It's a good time to be a start up company

By Shani Shoham, November 10, 2011
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What an exciting time for entrepreneurs and venture capitalists (VCs). Two elements transform entrepreneurship and the VC landscape: cost and time.

Cost: the cost of building an online company today is considerably lower than the cost of building a similar business five years ago. With Software-as-a-Service (SaaS) there is no longer a need to build client-server architecture. With Facebook and Google ads one can validate assumptions and get beta users cheaply. With cloud computing (computing resources that are shared and outsourced remotely) there is no longer a need for stacking up expensive servers. This also means saving on the cost of energy and space enabling many startups to emerge from a coffee shop or bedroom.

Time: development cycles have shortened tremendously. There is no need to wait months to learn how your customers use your product. You can analyse user behavior in days and adapt your product to serve their needs quickly.

Shorter cycles and lower costs have led to the emergence of lean startups. Years ago, $20,000 was barely enough to buy a server. Today companies go beta with that. But there is a downside. Markets change quickly and the competition is based on being the first to figure out upcoming trends.

Location is key to this. Being in SIlicon Valley I know of startups who knew about Facebook's recent changes weeks before they were announced and had already developed products to leverage them.

Changing markets has also resulted in the development of smaller investment vehicles such as micro venture capital funds (micro VCs).

Micro VCs, such as Tugboat Ventures and Union Square Ventures, usually provide small seed investments of around $1 million and manage funds of $50 million-$75 million. This is significantly lower than the funds VC firms managed five years ago.

The VCs that didn't make the transformation in time are challenged. With a $250 million fund, they can't deal with $1 million investment rounds. It is impossible to manage 250 portfolio companies.

Some companies don't need late stage investment rounds. Their growth is financed by revenues. Less swans in the pool leads to fierce competition and higher valuations. To get a 20 per cent internal rate of return on a $250 million fund, the VC firm needs to target $2.5 million of exits (assuming an average 20 per cent equity at the time of exit). You need to have some real blockbusters to achieve that.

Shani Shoham is an entrepreneur, VC and a board member of four incubators

Last updated: 10:49am, November 10 2011