One can argue that the rules for picking winning startups have evolved over the last ten years. In Bubble 1.0, you could have used a dart against a Broadview market map. Bubble 2.0 is all about consumer online/mobile plays, which are characterized by a fast transition between “gee, this may be cool” to “wow, they are getting a ton of traffic” driven by the low cost of consumer/content acquisition, often aided by viral effects.

Spreading your bets in a hot space can be a good idea. For example, how many social networking plays has Benchmark backed? It seems that CRV is going the same direction in an extreme way using its QuickStart program. It’s great that CRV is experimenting. Josh Kopelman who’s worked with CRV on Odeo has a good analysis. The biggest problem I see with this type of approach has to do with the reduced value-add provided by the investor. Why take a VC’s money if you’re not going to get the VC’s attention? Angel money is just as good (and angels have been extremely active in the last couple of years) and may offer less potential for future conflict.

When we’ve won the privilege of working with great entrepreneurs in seed deals it has usually been because of the relationship that has developed between the founding team and one of my partners and the promise of the help we can give a growing company. Every last one of the deals has been good-enough to raise money from other sources, implying that the value of our cash has been low.

A related issue is the notion that since Web 2.0 companies don’t need much cash to grow, the business models of large VC funds doing early stage deals are broken. This may be true for a $500M fund only investing on the Net but is certainly not true for a truly diversified fund. I won’t bore you with the math–I’m sure you can fill Excel spreadsheets like the best of them. Let’s take PVP V as an example. It’s a $1B fund. In the same week that I closed the 8th Ring seed investment, we did an investment that was 100 times larger in a great & growing company with (gasp!) positive EBITDA. We have a small investment in Automattic, quintessential Web 2.0 play, while at the same time backing a capital-intensive dense cluster computing company (SiCortex). Our life science companies start small but if things go well, they become very capital intensive as they go through the FDA process. You get the picture. If you’re diverse, having a large fund is not a constraint, it’s an advantage. Because we can back growth equity companies, there is less pressure to shove millions into startups that don’t need them. On the flip side, our CEOs like the fact that they can depend on us as an investor from seed all the way to (and including) an IPO.

Which brings me to the potential conflicts of working with angels and seed specialists. If you accuse large VC funds of wanting to put too much money to work, you can accuse angels of wanting to put too little. Because most of them don’t have the ability to participate pro rata in follow-on financings, they tend to sometimes worry too much about dilution (I did in my angel investments) and steer a company towards getting by on less capital than perhaps might be optimal. Sure, founders & execs get diluted, too, but they all get reloaded with new option grants–VCs (at least in the US, Europe is a whole other story)always want to make sure that the team is motivated.

Rules of thumb for entrepreneurs:

• Bootstrap if you can but carefully watch the opportunity cost of executing on a shoestring and not getting the help of well-connected investors.
• If you don’t need much capital over the life of your startup
  • If the overwhelming odds are that you will exit at <$100M or you’d like to do that because you prefer money in the bank to equity in your company, go with angels.
  • If you think you have a shot at breaking out like MySpace, Facebook or YouTube and you’d like to try that as opposed to sell out early, you ultimately should partner with VCs who understand your space–you might end up needing acceleration capital in a pinch and they’d be dying to give it to you.
  • If you can’t get VCs excited at terms that make sense to you early on, go with angels to demonstrate value and wait for VCs to come knocking. Timing is all about opportunity cost.
• If you need a lot of capital over the life of your company and you have the potential to generate significant value
  • If the ramp to initial value is short, bootstrap or go with angels. It will make raising your first venture round easier. Go with a VC only if you feel they will add a lot of value beyond giving you their money.
  • If the ramp to initial value is long, go with VCs. Be prepared that your seed/Series A valuation will have little to do with the intrinsic value of your idea/IP. The cap table will be engineered around your capital requirements, making sure that there is a big-enough stake to motivate founders and a large-enough option pool to attract new talent.
• If it’s none of the above, go do something else. Your time is too valuable.