VC is not broken – Anymore. Digital Media’s new funding models

I was a having coffee with a VC colleague last week.  This is someone I respect, and hope will fund some companies graduating from Bootup Labs.  I have probably explained Bootup Labs and why our investment model works to this individual on at least 7 different occasions.  It turns out that it took 8 times to get the ‘ah-ha’ that I was so patiently waiting for.  Up until then, I just didn’t think he liked the idea.  I’m happy to say, he is now a believer.  But, as any good entrepreneur would do, I immediately reviewed the other 7 pitches in my head — searching for the flaws that made it so difficult to inject the concept into this guy’s brain cells.  Could it be that he isn’t staying up to date with the VC industry? Is he not reading the same blogs, following the same people on twitter that I am? Is he not talking to entrepreneurs at the seed stage, flying to meet the thought leaders in the space, or engaged in local startup community?  And if not, why isn’t he, or more importantly, why was I?  Perhaps I was the one missing something; Maybe there simply isn’t a return-on-time for those activities.  Who am I to judge?  Maybe the status quo is simply good enough?

The truth is that the status quo is good enough for bio-tech, clean-tech or any other capital intensive, high risk, high reward company, which is why you see many VCs move toward those sectors and away from investing in digital media companies.  Internet companies quickly have become low capital, lower risk, investments, but can still have some pretty big exits.  Basically, if the companies you invest in don’t need very much money, then you don’t need to raise large funds, so the 10-2-20 model is officially broken.  (10 year fund, 2% fee on capital under management per year, plus 20% of proceeds paid to management)  If you don’t have a large fund, the 2% management fee doesn’t add up to enough to pay for the fund’s expenses. Plain and simple.

I touched on the concept of a broken VC model over a year ago, and since the economic down turn, it’s been talked about by a plethora of notable industry insiders. But, since then, I’ve learned a lot about the inner workings of the venture capital world, and one thing is for sure: Investing in Digital Media companies (Consumer Internet, Enterprise Internet, Online Gaming, and Mobile Software) requires a new model.

It wasn’t until my 8th pitch to my VC friend, that I defined what “lower capital requirements” means in real life.  It means that some of these companies will never need to raise a series A and most will not need a series B.  On top of that, these companies are exiting within 2-5 years at a rate of 25 exits/month.  This formula has changed so much and so fast, it caught most of the industry off guard, and if they’re not paying attention, they’re paying the price.

The Bootup Labs model is unique, even among our well established peers.  There is TechStars, Seedcamp, Extreme University, Launchbox, YCombinator, etc who all invest around $20k in each group of founders and provide a great deal of support and connections for around 3 months.  Then there is Union Square, CRV, FirstRound, SoftTechVC, etc who typically invest $250k-$1M. We feel the sweet spot is a TechStars-like, mentorship driven program for founders, but instead of focusing on getting them seed funded, we invest $150k and give them 8 months to get their company to at least “ramen profitable“.  After that, they can choose to raise a larger round or continue to grow their business organically.  Their success does not rely on upstream VC support, but many will probably choose to take it anyway as a way to accelerate their growth.  If you happen to be a VC, don’t worry, there will still be plenty of deal flow coming your way.

View this Google Spreadsheet to see how the Bootup Labs Fund makes money, and if you’re an investor, please contact me.

Subscribe to these guys if you want to get caught up.  Their twitter addresses will be listed on their blog too.  Follow them (and us).  Use an RSS reader.  But better yet, start your own blog, comment on this post, and start tweeting out your thoughts.  We’re listening!

• http://crunchbase.com/acquisitions
• http://www.avc.com/
• http://www.startuplessonslearned.com/
• http://www.askthevc.com
• all these: http://firstround.com/blog.html
• http://ycombinator.posterous.com/
• http://blog.softtechvc.com/
• http://sethgodin.typepad.com/
• http://www.unionsquareventures.com/
• http://500hats.typepad.com/
• http://ricksegal.typepad.com/pmv/

The truth is that the evolution of this space is still evolving at an enormous rate.  More on my predictions in a subsequent post.