Google is threatening to do to venture capital funding what it has done to the search, browser, applications software, advertising and publishing worlds: turn the status quo upside down. The company has been quietly making relatively small investments in the $500K range in promising technology startups since 2Q 2007 — and then typically buys the most promising companies while the technology and resources are still relatively cheap — beating the traditional venture capital industry to the punch and leapfrogging the traditional model, which involves closely working with a target and supervising development and growth in order to ensure the success necessary to reap early investor multiples. The company’s confirmation that it is actively exploring a formally-organized venture capital fund has created new headlines and has left venture capital companies wondering where they will invest their new rounds of cash.

What Dot Com bust?
In Internet Years, 2001 is the equivalent of the Silent Generation — everyone who was there is grateful that today is not yesterday — and everyone younger doesn’t remember why it was so bad. Google’s efforts come at the time when the venture capital industry has finally regrouped, and refunded after a several-years slump, flush with cash and ready to push investment into small technology startups with renewed vigor. Investments in venture funds topped $1.3 billion in the first half of 2007, up 30% from a year earlier. Venture capital funds are not so happy about the Google development: one partner at a large VC firm says the purchase of startups not long after making a small investment “very inconsistent with the venture community’s strategy” of providing guidance and making several rounds of investments.

The pool is definitely getting more crowded: according to the Wall Street Journal, Google is only the latest technology giant to seed startups with a venture capital arm, following Intel, Motorola, Comcast, and Disney’s Steamboat Ventures.

The king is dead, long live the king
Industry commentators point out that the venture capital model has seemed dead for a while now — Google may just be adding some nails to the coffin. Back in 2005, Paul Graham was ahead of the curve in describing what he calls the “venture capital squeeze”:

deals now want less and less money, because it’s getting so cheap to start a startup. The four causes: open source, which makes software free; Moore’s law, which makes hardware geometrically closer to free; the Web, which makes promotion free if you’re good; and better languages, which make development a lot cheaper.

According to Graham, Sarbanes-Oxley and other burdens of public company structure have made acquisition the preferred route for most startups to achieve success. Taking a small investment from a large company like Google allows the innovative engine of a startup company to be what it wants to be: a tightly-knit group of technology innovators who can keep working the way they like and focus on leveraging their creativity to explore and develop different alternative implementations of their core technology, rather than turning some part of their attention to transitioning to commercial product implementation.