Venture Capitalists Sealing More Deals With Smaller Checks

Tomio Geron at Forbes has a story today about Intel Capital, a venture arm of Intel Corp. that focuses on tech investments, rising above a difficult time for venture capitalists, complete with a reference to Michael Jackson’s “Thriller.”

It gets most interesting at the end where Geron calculates the average investment per company in the last decade. Intel Capital invested $10.4 billion in 1,185 companies, which makes an average of $8.78 million per company. Year-to-date, it has invested $472 million in 72 companies, which makes an average of $6.6 million per company, and announced $40 million investments in 10 projects, which calculates to $4 million per company.

Intel Capital’s case may be an evidence for a trend of venture capitalists opting for more smaller-sized and earlier-stage deals, as reported by research firm CB Insights.

This is likely because starting an Internet company has become exponentially cheaper. Mark Suster from Both Sides of the Table has a neat chart on the fifth page of his slides, showing the figure drop by 99.9 percent to a mere $5,000 because of developments like open source models, cloud computing and developers using their own expertise to start a tech company.

Venture capitalists may also be funding a larger number of companies in earlier stages and with smaller checks because they are afraid of missing out on the next Google or Facebook. For safeguarding, they sometimes ask entrepreneurs to sign a pro-rata contract, which gives them the option to purchase additional equity of the same proportion as they bought during the seed stage. For example, if a VC provides a seed funding for 20 percent equity, they may exercise their option to buy another 20% during the second round of capital raising if they think the company is doing well or let the small check evaporate if not.

But some start-ups may fall into the trap of driving away future investors if they have too many pro-rata contracts that were not activated. It signals that the VCs that have poured seed funding into the company probably doesn’t think it is doing well, when the VCs may simply have too many start-ups to mind, considering they are signing more deals in more than two years.

Venture Hacks has a lengthy and comprehensive discussion between Chris Dixon, Mark Suster and Naval Ravikant on the pros and cons of this method, from both the entrepreneur’s and investor’s side.

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