The Future of Venture
Just before the end of the year, Erin Griffith of The New York Times published an article titled “What Is Venture Capital Now Anyway?” It’s a provocative look at the state of venture capital and, as these sorts of things are want to do, very quickly started making the round in venture circles as VCs tried to map how they fit into the landscape that Erin describes – a split in how VC firms are operating: some firms are keeping to a smaller, boutique style while a handful are becoming behemoths, almost unrecognizable as venture firms. There’s very little in between.
I think Erin’s description of how our industry is evolving is spot on. But this evolution in the venture market isn’t a surprise. In fact, it’s something I wrote about years ago – back in 2010. In that post, I described the bifurcation of the venture industry and predicted that large, muti-stage, multi-sector firms would continue to raise ever larger funds and that firms with smaller, more focused funds would proliferate at the other side of the market. I described the evolving landscape as increasingly barbelled – predicting that there would be relatively few firms in the middle. At one end of the barbell would be essentially asset managers (asset aggregators) and at the other, smaller firms that were more in the mold of what we historically thought of as venture. The former would be seeking beta and predictable, if lower, returns. The latter would be seeking alpha and greater risk. The middle of the barbell would be sparsely populated and firms inhabiting that space would run the risk of being too large to execute the alpha strategy but too small to be considered true asset aggregators.
I wrote a follow-up piece in 2013, parsing some then-current statistics from the NCVA that backed up what I had predicted in 2010. This trend – as Erin points out – is even more true today. In the 2013 post, I highlighted a few firms that were clearly on their way to the asset management side of the venture barbell. All have subsequently gone on to raise enormous funds: NEA (most recent fund: $6.2B), Norwest ($3B), A16Z ($7.2B), and Khosla ($3B), in particular. But also firms like Greylock ($1B) and CRV ($1B).
I didn’t fully understand the ramifications of the trends when I was first writing about them, but the implications of this continued bifurcation are becoming clearer to me. We often say at Foundry (where we have a fund investment practice and make direct investments) that fund size is fund strategy. That’s always been the case but is even more so now. Fund size has implications for both the kinds of deals your firm pursues, how concentrated your portfolio can be, as well as your approach to valuation and structure (not to mention fundraising – many LPs prefer to be able to write large checks to a small number of firms, something that is putting pressure on fundraising for the smaller end of the market as large firms hoover up a meaningful percentage of LP dollars each year).
I’m not at all saying that large funds are a bad strategy. It’s just a strategy different from what smaller firms at the other end of the barbell are pursuing. And the resources that these firms bring to their portfolio companies make them potentially quite attractive to entrepreneurs (and as co-investors in the right circumstances). But it also means that they have a different risk profile than smaller, earlier-stage investors, which can create misalignment across a cap table (earlier investors wanting to take more risk, asset aggregators looking for more modest risks, and assured returns). All of these firms describe themselves as “venture” but investing from a smaller fund, where returns are driven by a very small number of deals, is very different than investing from a larger fund where (whether you admit it or not), you are trying to put larger dollars to work in any given investment and where the dollar return can be more important than the multiple you generate. Larger firms are also generating a more significant percentage of their pay-outs to GPs from management fees than from carry.
The firms mentioned above who have all raised funds > $1B (in some cases many times that amount) are operating a different business than funds at the smaller end of the spectrum. They aggregate massive amounts of capital across a large and diverse set of funds and often build huge organizations to support their work. One of the key signs that a firm is in the asset aggregation business is not just the size and scope of the organization but specifically the size of its marketing and PR groups. These firms are often quite adept at pushing out materials and content (much of it high quality) to stay front and center in the market – not just among entrepreneurs but, importantly, among LPs. They require meaningful fundraising capacity to keep feeding the asset machine. Their funds are typically consistent performers but are unlikely to generate outsized returns. Importantly, they can accommodate very large LP checks, which many LPs like, and they are a brand name that LPs also feel comfortable with (as I often say, LPs are not in the risk business; they’re in the capital allocation business – which is very different). These firms are chasing something more akin to beta than alpha for the most part, although occasionally they’ll be early into a new market (AI or crypto are examples – especially in the case of AI where early investments required massive checks, which smaller firms were not set up to provide).
On the other side of the spectrum are firms that are true venture firms in the traditional sense. Their funds are smaller, and they tend to raise funds that are similar in size from one fund to the next. They take real swings. They make more of their money on carry than fees. Benchmark is a great example, a firm that Erin Griffith mentions in her article, but many other funds also have this model. Founder Collective may be the quintessential fund of this type (having stayed remarkably true to their mission and fund strategy across many fund cycles), but funds like Union Square Venture also come to mind. Because they’re going after alpha there’s more of a risk of a badly performing fund (and bad vintage) but they’re also more likely as a group to have funds that exceed 3x which is nearly impossible for the asset management funds to do.
More in a future post about the operations of funds at each end of the barbell, as well as some commentary about what happens when you get stuck in the middle. I can understand why Erin’s article made the rounds so quickly. The evolution of the venture market – especially in a cycle of decreasing liquidity and tightening fundraising – is important to track.