Bypassing Sand Hill Road?

"Will the Old Venture Model Work with New Web-Based Start-Ups?" That's the question asked in an upcoming research paper from Santa Clara University Associate Professor of Finance Robert Hendershott.

Hendershott's findings? Internet entrepreneurs who utilize Web-based software and services can quickly (and cheaply) build products and test them to see what is working, a model that doesn't require the heavy venture capital investments of the past.

This has been a hot topic on TechFlash, most recently with the insightful guest post from Urbanspoon founder Adam Doppelt who pointed out the benefits of bootstrapping a business. That's prompted an interesting debate on the merits of venture capital in today's startup climate.

Hendershott's paper-- to be published in the coming weeks International Review of Entrepreneurship -- offers two strong conclusions

"First, the decreasing cost of launching a new Web-based business and evaluating its potential gives entrepreneurs an increasing incentive to create and promptly sell budding businesses rather than pursue the longer, riskier strategy of building a complete business. Second, this change creates challenges for the traditional venture capital investment model, which means that many future entrepreneurs should expect to avoid the venture path."

The first point is interesting, showcasing the trend that some Web entrepreneurs are more than satisifed swinging for base hits rather than home runs. The second point should be of concern to VCs who have found positive exits hard to come by in recent years.

Hendershott also notes the power of boostrapping, something Doppelt emphasized in his top 10 list for TechFlash. Hendershott writes:

"Self-funding the launch of a new site or application and delaying substantial expenses until a product proves popular can cause short-term pain, but it also brings the potential for long-term gain because the entrepreneur captures a larger share of the startup’s eventual value.

Skipping the first round of venture investment also saves time, and it does not preclude an entrepreneur from eventually deciding to pursue venture investment and building a complete company rather than selling the budding business early. That the old venture model is a poor fit for new Web-based start-ups is likely to be a much bigger problem for venture investors than for entrepreneurs."

But the paper also notes some of the new models that are emerging in the venture business, pointing to the business incubator Y Combinator and Kleiner Perkins' $100 million iFund for iPhone applications.

Interestingly, Hendershott notes that Apple's app store in some ways mimics venture model. He writes:

"Success feeds upon itself because successful applications are presented more aggressively in the Store. Less popular programs can potentially slip into obscurity. To some extent this mimics the venture model where early success yields more capital to fund additional progress, culminating with a few eventual big winners."

But the model also presents challenges in part because of how cheap it is for a iPhone developer to roll out a new product.

"The end result is that in the next generation of Web-based start-ups venture capital may not be necessary to prove either the technology viable or that a market exits," he writes.

It is a fascinating paper and goes into much more detail. I am waiting to hear back from the University for a copy I can post here. In the meantime, feel free to add to the discussion on bootstrapping versus VC here or in Doppelts' piece.

[Flickr photo via Mark Coggins] 

Update: Here's the final working paper on which the research report is based.