Customers — The Future of Venture Capital and Accelerators
There are two things a startup needs:
1. Money
2. Customers
Everything else is secondary (okay fine, tertiary).
The former keeps the lights on, but the latter is what makes a business. It should seem strange then that for most of the history of VC, funds have focused on providing money, and left the customer acquisition to their portfolio companies. But the industry has been rapidly changing, driving funds and accelerators to move much more deeply into the sales funnels of their investees, and heralding a shift in the nature of VC.
The impact of YC and Andreessen
Y-Combinator started in 2005, and Andreessen debuted in 2009. The latter made waves with their development of an operating partner model, building an in-house team to help their portfolio with recruiting, operations, sales, BD, and any other functions not directly related to the core technology of the business. They don’t have a small staff doing this either; by my count, there are more than 90 people in operationally-related roles at the firm supporting an investing team of 25. The idea was to minimize distractions for their startups, remove as many growth roadblocks as possible (i.e., make sure there are enough talented bodies to enable scaling), and accelerate adoption. The latter team is called Market Development, and every one of the companies that I’ve spoken with that’s in the A16Z portfolio has mentioned it as game changing. They’ve credited it with opening doors that would have otherwise taken months or years to access, and dramatically impacting growth.
Similarly, though through almost entirely different means, Y-Combinator has been instrumental in generating early customer traction in its portfolio. It’s the least well understood part of YC (at least outside of silicon valley) and often gets minimized because it’s not a formal component of their program, but YC does speak to the power of their network at some length. Similar to the above, every YC company I’ve encountered has mentioned how that network helped them land many of their first customers. In YC’s case, at least in the beginning, many of these were admittedly other portfolio companies, but as the portfolio has expanded and matured, many of those in the network have become profitable, sustainable businesses and thus referenceable, long-term customers.
VC is turning into PE
This is taking place against a backdrop of an evolution in VC. As Tomasz Tunguz notes, venture has switched from focusing on leading indicators like product and vision to trailing ones like ARR and customer acquisition. I saw it personally, and see it in companies I work with as a mentor or advisor. Before there’s any substantial traction, there’s near zero interest from most of the professional investment community. Afterwards, the same investors can’t wait to throw money at them.
Of course the idea that somewhat de-risked capital is easier to come by than risky capital isn’t exactly new, but (in part due to the YC effect of generating early traction prior to pitching) there seems to have been a notable change in the risk tolerance of traditional VCs. As seed funds, angels, and accelerators have proliferated, the maturity of companies seeking their first institutional round has increased, and along with it the bar for that round. Venture firms are behaving more and more like private equity, providing relatively de-risked growth capital, and in some cases of “disruption”, providing money for roll-ups by another name or dumping by the new entrant to gain market share.
The growth capital bubble, and CVC as outsourced R&D
On the other side of the VC equation, firms are getting squeezed by the substantial availability of growth capital from said private equity funds, sovereign wealth funds, and giant later-stage funds. As wealth becomes more concentrated, there’s an increasing pool of investable capital searching for alpha. This has led to record funding of startups, but much of that funding is highly concentrated in later stage companies. Additionally, as corporate R&D spending has cut back, corporate venture (CVC) has increased drastically, and as that money often comes with a customer attached and without the same growth mandates, it’s particularly attractive to startups. Together this has lead to significantly increased pressure on deal flow, and potentially, returns.
And what about the startups?
Because of the trends above, later stage startups, those with solid traction, can be extremely picky about who they want as investors. Seed or napkin stage startups aren’t so lucky, as there’s been a pullback of seed and angel investment and finding pre-revenue funding has become increasingly difficult. In the case of the former, VC firms will increasingly need differentiation to attract the best deals. In the case of the latter, accelerators and true seed funds will increasingly need to help their cohorts gain traction so that they’re able to raise their next round. In the case of both, customers make all the difference. Customers are what turn a pre-revenue company into an investable one. Customers are what drive portfolio markups and high exit valuations. Customers are king (or queen).
The next stage of VC and incubators, and accelerators
The trend line is clear. General Catalyst and CRV launched the Velocity Network, and Mayfield recently joined. Techstars has developed multiple vertically focused accelerators in combination with industry, and innovation-focused firms like The Bakery are working to directly connect industry with startups. Other funds like The Engine, which is focused on areas where technology is more difficult to scale, have followed Andreessen’s lead and built out industry networks. Some, like Village Global or Pillar, have launched focusing specifically on their network value.
I expect to see more icons like this in the future.
