A Super Fast Overview and History of Tech VC: Part III
Accelerators, Web 2.0, and the Mobile Tsunami (2008–2013)
Thanks to Michael Ramos-Lynch for co-writing this series with me.
Venture capital for technology has evolved tremendously since it began formalizing almost 70–80 years ago. The last 20 years have seen the most rapid changes.
This post covers the rise of accelerators, the impact of increased access to information, and the domination of mobile, a time period roughly from 2008 to 2013. Our first post covered the 1950s thru the dotcom bubble, as well as a bit on who we are and why we’re writing. Our second post covered the post-dotcom era including the rise of the Internet and the cleantech bubble up through the Great Recession.
The era begins with the Great Recession driven by the subprime mortgage crisis. Unlike the dotcom crash, which was more concentrated, the recession hit the entire market. This was despite a lack of inherent/structural weaknesses in venture or early-stage tech companies. A crumbling mortgage market and reckless activity on Wall Street created much broader uncertainty and fear than America had seen since the 1930s.
People stopped consuming, the stock market crashed, and splashy exits came to a screeching halt.
Exit Valuations vs. Capital Raised (in millions)
As could be expected, limited partners reduced or stopped investing in venture funds, leading to a drop in average startup valuations. As relayed to us by samir kaji, Senior Managing Director at First Republic Bank:
“As the recession hit, it was clear that the combination of underwhelming returns over the prior decade, largely due to bloated fund sizes would cause most LP’s to back away from venture. During this same period however, we also saw an exponential reduction of capital required to get a company off the ground.”
Venture investment bounced back faster than from the dotcom crash. But some of this investment came from sources outside of traditional venture firms. Compare the dollars raised vs. invested by VCs in the below graphs.
Post-Recession Investment into Venture Capital Funds
Post-Recession Investment into companies
Some of the bounce can be explained from funds tightening up in 2009 and 2010, eventually calling capital and investing pent up dollars before the end of their investment periods. The rest likely came from increased investment from corporates and investors more typically focused on public markets, i.e. mutual funds and hedge funds. What was driving that growth? Great fundamentals in private tech companies and profligate monetary policy.
Low interest rates, better valuations, and strong performance gave non-traditional investors enough incentives to begin investing more heavily into tech companies. More on that in Part IV.
The Rise and Proliferation of Accelerators
Accelerators and incubators represent a fraction of overall venture investment but they provide unique insight into the ecosystem, acting as a leading indicator in many ways. They’re also invaluable in helping founders get off the ground and on the right track with guidance and access to unique networks.
Acting as a filter and source for future investors, there is a positive correlation between startups that gain admission to these programs and those that can raise institutional venture capital. However, by their nature, they miss the small percentage of startups that can raise large rounds directly from venture firms.
In 2005, Paul Graham felt that traditional venture capital firms were not sufficiently diversifying their investments in early-stage companies. Seeing an opportunity to solve the problem, he started Y Combinator, the first accelerator of its kind. It was soon followed by the launch of Techstars in 2006. Over the next decade, the number of accelerators would grow tremendously, with an average annual growth rate of ~50%. By 2015, one-third of startups that raised a series-A were graduates of an accelerator program.
According to our research, greater conservatism from investors post-recession actually resulted in significant potential returns being left on the table, much like we saw in Part II in the post-dotcom era. According to Ulu Ventures co-founder and managing partner Miriam Rivera:
“There is a boom/bust cycle that isn’t that uncommon in SV, and opportunity lies therein. In 2008, it was a great time to be an investor, because there was a lot less capital in the market and we were getting access to deals that would have been harder to access otherwise.”
The flipside, of course, is that a thinner market means fewer companies are financed at each stage and thus less make it to sustainability or a meaningful exit.
But for the recession, accelerator growth may have been even more dramatic over this time period. If early-stage venture continues expanding, we expect accelerators to continue expanding as well. VCs will increase their use of accelerators and incubators as a source of startups to invest in, creating a positive loop.
Despite this expectation, the data suggest market saturation as well as a misalignment of expectations between startup founders and funding sources. For example, the slow down in corporate accelerators was particularly pronounced in 2014 and 2015, likely from corporate boards and shareholders typically finding themselves too risk-averse and impatient to continue funding accelerators.
Total U.S. Accelerators
Still, accelerators have spread far beyond the innovation and VC hubs where you might expect to find them, e.g. Boston, San Francisco, and New York. Our cursory search discovered accelerators in cities we didn’t expect, including multiple in each of the 170,000 person city of Chattanooga and the 600,000 person city of Milwaukee.
So what caused this rapid expansion? Early successes for Y Combinator and Techstars fueled a massive influx of capital to create new accelerators such as 500 Startups in 2010. There was a market need, and accelerators filled it. More and more unicorns (startups with valuations above $1 billion) are beginning in accelerators, including names like Airbnb (YC 2009), Stripe (YC 2009), Dropbox (YC 2007), Digital Ocean (Techstars Boulder 2012), Twilio (500S 2008), Credit Karma (500S 2008), and Intercom (500S 2011).
EDIT: Twilio, Credit Karma, and Intercom did not complete the 500 Startups accelerator, they were non-program investments. TalkDesk, a unicorn as of 2018, did complete the accelerator.
Localized accelerators bring new investors with the promise of outsized returns and gain public support with the promise of new jobs and tax revenue. These resources, in turn, can drive startup creation and migration, creating a virtuous circle for smaller markets.
Information Ubiquity
A major factor that empowered the success of many startups and spurred the growth of the accelerators that helped fund them during this time was the massive increase in access to information. The phrase “Web 2.0” loosely describes internet usage and products/services starting around the mid-2000s.
