Demystifying Venture Capital Economics, Part 2
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Post 1995 the world changed drastically. Almost every innovation came in the form of software. Unfortunately software startups have the opposite characteristics of what Tom Perkins taught the VC industry to look for. Software companies have relatively low technical risk and high market risk. You know the company could deliver its product. The question was would anyone want to buy it. As I said before, market risk is generally not worth taking, so the intelligent VCs had to change their business model. They outsourced to angel investors the earliest stage funding for what they considered the poor risk/reward consumer-focused companies and instead focused on backing them only when they proved “the dogs wanted to eat the dog food.” The angels thought they won the business away from the VCs, but the poor average returns of the angels would say otherwise. Waiting until a company proved it had product/market fit meant having to pay a much higher price than they did in the past. Fortunately the Internet enabled much bigger markets to be addressed than in the past, so their outsized returns could be maintained.