How cloud computing hurts venture capitalism

One of the benefits of having a little prominence in the industry and a blog like this one is that you get pitched. I don’t mean every once in a while you get an e-mail, I mean full-on 15-30 e-mails a day and voicemail when you don’t respond. The ones I’m apparently soliciting with this blog are cloud flavored, of course. Most are from startups that run the gamut from green tech to medical to “Web 3.0!!!” Why share this information? Last weekend I had a conversation with a pair of intrepid salesman who asked me if cloud computing would kill venture capitalism. What a question!

Depending on who you talk to, venture capitalists wouldn’t really be missed. Love ’em or hate ’em, they’ve got their place and plenty of trophies in their case. Most startups are too small with too limited an operating history to secure a bank loan or come anywhere near completing a debt offering. Enter the VCs — very attractive for startups in this situation. VCs are willing to trade the high risk of dealing with new entrepreneurs for substantial ownership in new ventures. Let’s assume our brave business adventurers are using the money from the “evil” VCs to afford the most expensive parts of their new ventures: payroll and infrastructure. In the current economy, many are willing to outsource development in lieu of hiring full-time employees. I think it’s reasonable to consider infrastructure as the largest expense for a fledgling company with a small payroll.

We’ve talked before about the economics of the cloud. At conferences, I’ve often asserted that regardless of philosophy (cloud vs. direct purchase, in this case), infrastructure costs always even out as companies scale. But when you’re starting out, you’re not necessarily concerned with scalability; you’re just trying to scrape together enough change to buy a soda and a bag of pretzels from the vending machine. That’s exactly what my two friends and I started out discussing: how startups are always either struggling or out of business. Now, back to our examination of cloud computing’s potential impact on venture capitalism.

Unlike a venture capitalist, Amazon, with its EC2 cloud platform, doesn’t really care about my business plan, credit rating, or history as a founder. Plus, Amazon can reduce the amount of up-front financing I need and provide me with a manageable monthly payments. Why would I give up the majority of my company in exchange for money to buy what Amazon can provide at a low monthly rate? Using my two friends’ ventures as examples, a VC would want between 30 and 60 percent ownership in their businesses, while the cloud could provide their current infrastructures for less than $200 per month in both cases.

Not convinced? Joyent is offering to host your Facebook or OpenSocial application free for one year. That’s only one step removed from Amazon’s model. Think about that: a cloud provider giving you free services exactly when you need them, in your project’s first year of life. You’re free to develop your application, deploy it, and grow your business for one year with little or no up-front investment. That’s a stark contrast with what it took to start a Web 2.0 company just five years ago.

Folks who don’t recognize this potential threat or just plain disagree with me will argue that VCs bring much more to the table than just money. That’s absolutely correct, but companies are the most financially fragile in their early days, and surrendering controlling interest is never in the entrepreneur’s best interest, period.

The real kicker in all this: Almost every venture capitalist I know is investing in cloud computing, a business model that arguably affects their core business adversely. I don’t think cloud computing’s going to kill venture capitalism — too many shrewd investors — but it may alter the model.