Desperation trumps venture capitalists' impulse for total control (at least for now)

Search for next Google forces VCs to give entrepreneurs better deals with fewer conditions

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Time was when tech entrepreneurs hoping to raise venture capital to grow their start-ups had to all but grovel on Sand Hill Road and other VC strongholds.

(Also see: Thinking of co-founding a startup? Think again)

The result, if they had a persuasive pitch and promising business plan, was akin to a Faustian bargain -- they'd get their money, but often would lose their souls. Or at least any semblance of control over their fledgling businesses. In short, they became employees to capital.

These days, according to an interesting Wall Street Journal article, are different: The boom sparked by social media start-ups has made venture capitalists desperate to be part of the next Google or Facebook. As a result, VCs now are giving up far more control, and offering far more generous terms to start-up founders, than they did during the first Internet investing frenzy back in the late '90s.

As the WSJ reports:

The shifting power balance has pushed some investors to be more entrepreneur-friendly. Some investors are no longer insisting on a board seat in a start-up. Many venture firms are simplifying deal terms by reducing provisions that dilute the stake of an entrepreneur. Other investors are more willing to work with convertible debt instead of equity, which gives them less say in the start-up's business. ...

Many venture capitalists are desperate to find hit companies amid a shakeout in the industry. Venture-capital firms have been dealing with weak fund raising prospects and a dearth of Google Inc.-like returns following the recession and a general lack of initial public offerings and acquisitions in the last decade.

Given the history and nature of venture capital -- as Bob Dylan sang, "money doesn't talk, it swears" -- the current situation probably is the equivalent of an entrepreneur's Prague Spring. Still, I think it's healthy for the tech industry. For all the advantages that venture capitalists bring to the table -- operational experience, connections and, obviously, cash -- many of them are entirely capable of destroying a start-up through rigid control, a poor understanding of the entrepreneur's vision and an agenda that runs counter to the goals of the founders. Did I mention rigid control?

Further, many venture capitalists suffer from hubris that blinds them to their faulty assumptions. Don't get me wrong: Just about every venture capitalist I've ever talked to as struck me as intelligent and knowledgeable. Back in the late '90s, I ran numerous venture capital panels for the old Internet World trade shows and conferences. I remember many occasions when a VC would be confidently explaining to a packed ballroom why this or that business model couldn't fail, and while I was up on the stage smiling and nodding my head, inside I was saying to myself, "This is the stupidest thing I've ever heard." (I'm looking at you, Flooz.com and WebVan.)

But VCs can sound quite persuasive, especially when they're willing to give you a few million dollars, so many entrepreneurs jonesing for operating capital have gone down the VC road, often against their own better judgment. Now, at least, it sounds like start-up founders are able to leverage the desperation of venture capitalists to get deals on much more favorable terms. Good for them.

Chris Nerney writes about the business side of technology market strategies and trends, legal issues, leadership changes, mergers, venture capital, IPOs and technology stocks. Follow him on Twitter @ChrisNerney.

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