Curiously, one reason this is happening is that VCs are realizing that they didn't need as much power over founders as they had. All the returns come from the big winners, and the big winners don't need to be told what to do.
VCs may well make higher returns with less power.
I say largely because lower-tier firms have a different and less trusting relationship with companies they fund. They assume that if a company had to resort to raising money from them, it won't be one of the big successes. They are the hotel where the TV is bolted down so the guests don't steal it.
We are now happily seeking investments that are bigger than an angel, but smaller than VC, specially from private individuals, in a way to not be pressured into the classic VC model (ie: not having to exit, or return the VC investment in 5 years and so on)
I would say that the cost of reaching customers is rapidly decreasing. The popularity of various distribution platforms (Facebook, Search, Adwords, App Store, LinkedIn, Email, etc..) are allowing customers to be reached more efficiently.
My startup bootstrapped to over 100k users all from Twitter and inbound marketing. We spend $0 on marketing. That's real.
The promise of sustainable incubation without ceding control seems real using this model, but it might add overhead in areas where fledgling "companies" or projects might not have the time or bandwidth to steer.
Plus, I suppose, there's the question of the VC's rolodex vs. the "networking effect" of the crowd.
Arts organizations seem to rely on this model fairly regularly, but as much as one might want to be idealistic in suggesting that it is about "maintaining aesthetic independence" from monetary influences (big donors, government grants, "selling out" to the market), the drying up of funding in traditional areas is a prime motivator here as well.
That said, it seems like a daunting challenge for technical-oriented folks - this is exactly where a paired business/technical co-founders model should be very useful.
Generally, the more risk you can remove before accepting outside capital, the less you'll have to pay for it.
- They can limit the company's ability to raise future funds
- They can convert equity to debt if it's convertible. If the company can't pay back the debt they can gain more control
- They can have rights to control hiring and firing
- They may have voting rights with the equity
- They have a voice with the public, press, customers, hiring candidates
- They have rights as minority shareholders
- Various clawback and other provisions may raise or lower their equity stakes, giving them more or less control
- They have access to information they wouldn't have otherwise
Besides contractual and legal rights, they have relationships with management. Presumably they can just talk to management and influence them that way.
Also, power can also be used to act in concert with the company, which is augmented by their inside information and made more credible by their shared interest. They can
- Recommend candidates for hiring
- Recommend clients
- Inform about competition
- Recommend other investors
Startups that do make it big, usually stay big when the folks at the helm know what to do or can at least quickly figure out what to do by the seat of their pants. That's quite a bit harder when there's an additional layer of bureaucracy involved, so investors can choose to stay back and let the founders do their thing or founders decide to get fewer investors involved in the fist place to ensure their freedom to operate with some modicum of independence.
To be fair, percentage equity (or "Power") can be expressed in ways other than direct control of a company's heading.