Is the VC funding model broken?

During my daily tech blog scan, I came across a post from Om Malik on whether the VC model is broken (here), given the big news that Sevin Rosen wasn't going to raise another fund. He also pointed to another point of view from Fred Wilson of Union Square Ventures (here).

I've got a little bit of experience with this, given that I've founded a venture-backed startup, worked for three others, and am a limited partner in a VC fund. I'm with both of these guys in saying the model needs to change, but strongly believe there will always be room for venture funding. But not 2000 different VC partnerships and $30 billion a year in investable capital. You just can't put that much money to work cost-effectively.

Why? Because it just doesn't cost that much money to get a start-up going nowadays. Unless you are building custom silicon (and you need to have a damn good reason to do that now), it's all software. Software is cheap to build and cheap to bring to market. Most of the new fangled stuff is either delivered as SaaS (meaning you cobble together a LAMP-based platform - Linux, Apache, MySQL, PHP and maybe pay a couple hundred a month to host the site) or as open source. Either way, your cost to take a product to market is a fraction of what it used to be.

Fred Wilson puts forth a few new rules of the VC road, and I am on board with these:

We've got to raise smaller funds.
We've got to do less "hard tech" and more "soft tech"
We've got to figure out how to make great returns on $100mm to $250mm exits
We've got to limit our IPOs to our very best companies

I actually think that $100-250 million is going to be a big exit moving forward. Anyone in the VC business (focusing on security anyway) or thinking about becoming an LP in a fund better make sure they are comfortable seeing how money can be made with a $75-100 million exit as the top end. Maybe not a home run, but probably a nice 5-6x multiple all in. The big outcomes ($250 million +) will be few and far between. Very few and very far between.

The deals we've seen of late have validated this. The days of 14x multiples on sales are gone, unless you've got minimal sales (like SiteAdvisor) and then the sales multiple is big - but the deal size isn't.

So what? If you are an end user, why do you care? Because you are going to see a lot more of the walking dead in the security space. You need to be extra careful when selecting strategic vendors. These walking dead have raised enough money to get to cash flow positive, but end up not being able to grow significantly because of a limited market opportunity and outsize expectations about what they are worth.

Or maybe they haven't raised enough money and then they have to do a fire sale to salvage anything. Either way, customers are left holding the bag.