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Hacking Venture Capital: A Taxonomy

Over the last few years (and especially the last few months, it seems), I've seen a proliferation of new firms iterating on the traditional venture capital model. This is awesome, but keeping it all straight can be confusing. First, let's understand what's being hacked. The following is a rough oversimplification of the way venture capital currently works.

In the traditional model, the managing partners of a venture firm raise a pile of money ($50 - $500 million) from limited partners (people like state pension funds and university endowments) and put it into a fund. They invest that money in a set number of businesses (typically about 10 businesses per managing partner) over a set period of time (typically 2-3 years). They support those businesses by attending board meetings, making the occasional introduction, and (perhaps) saving some excess capital for follow-on investments in successful portfolio companies.

Many people think that the traditional venture model is broken, at least when it comes to web businesses. I'll save a full explanation for another post, but it basically comes down to (a) reliance on traditional private equity structures leading to (b) oversized funds, which combined with (c) decreasing costs for building web businesses leads to (d) an overwhelming need to deploy capital and (e) an unhealthy fascination with the "mega hit", misaligning the interests of founders and investors and leaving venture capitalists frustrated with even a $300 million exit.

So there are a lot of points here to hack. How are different firms going about it?

Hack the Partnership Structure: Betaworks, Tipping Point Partners Limited Partnerships work for private equity firms and large VC shops, but it may have grown long in the tooth for supporting web businesses. In a limited partnership, managing partners earn management fees from their limited partners (investors), which scale linearly with the size of the fund. Thus, there's a strong incentive for venture capitalists to raise bigger funds than they need. Betaworks, for example, is actually structured as a corporation and takes "investment" in the same way that a startup would. And just as a startup is incentivized to take the "right amount" of money, these firms aren't going to raise more capital than they absolutely need.

Hack the Limited Partners: Founder Collective, Zelkova Ventures But partnerships aren't necessarily a bad thing. Founder Collective, for instance, has replaced "dumb money" LPs with real entrepreneurs, providing value with more than their money. With a group like Founder Collective, the LPs are much more familiar with the nature of seed-stage capital, and the misalignment of interest is mitigated. And (at least in the case of Founder Collective), they also...

Hack the Size: Greycroft, Andreessen Horowitz Could Alan Patricof and Marc Andreessen raise more money than they have? Absolutely. Do they? No, because they don't care to live off of a 2% management fee. And by making that choice, they allow themselves to make small(er) bets on companies that may not be the next Google or Facebook, but have a pretty good shot at a $30 million exit.

Hack the Relationship with the Entrepreneur: Presumed Abundance I'm not sure how Presumed Abundance's experiment will work out, but it's an interesting hack. In an attempt to re-align incentives between investors and entrepreneurs, they have made the entrepreneur a "conditional managing partner" (of sorts) in the fund, where the condition is a successful exit that contributes to the general fund.

Hack the Value: YCombinator, TechStars, DreamIt Many VCs bring money and little else. Some firms bring lots of "else" and very little money. "Else", of course, means connections, assistance and (often) space. This is one of the most well-established ways to hack venture capital, although it's still an experiment in progress.

I think there is still plenty of opportunity out there for entrepreneurs who are interested in hacking seed-stage venture capital. It's absolutely an industry in transition, and the barriers to entry are high enough to let new entrants carve out and establish valuable niches.