The Changing Venture Landscape

Technology is accelerating in more industries, creating new disruptions in the world. The society is shifting to a new norm after the pandemic. This even before the actual pandemic was over. The loosening federal monetary policies in the US has seen more money flowing into venture ecosystems at all stages of funding.

These trends offer huge opportunities, but also great challenges. Authoritarians use technology solutions to control and monitor populations or foment chaos by using demagoguery to undermine a company's economic prospects. The world we live in is also, as Thomas Friedman put it so well, " Hot & Flat & Crowded."

How can the venture capital market remain untouched by the massive changes in our economies and financial markets? We can't. We are literally changing the landscape.

What has changed in financing?

People are often curious about but afraid of venture capital and technology markets. I am frequently asked the question, "Aren’t technology markets way too overvalued?" Are we in a bubble?"

I often reply the same way...

"First, almost every corner of our market has been over-valued. I am over-paying for every check that I write to the VC ecosystem. Valuations are being pushed up absurdly high and many of these companies and valuations won't last long.

To be a great VC, you need to have two opposing ideas at once. One, you are overpaying for every investment and valuations don't make sense. The other side is that the greatest winners will be greater than the prices paid and this will happen more quickly than ever before in human history.

To understand this phenomenon, we need only look at Discord, Stripe and Slack's extreme scaling, as well as those of other companies such as Zoom, DoorDash or SnowFlake. We operate at a scale and speed that is unmatched in human history.

Ten years ago, I wrote my first article about changes in the Venture Capital ecosystem. This still serves as a great primer on how we got to 2011, a decade after the Web 1.0 dot com bonanza.

Part 1 and Part2:

In summary, I wrote in 2011 that cloud computing, especially Amazon Web Services (AWS), was a new trend.

The micro-VC movement was sparked

This allowed for a huge increase in the number of companies that can be created, while spending less money.

A new breed of LPs was created that focuses on early stage capital (Cendana and Industry Ventures).

The average startup was less than a year old and the startups were more technically-oriented.

The main difference in VC between 2001 and 2011 (see graphic below) was that former entrepreneurs had to start their own businesses, except in the most egregious dot com bubble. By 2011, a healthy micro-VC marketplace had developed. Companies IPO'd quickly in 2001 if they were successful. However, IPOs have slowed to the point where Aileen Lee from Cowboy Ventures cleverly called billion-dollar outcomes "unicorns" in 2013. We didn't know how ironic but that term has endured.

Much has changed in ten years.

A time traveler would have difficulty recognizing the market of today if it was 2011. First, a16z (along with Bitcoin) was just 2 years old in 2011. Funders today are focusing on Day 0 startups, or those that haven't yet been created. These could be ideas that they have developed internally (via a Foundry), or founders who are just leaving SpaceX and need to raise money to pursue an idea. Two founders from a garage are the legends of Silicon Valley (HP Style). High-potential and connected founders need a lot of money. They need it because no one at Stripe, Discord or Coinbase, or even Facebook, Google, or Snap, is leaving without plenty of incentives.

The "A" round of 2011 was now called a Seed round. This has become so common that founders will not accept less money to avoid having to include the word "A round" on their legal documents. There are seed rounds and pre-seed rounds. You can raise $1-3,000,000 on a SAFE note without giving out board seats.

These days, a seed round is usually $3-5 million. There is so much money being thrown at entrepreneurs, that many firms don’t care about governance rights or board seats. Many see seed as an option. Many entrepreneurs actually prefer this method.

Many Seed VCs are available to serve as board members. They don't tend to over-commit and help companies build their foundations. It's self-selecting in a sense.

A-Rounds were once $3-7 million. The best companies were able to raise $10 million using a $40 million premoney valuation (20% dilution). The best A-Rounds are now worth $10 million and many are raising $20m at $60-80m pre-money valuations or higher.

Because there is so much private-market capital at attractive prices, and without the scrutiny of the public markets, many of today's best exits take place between 12-14 years after inception. This has created a strong secondary market where both seed-funds and founders are selling their ownership well before they are ready to exit.

Upfront Ventures recently returned more than 1x a $200 million fund by selling small amounts in secondary sales. However, we still have most of our stock to allow us to exit the public markets. We could easily sell >2x the fund in secondary markets, with substantial upside. This would not have been possible 10 years ago.

How do VC Firms like ours organize to meet the challenges?

The majority of our playbooks are the same as the ones we've used for the past 25-years. We support very early stage companies. We work with executive teams to build their teams, launch products, announce companies, and raise capital. This was once known as A-round investing. Although the market definitions have changed, what we do has not. We are now Seed Investors.

Our biggest change in early-stage investing is the need to make commitments earlier. We cannot wait for customers to try the product for 12-18months before we start customer interviews and look at purchase cohorts. We must be confident in the quality and potential of the team, and we need to be able to commit faster. In our early stages, we are 70% seed and 30% preseed.

It's very unlikely that we will ever do an "Around." We are unlikely to be able to invest at $60-80 million (or even $40-50,000,000) pre-money valuation before we have enough evidence of success. You need to write checks starting at $700 million if you want to play in the major leagues. The fund is $1 billion, so a $20 million check is only 2-2.5%.

Our A-funds are limited to $300 million. This allows us to maintain the discipline of investing early and small, while also building our Growth Platform to make late stage deals. We currently have more than $300 million in Growth AUM.

We promise entrepreneurs that we will help finance a seed extension if you are in for $3-4 Million and your business is doing well. These extensions are less likely at the next stage. Capital is much more patient when it comes to scaling.

We believe that our approach is different from other Seed Firms in that we consider ourselves to be "Seed/A Investors". This means that if we raise $3.5 million in Seed rounds, we are just as likely to raise $4 million in A rounds if we have a strong lead.

We have a "barbell strategy", where we avoid high-priced and less-proven A & B rounds. However, we have raised 3 Growth Funds which can then lean in when more quantitative evidence of market leadership is available.

We just announced that we have hired a new head for our Growth Platform (follow him on twitter here - Suriyapa -- I was promised he would drop Corp Dev knowledge). Aditi Maliwal, who runs our FinTech practice, will also be based in San Francisco.

While the skills required for a Seed Round investor are closely aligned to building an organization, helping to define strategy, raising awareness of the company, and eventually helping with downstream financing, Growth Investing requires a different set of skills and is highly correlated with exit valuations and performance metrics. Because the time horizon is shorter and the prices paid are higher, you cannot only be correct about the company. You also need to be accurate about the exit price and valuation.

Seksom was most recently the Corporate Development & Strategy Manager for Twitter. He is an expert on exits to corporates, and whether he funds startups or not. I believe many will benefit from having a good relationship with him because of his knowledge. He was also an investment banker and held similar roles at SuccessFactors, Akamai (telecoms infrastructure), McAfee ("Security Software"), and SuccessFactors (SaaS). He has a lot of industry knowledge and M&A skills.