One of the problems in venture capital today is a fundamental impedance mismatch: fund sizes remain large, while capital requirements for many Internet/software deals are shrinking.

You don’t need much money anymore for many software ideas: the software stack is free, servers can be rented for $50-$100/month, and there’s cheap labor offshore. There are a lot of ideas that can be vetted for $100k to $1m.

At the same time, venture funds have grown and stayed big, driven in part by VC compensation. As I wrote in an earlier post: venture isn’t generating great returns these days, pushing VCs to make their money on fees. The larger the fund, the larger the fees.

The mismatch happens when you do the math: for a $200m fund with 4 partners, each partner needs to invest $50m. If each partner does 1-2 new deals/year, and the fund is committed over 3 years, then each investment has to be a $8-$16m commitment. (That doesn’t mean that Series A needs to be $8m, but it means that the total invested is in that range).

You can see where it is hard for many firms to do $1m investments — it’s just too small. And some of the most interesting stuff is happening “down there”!

We all know folks that made money on Bubble 1.0 that shouldn’t have and vice versa. The point: no matter what you do, sometimes you’re just lucky (or not).

Startups are calculated risks. Entrepreneurs work hard to manage all of the factors for success, but you can’t manage everything. Sometimes the low-probability, high-impact “perfect storm” happens and wipes things out. Or sometimes, the stars align in surprising ways and everything takes off.

The key, I think, is to be as relaxed as possible about it. Sometimes you do everything exactly right and it still doesn’t work out. The trouble starts when the anxiety of failure starts to creep in. When that happens, remember, it will all be OK: your spouse will still love you, and your friends will still call you back.

A while back, I wrote an essay on the pitfalls of Entrepreneur In Residence (EIR) arrangements for entrepreneurs. (And I’m now shamelessly recycling bits for blog fodder).

The essential point: EIR arrangements give quasi-exclusivity from the entrepreneur to the venture firm. Entrepreneurs need to make sure getting enough value back for that exclusivity.

For companies seeking additional funding with new investors: watch out! Inter-firm relationships can be “interesting”.

Your existing VC investors frequently have an agenda when they refer new follow-on investors (or steer someone away). Most often, VCs want to expand their relationship with another firm (one way VCs get to know each other is by doing investments together). Or, they’re returning a favor — the other investor helped them with another deal, and they’re giving back.

When you’re steered away, it can sometimes be because of a grudge, or a competitive issue. Maybe your VC felt screwed in some previous deal with the other investor. Or, they feel like it’s a one-way relationship: they show the other group deals, but don’t get anything back. Or, they feel like the investor will hear the pitch just to get competitive info, not with any intent to invest (sometimes, a very legitimate concern).

The key point: the company (usually the CEO) should lead the fund-raising process, not the VCs. The CEO has a clear fiduciary responsibility to act in the best interest of the company. The VCs on the board also have this same responsbility, but sometimes can’t separate that responsiblity from their own firm’s agenda. (NOTE: If the VCs are driving the process, that’s a sign of a weak CEO).

When existing VCs are suggesting leads for follow-on investors, the CEO should do her homework with the VCs:

• Have you done any deals with this firm before? Which partners have you worked with? If so, what was the outcome?
• Has this firm ever referred you deals? Have you referred them deals? How recently? If so, what was the outcome?
• If you haven’t worked with this firm before, why not? How do you know them, and what do you know about them?