In this three-part series I will explore the ways that the Venture Capital industry has changed over the past 5 years that I would argue are a direct result of changes in the software industry, not the other way around. Specifically, Amazon has changed our entire industry in profound ways often not attributed strongly enough to them.
I believe the changes to the industry will be lasting rather than temporal change. Venture capital is in the process of its own creative destruction with new market entrants and new models of innovation at the precise moment that our industry itself is contracting.
I will argue that when the dust settles, although we will have fewer firms, each type well end up more focused on traditional stage segments that cater to the core competencies of that firm. The trend of funding anything from the first $25k to funding $50 million at a billion+ valuation is unlikely to last as the skills and style to be effective at all stages are diverse enough to warrant focus.
I will argue that LPs who invest in VC funds will also need to adjust a bit as well.
When I built my first company starting in 1999 it cost $2.5 million in infrastructure just to get started and another $2.5 million in team costs to code, launch, manage, market & sell our software. So it’s unsurprising that typical “A rounds” of venture capital were $5-10 million. We had to buy Oracle database licenses, UNIX servers, a Sun Solaris operating system, web servers, load balancers, EMC storage, disk mirrors for redundancy and had to commit to a year-long hosting agreement at places such as Exodus.
Open-Source Software & Horizontal Computing
The first major change in our industry was imperceptible to us as an industry. It was driven by the introduction of open-source software, most notably what was called the LAMP stack. Linux (instead of UNIX), Apache (web server software), MySQL (instead of Oracle) and PHP. Of course there were variants – we preferred PostGres to MySQL and many people used other programming languages than PHP.
Open source became a movement – a mentality. Suddenly infrastructure software was nearly free. We paid 10% of the normal costs for the software and that money was for software support. A 90% disruption in cost spawns innovation – believe me.
We also benefitted economically from a move to “horizontal computing.” What this meant was that rather than buying really expensive UNIX servers (and multiple machines in order to handle redundancy) we could buy cheap, replaceable servers for compute resources.
As our needs grew we could just add more cheap boxes and as boxes failed we could just chuck them out. We had to learn how to be better at “load balancing & replication” – meaning how we managed data across all the boxes since they weren’t centralized on one box.
These two trends had a major impact on the computing industry from 2000-2005 but the effects weren’t yet felt by the VC industry.
The Emergence of “Open Cloud” Infrastructure
The biggest change in the software industry beyond open-source was “open cloud.”
When we talk about cloud computing we have to be careful to differentiate between open cloud (services the are provided solely to for the economic purpose of building a cloud business) and the “platform cloud” where certain service providers offer cloud services wrapped around their core product. These are very different.
Platform cloud players like Salesforce.com provide compute resources so that third parties can build applications that integrate with its core product. That’s awesome for users of Salesforce.com or companies that want to cater to them but less awesome for pure startups that want independence and are really just looking for cloud infrastructure. Facebook is a “platform cloud” provider, too. That makes both of these amazing companies great channels for startups.
True that Salesforce.com in particular has made interesting moves toward open-cloud services by purchasing Heroku and also launching Database.com. It seems if anybody wants to move more toward open it will be Salesforce.
But for now when you want to build an independent, high-growth, VC-backed startup you need to build your overall company on a truly open cloud.
They came from a different perspective. They have the mass retailer mentality of “stack ‘em high and sell ‘em cheap.” They started by offering cloud storage (S3) on a super cheap, pay-as-you consume basis. Every startup I knew in 2005 (when I started my second company) was using this. Why would we commit hundreds of thousands to EMC before we knew whether we had a big business?
They then launched processing capabilities (EC2) and we startups suddenly didn’t need to buy production servers. Then they launched a simple database, management tools and so on. Amazon will surely keep moving up the stack. My bet is that they fold A9 (their search tool) into AWS and offer search-as-a-service, too.
It sure would put pressure on Google if they had Facebook competing on one side of them for share of users’ time and Amazon flanking them on the other side by providing search to every website out there that might threaten AdSense and even Google’s core search business. Who knows?
If you want a deeper understanding of the layers of the cloud , how it is emerging and some of the exciting new players you can read it here.
Amazon changed our industry. This is mind boggling. That little online book company. Not Google. Not Microsoft. Not IBM, HP, Accenture, Cisco, Salesforce.com or anybody else. Amazon. 100% of the credit. And 9 years after they launched AWS there are still no credible competitors.
I find this strange. And maddening.
That said, Amazon – through AWS – even without strong competition is as wonderful an experience as Amazon the eCommerce retailer feels to you as an online shopper. Jeff Bezos simply deserves to be held up with Steve Jobs as two of the most important people driving innovation in computing today.
Spawning of Micro VCs
The biggest media attention in our industry went to the so-called “super angels” during the 2009/10 timeframe and while I don’t believe there is such thing as a super angel I believe that much media attention was deserved.
The earliest people that I spoke to who understood the changes in our industry were True Ventures & First Round Capital. They built industrial-scale funds dedicated to backing early-stage startups with $500k rather than $5 million. They knew the venture math that if only 50 companies / year are sold North of $100 million the entry price for their investments mattered. These funds were active back in 2006 when I was raising money for my second company. As were individuals like Jeff Clavier with SoftTech VC who was also way ahead of the market in spotting this trend.
More recently great funds like IA Ventures, Floodgate, Rincon Ventures, Founder Collective, Freestyle Capital and others have raised money to focus on early-stage investing as a strategy. And many more individuals that I respect are switching from investing as individuals to fund structures to invest in this category like Aydin Senkut (Felicis Ventures), John Frankel (ff Venture Capital), Manu Kumar (K9 Ventures), Chris Sacca (lowercase capital), Dave McClure (500 Startups) and many more.
I have called the creation of Micro VC as the most important change in our industry and I believe it. These people understand that the nature of startups have changed. They have increased the number of investments, they understand that outdated board meeting formats are too slow & unresponsive, they have designed founder-friendly term sheets that can be executed cheaply and they are allowing for a massive increase in the rate of new startup innovation. At least in the consumer & business web.
The larger ones also do more to hold CEO summits, create recruiting databases, set up email distribution lists, create pools of stock options that can be shared across companies, etc.
I still think it was Amazon that created this category not the other way around. Where open-source computing gave us a 90% reduction in our software, Amazon gave us a 90% reduction in our total operating costs. Amazon allowed 22-year-old tech developers to launch companies without even raising capital. Amazon sped up the pace of innovation because in addition to not having to raise capital to start I also didn’t need to wait for hosting to be set up, servers to arrive, software to be provisioned.
I know I’m going on-and-on. I’m not a shareholder. I’m just in awe of what they’ve enabled and baffled that the media doesn’t give this more focus.
In tomorrow’s post I will explore how the changes initiated by Amazon and then propagated by Micro VCs has led to a blurring of the lines in which stages VCs & later-stage investment firms traditionally invest and why this is driving up valuations in private companies beyond common sense.
(Cross-posted @ Both Sides of the Table)