Paul Graham of Y Combinator suggests one of the key characteristics of Web 2.0 is the democratization of information. Marquee companies founded in this time period experienced tremendous growth in part because they capitalized on an interconnected information cycle.
Overlapping concepts include the idea of growth loops and network effects. In short, users of different or the same type connect through the internet and exchange value in a way that creates value for others beyond the initial two exchangers. Social media is the easiest example, where (1) users create content, which facilitates and encourages (2) content consumption. Platforms that enable (3) connection through interactions (commenting, liking, hearting, resharing), allow for the(4) building of community around that content. Examples include Facebook, Reddit, YouTube, Twitter, and almost all others of their ilk.
We first saw this behavior in forums. Newer platforms and tech/design that allowed users to create, post, share, and consume more easily greatly benefitted from more rapid growth and greater engagement. And while forums easily translated to platforms that leveraged user-generated content as a powerful foundation, organizations aggregating, formatting, and making widely accessible other types of data were just as impactful.
The SEC created an online system called EDGAR for securities-related reporting in 1996. The regulator intended to increase the efficiency and equitability through transparency. The increased access to such information in a standard format enabled others to use the data to find and present useful insights to users.
Increased technological ease of scraping and presenting data led to a number of successful companies focused on collecting, sorting, and presenting startup funding data. Companies in this category took data from EDGAR, state organizations, press releases, online publications, social media, etc. These companies became vital for market research and allowed new investors to more quickly become informed about various sectors, companies, and other investors. Example include Crunchbase (founded in 2007), CB Insights 2008), PitchBook (2008), MatterMark (2012), and DataFox (2013). These businesses also benefit from network effects. The more companies and investors contribute data for validation or signaling, the more complete the data set, and the more individuals looking for data come to the platform.
Social media and data platforms were a key component in the rise of new investors, a topic we’ll in our next installment.
The Mobile Takeover
The release of the iPhone in 2007 increased the robustness of these network effects by further increasing connectedness, making it easier to share information and content.
Leading up to the Facebook IPO in 2012, several investors expressed concern about the company’s poor mobile adoption. When the IPO performance came in, many pointed to the company’s “fledgling” mobile strategy.
The prioritization of mobile is clear in Facebook’s acquisition strategy. Facebook acquired Instagram in May of 2012, just prior to IPO, for $1 billion. In 2013, Facebook tried to acquire Snapchat for $3 billion. A year later, it acquired WhatsApp for $19 billion. Facebook understood that whoever owned the mobile platforms with the most users would be able to dictate their own advertising revenue. It wanted a better mobile presence to offer more and new advertising, but it also had to prevent major competitors (Google) from making these acquisitions and having deeper ownership of the mobile advertising landscape where both Facebook and Google generate their massive revenues.
As context, note the dominant and growing market share that Android already enjoyed by 2012 and the consequential reliance of mobile-dependent unicorns on Google and Apple to play nice.
Worldwide Market Share in OS
While incumbents like Google, Apple, and Facebook in many ways led and owned the mobile wave, many startups saw great success as well. Beyond social media companies mentioned above, mobile had other major categories, such as gaming (Zynga, Rovio, King) and the sharing economy (Lyft, Uber, AirBnB). On the VC side, incumbent funds like Kleiner Perkins and Sequoia were very successful in riding the mobile wave.
Still, newer funds emerged in this era, many building their own top-tier returns from mobile. Andreessen Horowitz, somewhat surprisingly, was only founded in 2009, and invested in mobile companies like Twitter, Zynga, and Lyft. Lowercase Capital, founded in 2010, invested in Uber, Twitter, Twilio, and Instagram. Younger funds, some mentioned in Part II, like Floodgate, Felicis Ventures, and Eniac Ventures also performed well in mobile, making strong early investments and expanding the seed stage.
Analysis from Cambridge Associates bears out the success of new funds. The conventional wisdom is that 10% of firms generate 90% of the returns. It may actually be worse than that, but at least the distribution may be bimodal as we saw with mobile.
The top 100 investments in any year generate most of the returns. However, about 50% of the returns are attributable to new and emerging firms.
Top 100 investments create most of the value
New/emerging firms capture ~50% of value
Data and analysis from Invesco and Silicon Valley Bank also suggest that smaller, earlier funds are more likely to generate outsized returns with better IRR/TVPI on average.
All of this points to continued excitement and opportunity for new funds, especially smaller ones focused on the early stage through this time period. According to samir kaji @ First Republic:
“During the downturn of 2009 and in the years following, a clear funding gap emerged between angel and Series A, with new firm formation looking to fill this gap. From my perspective, this was the first stages of the broad re-engineering of the venture landscape, something that hadn’t occurred since the 90s.
The result was a barbell shaped industry with the best firms raising more capital, as LPs concentrated capital to a smaller group of high performing large managers while the other side of the barbell being comprised of small Micro-VCs, which were now viable given the capital efficiency of companies at the earliest stages.”
In this context of mobile and data ubiquity, we saw a democratization of information, but also perhaps of technology and venture capital. These rapidly growing companies and funds brought excitement from investors in other industries and all around the world, and as we left 2013, new venture investment into tech was primed for another round of great growth. But could new companies and funds compete with incumbents after the mobile wave crested? More on that in Part IV.
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Neil Devani is an early stage investor based in San Francisco, California working with companies that create positive externalities, with a focus on the healthcare, financial services, and education sectors as well as certain frontier technologies. He is also a licensed attorney in the state of California. Find him on Twitter, AngelList, or LinkedIn.
Michael Ramos-Lynch previously worked for a venture firm in Palo Alto, California and is currently an entrepreneur and practicing attorney in Austin, Texas. Find him on Twitter, AngelList, or LinkedIn.
None of the above post is intended as investment or legal advice.
