Developing the Venture Capital Model

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News broke yesterday of Sequoia Capital putting US$2m of funds into a joint project with Y-Combinator. While many commentators have focused on life in venture capital, most have ignored the strategic angle to the partnership.

Y-Combinator and similar organisations (SeedCamp in Europe) take what is a ball of mud, clean and polish it and see whether there is a diamond (however rough) in the middle. They reduce the risk of very early stage ideas. The funding provides Y-Combinator with more resources to find more diamonds.

Sequoia Capital gets a better pipeline of potential deals. These companies have been polished, cleaned and have core basis for growth that is articulated. To continue the analogy Sequoia Capital can do less polishing and focus on the cutting.

Doing this very early company nurturing is not the same as traditional venture capital and Sequoia Capital (for that matter any VC fund) is not set up to do it. The cost structure of the fund doesn't lend itself to company nurturing. Y-Combinator doesn't suffer that problem and so more money ends up for nurturing companies and Sequoia Capital builds on the experience of Y-Combinator.

The partnership points to an intereting evolution of the venture funding model. I expect we will see similar future deals between VC funds and company nurturing funds as all VCs aim to improve their pipeline and manage their risk.

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