November 12, 2011

New Waves of Disruptive Innovation: Why Micro-VC Is Happening Now

Sophisticated investors know that significant excess returns are available if they can invest with the best venture capital managers.

In the 1990s, a consensus emerged around a list of top venture brands, based on triple digit returns produced before the collapse of the tech bubble. Ten years later, the brands on that list retain significant cache among the limited partner community, despite profound changes in the opportunity set and disparities in recent performance. For investors without independent sources of information and context, the list of brand name VCs is a false friend.

Venture capital today is in the midst of a particularly disruptive transition, thanks to the maturation and increasing ubiquity of a previous generation of hot technologies. The maturation of innovation waves is a normal part of the innovation lifecycle, and over time the most nimble venture firms have successfully made multiple transitions.

Complicating the current transition is the fact that the costs to develop and test market web- based applications have fallen so low that brand name firms managing large funds find it difficult to justify spending time on start-ups that require so little capital. This transition has three consequences:

1. It creates favorable risk-return opportunities for early stage investors.

2. It opens the field to new VC entrants in an unprecedented way.

3. It requires established brands to shift not only their technological focus, but also their investment model.

Investors in VC funds who can bring themselves to turn off the autopilot will see tremendous opportunities for returns. Those who can’t may be in for a bumpy ride.

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A nautical term that indicates a favorable position relative to the wind. A ship that "has the weathergage" has the initiative and hence a significant advantage over its rivals.