Do tech entrepreneurs need VCs?

By Felix Salmon
August 16, 2010
Mike Arrington, today, repeats a very similar argument when it comes to angel funds:

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One of the least convincing and most annoying arguments against investing in index funds is the idea that if everybody did it, then the stock market wouldn’t be able to efficiently allocate capital any more. Well, yes — but there will always be people picking and buying individual stocks and funds. That doesn’t mean that you and I should count ourselves among their number.

Mike Arrington, today, repeats a very similar argument when it comes to angel funds:

Very few angel funded startups end up very big or interesting. “An entire generation of entrepreneurs are building dipshit companies and hoping that they sell to Google for $25 million,” lamented a venture capitalist to me recently. He believes that angel investors are pushing entrepreneurs to think small, and avoid the home run swings. And you don’t get a home run unless you swing hard, he says. When you play it safe you nearly always lose…

Some venture capitalists think that this “think small” attitude is driving entrepreneurs who may otherwise build the next Google or Microsoft to create something much less interesting instead, and then everyone loses. No IPO. No 20,000 tech jobs. No new buyer out there for the startups that don’t quite make it.

And without those occasional but huge exits, the entire ecosystem can fail. Venture firms need big returns to raise new funds. Without venture money a lot of the innovation in Silicon Valley would end.

So in effect, the argument goes, the angel investors are like a quickly growing cancer. Without radically invasive surgery, Silicon Valley will eventually flatline.

All of this doom-mongering is based on the existence of angel funds adding up to $200 million, tops, when you put them all together: chump change compared to the kind of money that the big VC firms control.

It is true that as barriers to entry in the tech space get lower, that reduces the amount of money that entrepreneurs need, and can result in venture capitalists being left out of the funding equation altogether. Doesn’t your heart just bleed.

But the idea that an uptick in angel-backed companies will result in fewer huge successes is just silly. Yes, it’s possible that angel-backed companies are happier with smaller exits than their VC counterparts. But if the VCs see an opportunity there to become the next Google, they’re more than welcome to buy the company themselves: they certainly have $25 million lying around to do just that. More realistically, VCs can certainly take over as and when original investors feel like cashing out, just as public stockholders take over when VCs cash out in an IPO.

Reading columns like this, though, does make me a bit more hopeful when it comes to the tech startup scene in second-tier cities like New York. In California, it seems, the funding architecture is incredibly rigid and inflexible, and any threat to that architecture is met with wails of pain. The rest of us, I think, are lucky to live in a world with a bit more optionality when it comes to funding. And who knows — maybe in the future starting an online company will be so cheap that it can be done entirely on debt, with no equity investment at all. That won’t help the people dreaming of getting rich through getting lucky with tech investments. But it might well help company founders avoid a lot of the poisonous funding politics that Arrington talks about.

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