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June 25, 2003

Are VCs and software entrepreneurs incompatible?

According to Joel Spolsky, founder of Fog Creek Software, "there's something wrong with the VC model as it exists today". "There are certain fundamental assumptions about doing business in the VC world that make venture capital a bad fit with entrepreneurship. And since it's the entrepreneurs who create the businesses that the VCs fund, this is a major problem," he says in an article titled "Fixing Venture Capital" on his web site "Joel on Software".

The basic problem, according to Joel, is that founders would prefer "reasonable success with high probability", while VCs are looking for "fantastic hit-it-out-of-the-ballpark success with low probability".

Some extracts from the article that explain the "problem" further:

A VC fund will invest in a lot of startups. They expect about seven of them to fail, two of them to trudge along, and one of them to be The Next Netscape ("TNN"). It's OK if seven fail, because the terms of the deal will be structured so that TNN makes them enough money to make up for all the losers...

But founders are much more conservative than that. They are not going to start ten companies in their lifetime, they're going to start, maybe, two.....

The difference in goals means that VCs are always going to want their companies to do risky things...

(Extracts end)

Interesting, so far? Click Here to read the full article.

While "VCs vs. entrepreneurs" is an old topic (including the focus of several books by entrepreneurs trashing their VCs), what's interesting this time around is that Naval Ravikant of August Capital has chosen to respond to Joel's critique of the VC model.

Click Here to read Ravikant's response to Joel--and decide for yourself which side you are on!