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Internet start-ups and VCs

Claire Cain Miller
Last Updated 17 May 2009, 17:26 IST

Is venture capital becoming obsolete for Web start-ups?  Yes, according to Robert Hendershott, a professor of private equity and entrepreneurship at the Leavey School of Business at Santa Clara University. He makes the case in a paper of International Review of Entrepreneurship, formerly known as International Journal of Entrepreneurship Education.

As cost of starting a Web company decreases, thanks to cloud computing services and technology that entrepreneurs can rent instead of buy, many founders can finance a new company without the help of venture capitalists, using their savings, money from family and friends and credit card debt, Mr. Hendershott writes.

More often, they are choosing to sell small, immature companies instead of taking the longer, riskier path of developing a business that could one day go public. That makes venture capital less relevant, he concludes.

“Potentially, the venture model for finding, developing and vetting new Web-based businesses breaks down,” he writes. The venture capital model evolved to start and expand capital-intensive semiconductor companies. Now, Web start-ups are routinely started for less than $50,000.

One of the key roles of venture capital, Hendershott argues, is providing the money needed to prove that a new technology works and that a market for the technology exists. During this period, start-ups rely on outside capital because they are not making any money for themselves.

That period may no longer be necessary.  They can do so with only a few thousand dollars and, in some cases, they end up quitting their day jobs. “In this situation, financing is no longer a crucial component to an entrepreneur’s creativity and passion,”  Hendershott writes.

“To some extent, this mimics the venture model, where early success yields more capital to fund additional progress, culminating with a few eventual big winners,” he writes. “The end result is that in the next generation of Web-based start-ups, venture capital may not be necessary to prove either the technology viable or that a market exists.”

When venture capitalists do finance Web start-ups, they can find themselves at a disconnect with entrepreneurs. Instead of dedicating three to five years to a chip start-up, founders dedicate three to five weeks to building iPhone applications. That means a lot less personal risk and much greater willingness to sell early. Because venture capitalists put less money into Web start-ups, they most likely have less of a say at the negotiating table. “That creates a problem if you’re a VC looking for people with an IPO as their clear goal,” Hendershott said in an interview.

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(Published 17 May 2009, 17:26 IST)

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