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Two Venture Capital Industries December 2, 2010

Posted by Ian Cheng in Funding.
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Fred Wilson

I attended a breakfast meeting the other day where David Silverman of PWC presented the latest Money Tree data on the venture capital business to a room full of entrepreneurs and VCs.

As I sat there and listened and read the charts, it occurred to me that there are now two distinct and very different venture capital businesses.

The first VC industry is investing in software based businesses. The software VC business has been fundamentally altered by the massive decrease in the cost of building and launching a software based business. I don’t think I need to explain why this massive decrease in cost has happened to this audience. We’ve talked about that ad naseum here and on other tech blogs.

The second VC industry is investing in cleantech, biotech and other capital intensive tech businesses that have economic models that have not been fundamentally altered. This VC industry operates largely the same way it has operated for the past twenty or thirty years.

I’ve asked David to help me put together some numbers that will show this breakup of the venture capital business. I hope to get the numbers in the next few days and will be posting them and some additional thoughts on this topic in the coming weeks.

I don’t think you can make blanket statements about the VC business anymore. These two industries are very different from each other and will have very different business dynamics and risk and return characteristics going forward.

Jeff Bussgang

Fred Wilson posted a blog last week regarding the “Two Venture Capital Industries” — observing that the Internet/software industry, where he invests, has undergone great change due to the lower-cost model (commonly known as the “lean start-up” movement) but the more capital-intensive industries, such as life sciences and cleantech, where the fundamental economic model has not been altered.

The post is a great one, and it raises something I’ve been thinking a bit about lately, which is whether the lean start-up approach to building start-ups can be applied to industries beyond Internet/software.

HBS Professor Tom Eisenmann is creating a course next spring on “Launching Technology Ventures” where he is going to delve into lean start-ups, finding product-market fit, what are the key start-up activities before product-market fit and what are the most important activities afterwards, and other salient topics.

In my role as an EIR at HBS this year, I’m teaming with Tom on this course. The case studies will go beyond Internet/software start-ups in exploring how other sectors can apply lean start-up theory. One of the reasons I have so much personal conviction of the breadth of these theories is that there are two companies in our portfolio – one a clean tech and the other a life sciences – that have applied parts of the lean start-up methodology very effectively. Their stories help illuminate the opportunity for others.

The clean tech company is Digital Lumens, recent Innovation award winner at the World Economic Forum. We seeded the company, and founding entrepreneur Jonathan Guerster, with a mere $500,000 to explore a thesis around software-controlled, industrial LED lighting. Jonathan recruited a technical team out of Color Kinetics and built a proof-of-concept. We then raised a $5 million Series A, hired an outstanding CEO (Tom Pincine), and the company built v1.0 of the product. With the success of v1.0 behind it, the company sought out a few customers to work through the kinks. Once that was done, and rapid product iteration cycles, the company raised a Series B and is now scaling sales operations. If you didn’t know the company was a demand-side energy technology company, you would think the above description applied to a Web 2.0 company. Digital Lumens may require 10s of millions of dollars end-to-end, but just because it’s a capital-intensive business, doesn’t mean they couldn’t apply lean start-up approaches to change the risk-reward profile for the early investors.

Similarly, Predictive Biosciences has been on a lean start-up path. That sounds odd to say for a company that has raised a total of $56 million to pursue a very big vision for urine-based biomarkers (pee in a cup and Predictive will tell you if you have cancer – and what type). But the initial investment we and Highland made was a mere $500,000 each to spin the IP out of Children’s Hospital, hire an initial technical team to build the product/prototype, and figure out which market to target and how. Only then did we raise a $10 million Series A, and even that capital was deployed in a very focused, test and learn fashion until the initial market (bladder cancer) was identified and vetted. Again, many of the same lean start-up processes that Mint.com or Xobni or others have deployed in the Web 2.0 would feel very natural to the dozen PhDs running Predictive.

So, yes, the cost revolution impact to one type of VC investing has been enormous. But the lessons, frameworks and paradigms can be applied successfully to the “other” VC type of investing as well.

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