Can Venture Capital Scale?

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Several weeks ago we looked back at the history of venture capital, its French founding father, and the inextricable link between the newly developed financing model and the modern computing industry. Today, I’d like to fast forward back to the present. What once was — and often still is — referred to as a cottage industry appears to be one of the most sought after investment vehicles of the past decade. There’s no major surprise there: astronomical returns combined with low interest rates, it’s simply a function of capital seeking better outcomes in the midst of a volatile macroeconomic environment.

Yet as capital flows into the venture ecosystem, so do new investors. The elite institutions of Sand Hill Road no longer rule the roost, at least not completely. In this piece, I’d like to unpack how these macro trends are changing the venture landscape and what that means for startups and investors alike. Ultimately, the question is: can venture capital scale?

Becoming an investor (in name) is easier now than ever. Barriers to entry have lowered through access to information, digital platforms to pool capital, high throughput communication, remote work and diligence processes. Building a fund has fundamentally changed as well. Credibility and access is no longer reserved to longstanding Silicon Valley veterans but to Twitter personalities, podcasters and former startup operators with a successful exit. These trends are ever-evolving but what hasn’t changed is the fact that venture capital investing is hard. There’s no way around it. It requires skill, patience, network, execution and a bit of luck.

The aforementioned “mass migration” to venture capital has had a number of knock-on effects. Some of the most obvious are increased multiples on valuations, blurred lines between fundraising rounds and a premium on speed over caution. While some see this as bordering on the speculative, others view it as a great shift in the way innovation gets funded and furthermore a broadening of the equity pool to individuals who previously were left out from the early gains.

These debates can be endless and in a bull market they appear to be a trivial side show. But when financial experts around the world begin to forecast bear markets, or even depression, the music stops and people start to take a more serious look at the commentary.

Source: Thread from Gil Dibner of Angular Ventures on impact of VC “gold rush”

Lately, I’ve been keeping track of said commentary and there are two main trends in the way industry experts articulate the evolution of venture capital structure and positioning:

  • The first is around the shift to extremes, a binary model in which you fall into one category or another, otherwise you’re “doomed.”
  • The second is around plotting your fund on a cartesian plane; the x-axis is stage and the y-axis is sector. This offers a bucketing approach, no longer binary but still limited to 4 primary categories.

The first category is best articulated in an article titled “Playing Different Games: or why Tiger is eating your lunch (& your deals)’’ written by Everett Randle. His thesis implies that as a result of capital overflow in VC there are really only two effective strategies to win deals while maintaining IRR in the long run.

In economics there is a concept of luxury and normal goods based on consumer price elasticity. If your income increases do you buy more of a particular good? If so, it’s a luxury, not a necessity. In the case of venture funding, the price isn’t monetary, per se, but related to time and involvement for a startup founder.

Source: Playing Different Games from The Valley of Dunning-Kruger Newsletter

The graphic above illustrates Benchmark as a luxury good — it requires more diligence, oversight and perhaps equity but it’s worth it for the network and guidance. Tiger Global, on the other hand, represents a normal good: no frills, no strings attached cash — quickly. Cheap, fast capital to pour fuel on the fire without the mentorship and strategy you might expect from a traditional fund. I would agree that these two categories exist, but I’m less inclined to believe that anything in between is a “dead zone.” In fact, the spectrum between these two poles is more populous and thriving than ever.

The Spectrum of Modern Venture Capital

Granted, at any given snapshot in time, these two strategies might be the best approach. But I find it tough to believe that the future of VC will skew towards ultra luxury goods or low-touch, fast money products.

In 2021, for example, the markets flush with capital, it was the first time in decades where startup founders, not VCs, had the upper hand at the negotiating table. If one VC didn’t provide amenable terms, the next one would… and so on. Which is why this bifurcation makes a lot of sense in a frothy, capital rich market. But nothing lasts forever, and the scales will inevitably tip back to a normalized spread across various VC attributes that align with various founder needs.

