So last week we left you with an interesting tweet that we saw that we wanted to discuss this week around venture capital and "risk" taking. As a reminder, here is the post again before we get into it.
Ok, so there is a lot to unpack here but it also raises some interesting questions about the evolution of the venture capital industry. First things first, I think it serves all of us a good reminder that finding ways to mitigate risk is a good thing. The majority of Venture Capital is institutional dollars representing pension funds, endowments, and other large-scale financial institutions that trickle down to everyday people saving for retirement. I don’t think the startup and venture world thinks about that dynamic enough.
Sure the job is to direct capital into promising young companies that are innovating a new future for us as a society. But that is only half the job, Venture Capitalists are fiduciaries as well with a financial responsibility to preserve and return capital to their limited partners. Now look, I’m not saying that isn’t in the back of the mind of every VC, after all, if they don’t return capital the chances of them raising a second fund is essentially zero. But it’s not the sexy thing to talk about, when I see VCs in the media and tweeting it's often to celebrate unicorns and discuss the innovation that a portfolio company is going to bring to whatever market or issue they are solving for.
I also think that they fails to recognize the even in a venture setting where you are looking for bold bets and outsized returns there is still a process that many VCs put in place to assess and direct where they deploy capital. While Venture Capital is a power-law game when it comes to returns, most VCs aren’t just blindly writing checks. They are putting startups and founders through a process to determine the size of the market potentials, identifying other trends, how well customers like their solution and the viability of the team to execute. See, while I agree with the post above that VC should be about taking bold bets to back the companies that will become the household names of tomorrow, but that doesn’t mean you can’t take steps to mitigate risk, especially when you are investing with other parties funds.
The author also neglects to discuss the facts that VC has evolved as an industry as any industry should. We have learned so much about how startups operate and scale. Similar to sports, with practice, we should be getting better at this and prominent and long-time VCs who have seen success stories play out and can take those learnings and use them to spot the next success stories. Even founders learn, rinse, and repeat, often with greater success. I myself am working on my second startup and I can say without a doubt that I have a much better understanding and plan for how I am going to execute.
To be fair, I do want to share some data that supports the argument above as I do think that the data (yes I know, data, data, data) tells an interesting story that in all honesty, is pretty hard to decipher. Let’s take a look at the total venture capital dollars invested over the last several years against the total number of companies the industry has invested in:
In this chart, we can see a sharp rise in the dollar amount invested in 2017 through 2020, yet the number of companies that that capital has invested in has plateaued and even begun to decline through 2020. Now some of that might be the effects of the pandemic, but when combined with this next data set you will see how it is hard to decipher what is actually going on.
Over the last 3 years, 2018–2020, we set the record for a total number of Mega-rounds invested and the total dollar amount invested in those rounds. So what does this mean for the industry? Well, it means that the author of the post above might have a point, maybe. So yes, the last three years have seen what I would call consolidation in the industry, which in most markets tend to be healthy cycles wiping out the unhealthy parts of a market.
On the flip-side, it is hard to really tell if these “winners” really are the winners because they have been flushed with so much cash that in the short-term they look like winners because they spend like crazy on advertising and hire, hire, hire. Uber, a venture-backed “success” story has burned through half ($45B) of its market cap ($90B) in the last several years alone. Is Uber really winning or do they just have so much cash that they have been able to float by? Time will tell.
In referring back to the original post that was the cause of this article, I think what would be fairer to say is that venture capital these days feels less like a “chase” and more just everyone following each other's lead. For me, the biggest difference between VC and plain old PE is that venture is meant to be about the hunt and chase for new and exciting innovation. Traditional PE puts money into proven business models that have demonstrated success in returning capital to others, sure there is less likelihood of “bankruptcy” but for me, that shouldn’t be the focus of the professionals in these two markets. For Venture Capital to continue to grow and succeed, we need funds and professionals looking to the outer edges to constantly be finding the next thing that is going to change our world and then make bold bets on those ideas and the people building them.