BlackJet leading the way. These companies, which make money by helping consumers share their tangible assets with other consumers for profit, have the right idea. Thanks to the convenience of our digitized world, they create efficiencies from portable assets. How does that apply to raising capital? Because of another aspect of the sharing economy, crowdfunding.
Crowdfunding, wherein individuals each contribute small amounts of funding to a project in return for a tangible or non-tangible benefit, is an aspect of the sharing economy that has the potential to significantly diminish the need for small business loans. For that matter, it stands to wipe out the demand for VCs. Crowdfunding has many permutations, as it can be used in nearly any project that requires vast resources: movie production, scientific research, invention development.
How Crowdfunding Applies to Startups
Tech startups can benefit from crowdfunding as well. There are plenty of ways a new mobile app, video game or web-based service can compensate its crowdfunders. If film producers can give a producer’s credit to all the crowdfunders that send them a few hundred dollars, why can’t a tech startup do the same?
Thanks to the effectiveness of crowdfunding, the traditional venture capital model may be on its way to being replaced. According to well-known VC expert Fred Wilson, more VCs are waking up to the fact that they will have few assets to work with in the future. At one forum recently, Wilson was asked a question commonly attributed to Paypal’s Peter Thiel: “What do you believe that very few people agree with you about?” His answer was this: “In the venture capital market, there ultimately won’t be a need for VCs to ever have funds.” Huh?
Here’s one explanation. Today, VCs raise money from Limited Partners (LPs), who trust the VCs to invest in companies that will grow over the next 3-10 years and deliver a good ROI. Because their money is not their own, VCs may eventually become obsolete as LPs begin to take a more active role in identifying opportunities.
The Shift is Beginning
Although Wilson admitted the transition will happen years down the road, he believes this is already starting to happen for early-stage investing. “Expect to see more and more ‘out-there’ experiments,” he said, when it comes to the seed round for new startups. Crowdfunding is one of the tamer models of experimentation, but as more startups see its value (providing user validation is just one example), more experimental funding methods are bound to start sprouting up.
Established VCs have little to worry about now, but as any former Palm Pilot user will tell you: Things can change very quickly. That’s why we believe those with smart money need to smarten up about the traditional VC model, and look to crowdfunding as a new way to make ideas happen.
Article originally written for BizHack.IT blog Is the VC Model Broken? Smart Money Needs to Smarten Up