Venture capital could be ripe for business disruption

I’m at Buck’s Woodside for a weekday breakfast meeting; if the venture capital industry is being disrupted, it’s not obvious to me. It’s the usual mix of local residents and farmers, as well as entrepreneurs and engineers pitching the crew from Sand Hill Road.

There’s no doubt that the Internet has had a profound impact on a broad range of industries. E-commerce has changed the nature of the retail industry. News sites and online ad sites have helped scuttle the newspaper business, and the distribution of open source software continues to have impact in IT.

[ Also on InfoWorld, Zack Urlocker investigates disruption in the enterprise: “What does it take to create business disruption?” and “Disruption as a business strategy” | Stay up to speed with the open source community via InfoWorld’s Technology: Open Source newsletter. ]

There have also been reports that given the financial meltdown of the last year, the venture industry itself is undergoing massive change. In an article in the New York Times (via ReadWriteWeb), Bernard Lunn provides a view on how online transparency will ultimately disrupt VCs:

It used to be that VCs were like the Wizard of Oz at the end of the yellow brick road: not as impressive in the flesh on Sand Hill Road as their expensive PR legend had you believe. That is changing, thanks to three trends:

1. VC blogging and tweeting.

   This is a very positive trend for both parties. VCs get to engage in conversations that drive high-quality deal flow. Entrepreneurs can gauge the quality of their thinking. It is good for all, and empty suits are more easily exposed.

2. A willingness to criticize VCs publicly.

   Historically, anyone who has criticized VCs has been labeled a sore loser who couldn’t raise money. The Funded may be controversial, but VCs have grudgingly come to accept that they can be rated just as restaurants and plumbers can be rated on Yelp…

3. Transparency in deal data.

   The data on which VCs actually base their deals is much easier to find. This makes it harder for a “zombie VC” (i.e. a VC with an impressive name and site but that no longer actively invests) to hide. This has to go much further. It would be great to see real data about exit valuations and returns, so that we can see which VCs are doing well. VCs generally don’t like this transparency (though many of their LPs do).

I agree that some VC firms may have weaker returns if there are fewer opportunities for IPOs. Transparency may make it more obvious who is strong and who is weak — it may even accelerate changes in relative positions. But in my view, it does little to fundamentally disrupt the business.

When an industry is disrupted, it’s because some new factor has changed the competitive environment by expanding the market and making it easier for the underserved to get access to resources with greater convenience or lower cost. Open source, for example, enabled developers to get enterprise-grade software from the Internet, rather than have to go through a traditional IT vendors. While the cost of creating many types of high-tech firms — notably, software companies — is lower than ever before (again, because of disruption), most medium-size and large businesses still need risk capital in order to grow.

The other point that’s overlooked is that being a successful VC is much tougher than it seems. Figuring out the right business model and product fit, helping entrepreneurs attract an experienced team, and building a large company takes a lot of work. Some VCs are better at it and add more value than others. At any rate, I don’t think there will be some massive infusion of lower-cost capital available to entrepreneurs than what VCs provide, nor do I think the need for capital will disappear.

Lunn’s article is still worth reading as he points out the challenges in scaling a VC firm. Bill Gurley of Benchmark Capital also has an interesting perspective on the internals of the venture capital business. Venture funds may come and go, and the types of investments being made may change over time. Some will adapt to new business models, and others won’t. Bottom line: Venture capital has helped build a lot of great businesses, and I believe it will continue doing so for another 20 years.

You can follow Zack Urlocker’s posts about business, technology, and music at www.twitter.com/zurlocker.

This story, “Venture capital: Ripe for business disruption?,” was originally published at InfoWorld.com. Follow the latest developments in open source at InfoWorld.com.