Three Methods of Venture Capital

A Guide to Navigating a Manic Market as a Venture Capitalist (part 1)

A new world for venture

Last week, we announced our $80M Fund II and the addition of David Peterson as a full Partner in Angular Ventures.

As we set out on a new chapter in our journey as a fund, I thought it might make sense to reflect a bit on how we see the world of venture capital and our role within it.

This post looks at the changes to the VC market and three methods of venture capital that are all rational responses to current market conditions. In part 2, I offer my advice to VCs pursuing the third method: artisanal venture capital.

There is no doubt that everything in venture is changing, and changing fast. By now we all know the contours of these changes:

• Increased opportunities for tech companies to create value that are bigger than ever which has led to larger outcomes than any of us ever imagined.
• A flood of capital as low interest rates have depressed returns everywhere else, so money is flooding into tech at an unprecedented rate.
• Bigger and bigger round sizes, valuations, and fund sizes that are breaking new records on a weekly basis.
• An ever faster pace of venture investment. Many founders find themselves with multiple term sheets almost instantaneously. VCs are frantically chasing deals and under increasing pressure to compress (or eliminate) their diligence process.
• Everyone is in the game — and there are no swim lanes. The number of sources of financing for early-stage (or late-stage) tech companies has exponentially increased: classic VC funds, specialist funds, emerging managers, big funds launching seed vehicles, VC scouts, operator networks, angels of every type and stripe, rolling funds, corporate funds, and even funds run by venture-backed companies with so much cash on hand that they are spinning up VC investments off their own balance sheet.

In private, VCs are stressed

Private conversations between VCs these days are very consistent and strangely apprehensive. While many are excited by the returns they are seeing, the market environment is disconcerting and fills many of us with uncertainty. It fills me with uncertainty. Everything is marked up to insane levels overnight. Every deal I pass on seems to be funded the next morning at twice the price the founders wanted when they spoke with me the previous day.

What the blazes is going on? How long will it last? Do I need to completely rethink my operating model? Do I need to write smaller checks earlier? Do I need to write bigger checks later? Maybe I should write bigger checks, but earlier? What if I totally abandoned my ownership targets? Should we move faster? Can we move faster? What if we raised a fund that was 10x larger? What if I just went off to make goat cheese on a Mediterranean hill somewhere until this all blows over?

Three methods of venture capital

For the most part, VCs have responded to these tectonic shifts in one of two ways: scaling up or indexing the market.

Method 1: Scaling up

One rational response has been to write bigger checks and raise larger funds. We see this in the massive seed funds announced by Sequoia ($195M), Index ($200M), Andreessen ($400M), and Greylock ($500M). We see this in the dramatically increased activity of “big dollar” funds like Tiger Global, Coatue, Softbank, Stripes, Addition, Insight, and others. In a market with increasingly frequent and increasingly large outcomes, it is not irrational at all to make larger bets at higher valuations. After all, one $10B outcome drives a lot of return, and higher entry valuations are just bringing these returns down to a more rational level. Some increase in rounds and prices also reflects somewhat reduced risk in certain situations. Everett Randle offered a great summary of this phenomenon and why the scale-up strategy is completely rational in his post on Tiger Global.

Method 2: Indexing the market.

A second rational response by VCs has been to index the market. As John Luttig wrote, this consists of applying the “index mindset” to private investments: spreading one’s bets across a much larger number of positions. This means buying “cheap” options on future outcomes, and it can be very efficient because less due diligence (if any) is involved. The result is enormous portfolios that can still be very performant given the larger outcomes we are occasionally seeing. We see this strategy at work in seed funds that are writing 50 checks per fund or per year (!). We see it at work in certain multistage firms that are deploying $1M seed checks out of a $1B fund. We see it at work in scout programs where armies of people have been given a green light to invest a VC firm’s capital in a large number of companies with minimal oversight or buy-in from the actual firm. We also see it in accelerators. Y Combinator, by far the best accelerator, is backing 600 companies a year. The indexing strategy is completely rational, especially in the current environment.

The third method: back to basics

At Angular, we are committed to practicing venture capital as an artisanal craft. There are other funds that are similarly committed to this way of doing things, but not very many.

This is a third completely rational response to the market we are experiencing.

We are not going to massively increase our check sizes or our fund sizes. We are not going to massively increase the volume of deals we do each year. On the contrary — we are going back to basics with a very high-conviction, high-concentration strategy.

At Angular, we look for a small number of situations where we can be the first and best partner to a founding team at the very beginning of their journey, where it makes sense for them to partner closely with a venture firm to help them build the business, and where we can have a real impact on the trajectory of the company.

In many cases, we find ourselves as the only investor that believes in an opportunity — and we are comfortable with that. As certain investment theses become increasingly obvious (SaaS, open-source, developer tools) and easier for other VCs to get behind, we try to move on to less obvious areas, less obvious founders, or less obvious growth strategies.

Naturally, we have found that very deep technology is a big part of this approach. Our investment decisions often hinge on our ability to go deep with founders to understand both technical innovation and its business implications.

More important than technology, however, is that this approach is about people and relationships: real intimacy and commitment between founders and VCs to work together in partnership to build a business against impossible odds.

This approach to venture capital harkens back to the earliest days of the industry: when a small group of misunderstood investors on Sand Hill Road and Route 128 worked to finance a small group of misunderstood technical founders. In 2021, this is not the only way to be a venture investor — but it continues to work because it’s grounded in the fundamental needs of early-stage technical founders.

Discipline, focus, and sanity. Maintaining the discipline, focus, and sanity to pursue the artisanal approach in the face of a rapidly shifting landscape is not easy. The gravitational pull of the “scale up” and “index” strategies are difficult to resist. In part two of this post, I’ll offer some advice on how VCs that are committed to artisanal investing might be able to best stay the course.