“Too much money chasing too few good deals”.
I can’t shake this phrase.
It was a very common one among VCs when I entered the business in ’01. Some often cited, but never published online, research done by Andy Rachleff around that time pegged the number of “good deals” per year to be 15, plus or minus 3.
Fast forward to today and the same refrain remains. Despite the “seed surge” effect of 7x more founders raising $1M-$2M rounds in the last 10yrs, the number “good deals” has held steady, if not slightly less than Andy posited.
In Aileen’s 2013 Unicorn report, she uncovered 39 “good deals” defined as companies valued at $1B or more, averaging around 4 per year. Given a universe of 60,000 investments, these “good deals” make up only .07% of total deal. As an aside- the discrepancy here is likely due to definitions: Andy defines a “good deal” as one that generates over $100M in revenue, Eileen defines them as companies valued at $1B or more.
In her 2015 follow up piece the number of Unicorns surged to 84, a 115% increase in a mere 2yrs. This also bumped per year average up from 4 to 8, which starts to get closer to Andy’s original number, and represents .14% of of the 60,000 venture funded investments in the study. Worth noting that the vast majority of that growth came in the form of “paper” Unicorns.
Many industries run on rules whereby most of the value is created by a very small subset of overall participants: 80/20, 90/20, 99/1 are all rules we’ve seen elsewhere. In venture, that rule is closer to 99.9/.1.
Venture math is tricky, As Aileen explains in the pre-amble to her research:
That billion-dollar threshold is important, because historically, top venture funds have driven returns from their ownership in just a few companies that grow to be super-successful. And as most traditional funds have grown in size, they require larger “exits” to deliver acceptable returns.
For example, to return just the initial capital of a $400 million venture fund, that might mean needing to own 20 percent of two different $1 billion companies at exit, or 20 percent of a $2 billion company when the company is acquired or goes public.
If the situation were challenging with the scenarios Aileen spells out above, imagine how it compounds when fund sizes double, or early ownership levels are halved, while “good deals” have remained relatively constant in the 20yrs since Andy’s original research.
With the recent talk of dry bubbles, dirty terms sheets and Unicorpses, perhaps a more timely conversation would be to question whether we’ve reached the limits of the returns that the SIlicon Valley’s blitzscaling venture model can produce.
Despite seeing tweaks to the model of added service layers, digital platforms or intra-portfolio community building, the underlying funding mechanism, timelines and return model have remained unchanged for the last 40 years. And, as the data suggests, the arch of actualized returns still hangs on the outsized outcomes of the .1%.
Perhaps that’s the reason the Kauffman Foundation titled their 2012 report on the VC industry “We Have Met the Enemy…And He is Us”.
Unfortunately, the incentives on both sides of the LP and VC table are not to explore new funding models or founder archetypes that might change that math; rather, the incentives are to fight like hell to get into one, or more, of those 8–15 companies per year.
So, we end up with today’s VCs running a playbook they didn’t write, investing money they didn’t make, chasing returns they’ll never see.
Maybe the answer to the liquidity problems facing the Silicon Valley VC model isn’t a cleaner termsheet or a wider IPO window. As the old saying, history and data suggest, there are “too many VC dollars chasing too few good deals”, but that hasn’t stopped anyone from doing more of the same.
And more of the same will continue to yield more of the same results.