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The Venture Capital Squeeze

Paul Graham
Paul Graham, an essayist and programming language designer, has an interesting essay about the "venture capital squeeze."

To summarize, he says VCs have found themselves in competition with acquirers, with Google first on the list. Companies like Google have realized they can acquire a company early, and bypass venture capitalists. Graham proposes VCs, in response, should let entrepreneurs partially "cash out" early, so that the entrepreneur's interests are aligned with the long-term huge results that VCs crave. Google is offering start-ups a way to cash out early, and many entrepreneurs see that as a lower...

risk option.

...Google, typically, seems to have been the first to figure this out. "Bring us your startups early," said Google's speaker at the Startup School. They're quite explicit about it: they like to acquire startups at just the point where they would do a Series A round. (The Series A round is the first round of real VC funding; it usually happens in the first year.) It is a brilliant strategy, and one that other big technology companies will no doubt try to duplicate. Unless they want to have still more of their lunch eaten by Google.

Indeed, in many cases, Google or Yahoo can acquire a company for under $20 million, an amount that is so small that it is a rounding error for their books, and doesn't even require reporting publicly. Makes things much less of a hassle. It also means that we at SiliconBeat may be missing some of these deals.

Graham continues on why VCs need to rethink their traditional desire to lock up entrepreneurs, of not allowing them to sell shares before the "big exit:"

...In fact, letting the founders sell a little stock early would generally be better for the company, because it would cause the founders' attitudes toward risk to be aligned with the VCs'. As things currently work, their attitudes toward risk tend to be diametrically opposed: the founders, who have nothing, would prefer a 100% chance of $1 million to a 20% chance of $10 million, while the VCs can afford to be "rational" and prefer the latter.

His conclusion:

If VCs are frightened at the idea of letting founders partially cash out, let me tell them something still more frightening: you are now competing directly with Google.

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Goog is not the first to do this... Cisco and others have been doing it a bit. Interesting assessment but assumes that all entrepreneurs are looking for a quick exit in exchange for a sure albeit much smaller amt... ironically, the founders at Goog had a chance to sell to Yahoo for a couple of million but didnt... I think it will take away some of the market from VCs but many entrepreneurs have much greater financial ambitions, especially the repeat entrepreneurs

Herb on November 9, 2005 2:43 PM
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Great summary of an otherwise unremarkable article. It's an interesting point, but really won't affect many companies at the end of the day. These guys may step up the acquisitive pace a little bit, but they aren't going to speculate on $20MM bets to the extent that VCs will.

I do think a few more of these deals could spur an increase in seed funding from guys looking to serve more as a bridge to a take out than as a stepping stone for institutional money.

mitchel on November 9, 2005 4:07 PM
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For my money, I'd rather see one of my companies inside a company like Google than tied down by a VC. What's the logic? Its the entrepreneurial environment. VCs are not entrepreneurs. Google people are. Entrepreneurial people invent solutions to problems, see links and hooks between things that VC people can't. If I were looking to do a raise or to sell into a situation that would continue the growth of my company -- hands down, the Google model

Dougk on January 3, 2006 11:34 AM
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