Moving on to our second model for modern VC, we have to examine the chart below that I’ve annotated with labels for each of the four quadrants, plus some bubbles to fill the whitespace. This chart does a better job of illustrating current market dynamics, adding stage and sector as key variables. In essence, it implies there are a four primary of strategies for differentiating in today’s VC climate:

  1. Generalists: This the the largest, name brand legacy VCs (by and large) with the capital, brand equity and resources to staff teams for deal flow and communications across all investment stages and sectors. Very difficult for new entrants to compete. Sequoia, a16z, Accel appear to be the extreme outliers in this space.
  2. Short-Term (Narrow) Generalists: These VCs are industry agnostic but limit their surface area by focusing on a specific financing round. Expertise from seed stage deals to a Series C can vary widely which, in the case of some founders, may instill confidence or provide a higher touch interaction that is preferential.
  3. Long-Term Specialists: These funds specialize in a sector but provide resources across stages. This implies they have the resources, expertise and long-term strategy to carry investments round after round. Ribbit Capital, for instance, is exclusive to fintech deals but remains a multi-stage investor.
  4. Hyper Specialists: These funds filter across both axes to offer value to startups in a specific sector at a specific stage of their growth journey.
Source: Next Big Thing [Annotated]

Specialization across stage and sector is a natural progression in the VC ecosystem. As we know, software is eating the world so “tech” has expanded its reach beyond enterprise and consumer web applications into every category imaginable. That’s why the chart above presents a pretty solid picture of the world, at least for the past decade of tech investing. But you’ll notice that there is still a ton of whitespace on the chart (note: visually, this appears to be a function of the chart design, but theoretically, there is unlimited whitespace between each and every logo, which for the sake of this article is my argument).

My argument here is that VC isn’t binary (luxury vs normal), nor is it cartesian (stage & sector dependent) but 3-dimensional. Differentiation in the world of VC takes many shapes and I would propose a z-axis to the above chart to illustrate it. In a world with near infinite software (after all, it’s a non-rival good) and a growing set of potential investors, we should, in theory, be approaching a mathematical limit with regard to VC categorization. That’s to say, all the whitespace above will be filled in.

We are moving from a finite set of exclusive, dominant investors to an infinite number of multivariate investors of all types, stages, sector-specificity and differentiating factors. The expansion and contraction of the business cycle may at any given time shift the dominant model of the day, but all things being equal, progress will move toward a highly fragmented and distributed set of fund strategies.

VC Strategy Trends Plotted Against the Business Cycle

Which brings us back to our original question: can venture capital scale? It’s really two questions hidden in one:

  1. Can a venture capital firm scale in the way we would expect from a growth startup?
  2. Will the venture capital ecosystem scale from a cottage industry to a large, hyper competitive investment class?

To the first question, I would argue yes and no. Venture tends to be heavily reliant on network and relationships and for now, people don’t scale like software. You can amplify your reach through consistent and high quality media campaigns, you can build proprietary software to sort through deal flow (although this is still fairly unheard of in VC), you can build an audience or community to accelerate portfolio growth but at the end of the day, it’s a human capital intensive space.

To the second question, my answer should be obvious from my earlier ramblings: yes. The result of these two trends is that VCs grow and achieve scale in a particular category only to lose market share in another. The infinite combinations of specialization, stage, domain expertise, region and founder fit makes for an ever-expanding opportunity for new entrants to solve problems within that space. And then inevitably, they’ll grow out of it too. So where does Revaia fit into this matrix?

Revaia Value-Add is spread across key pillars

In a great piece from Investing 101, author Kyle Harrison outlines categories of what he calls VC Value-Add he determined from a survey of 90 investors at over 70 firms. These are the dimensions that dictate how you differentiate as a fund in the eyes of founders. You can see clear parallels between the earlier frameworks we discussed but at risk of analogy paralysis, I’ll leave those interpretations to the reader. The point I want to get across here is that Revaia offers both breadth and depth to our LPs and portfolio companies.

We have a broad mandate, yet specific core competencies around ESG; We offer highly localized deal sourcing and support, paired with international capabilities; we focus on growth equity but our crossover roots enable us to maintain relationships beyond IPO; we are a relatively new fund, but our partnership with Sycamore Asset Management bolsters our reputation and ability to compete in deals that would otherwise be out of reach for a fund of our size. We offer flexibility and stability, long-term, sustainable partnerships and expertise within a range of topics. While speed may win in the short run, we believe a measured, thoughtful approach is critical for long-term success.

The recent hype around quick and dirty capital deployment is likely tied to a localized peak in the business cycle leading to early celebrations and eventually down rounds and multiple contractions. Beyond financing there are governance and leadership challenges that often go unaddressed, which is simply incompatible with our core ethos as a fund.

Source: Keith Rabois of Founders Fund on Twitter

So with that, let’s scale with consideration, grow with purpose and invest in businesses and products we think can deliver outsized impact in a world that needs it!

Kyle O'Brien