“Venture capitalists will either find a way to provide value or they won’t and they will die” - Fred Wilson
I love venture capital. I was first introduced to the industry through watching Shark Tank and have been obsessed from that point forward. I’ve spent countless hours listening to various interviews with some of the greatest minds in the industry and have learned a lot in the process. Recently, I have been fortunate enough to work at 500 Startups and see first hand, the inner workings of a fund. From my experience, I know that working in venture capital is a very privileged position, and I am grateful to have had the opportunity.
However, I believe that ten years from now, venture capital will look very different than it does today. Since the inception of the industry in the 1970s very little has changed, particularly when compared to the dynamic nature of startups that venture capital firms invest in. This, along with increased competition in the industry, will force them to reinvent themselves.
While I don’t see ICOs (initial coin offerings) as direct competition to venture capital, they are still worth mentioning as they have raised over $4 billion in 2017 (cointelegraph). ICOs are not just a way to finance your company but are a native monetisation model of a business. As the utility of the product rises the value of the token will also rise, and this value can be captured by founders, employees, investors, and customers. This is drastically different from venture capital and therefore isn’t direct competition. More on that here.
The main competition the industry will face is from capital pools that don’t raise funds from traditional limited partners, but rather from overseas capital. Large funds, similar to the SoftBank Vision Fund, will continue to rise and compete with existing venture capital firms. When capital becomes commodified, venture capitalists will need to differentiate themselves by adding value. This is the only way for them to continue to attract the best entrepreneurs and invest in them.
Typically, funds have relied on leveraging the experience and network of fund managers to help entrepreneurs. But this becomes very difficult when the number of investments grow. Venture capitalists have to spend time not only working with their existing portfolio companies, but also sourcing and investing in new startups. Even if a fund invests in only 5 companies per year, the number of companies will continue to compound, which makes the standard way of adding value hard to do at scale.
From a conversation I had earlier this year with Chris Douvos, he told me that he values fund managers who build authentic relationships with founders and believes in venture capital as a craft business. While I agree with this, it is natural for a fund manager to dedicate more time to the winners in the fund and not spend as much time with other investments. Therefore the question becomes:
How can venture capital firms add value to founders in a scalable way?
- Network of portfolio companies. As a venture firm grows and raises new funds they will continue to make investments in more startups, therefore the number of startups they invest in grow naturally with the firm. This is a very underutilized resource of venture firms and tremendous value can be added to founders by simply learning from other founders. First Round Capital has done this phenomenally well and has built a community as a platform for founders to help each other.
- Network of limited partners. Limited partners are a key stakeholder that can help add value to founders. As a firm raises a new fund, new limited partners are often added and they have aligned interests to see the entrepreneur succeed. They also often have strong networks that can be used to help entrepreneurs with hiring and sales. Village Global is an example of how a firm can market their limited partners as a value add to entrepreneurs.
- Dedicated value add service teams. Andreessen Horowitz famously pioneered this model and has several dedicated teams to help founders with hiring, marketing, legal, etc. When founders take capital from a16z, they know that they are also getting help from various other departments which can help make their life easier. This is a great way to add value but, these services are expensive and require very large funds to successfully implement.
- Niche expertise. Recently, I have been fascinated by the emergence of new funds that have very specific ways that they want to help founders. Firms that work on developing processes in a specific skill set to help entrepreneurs may find this easier to do at scale. For example, Combine VC focuses on helping founders implement design as an early competitive advantage. NFX is leveraging their understanding of network effects to help founders understand these principles and use it as a defensible moat.
- Brand. While this is much harder to implement for new funds, branding still plays a very large role in the industry and having a big name like Benchmark or Sequoia as an investor adds tremendous value to a startup. The signalling that a great investor provides can help with customer acquisition, employee morale, and recruiting.
I hope you enjoyed reading this article, if you have any questions, comments or would just like to chat feel free to reach out to me at wingvasiksiri@gmail.com
