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November 19, 2013

I gave a quick talk today at the Future Forward conference on “How VC’s Win, and How Things Are Changing”. It’s a topic I’ve been thinking about a lot.

My observation is that the Venture Capital business has changed significantly in the past 10 years because of much greater capital efficiency at the early stages, and much greater transparency around the process of fundraising and the performance and value of investors.

Put another way, the venture capital industry has become more mature, and increasingly, the market for the companies we invest in is more and more efficient. This creates challenges for investors.

When markets become more efficient, a couple things happen. First, it becomes much harder to find “value”.  The way I see it, an efficient market means more competition for an investment, which in turn means that pricing will tend to be driven up to the point of discomfort relative to the risk.  If you are investing very early, pricing may be good, but the perceived risk will be high (and a lot of smart investors will pass on an opportunity).  But if you are investing after product-market fit, the price will be driven up to the point that an investment becomes harder and harder to justify given the remaining risks.

Second, firms in a more efficient market need to find more and better ways to compete.  Relying on charm and reputation doesn’t get you very far in a world where entrepreneurs are increasingly less enamored by a VC’s brand or historic legacy, and entrepreneurs are more savvy about asking the question “what do I really get from taking your money vs. someone else’s?”.

So, this is forcing VC’s to seriously rethink the way they compete in the market.  Those that don’t evolve will have a pretty tough time, I think. Specifically, I’ve seen innovations in the following areas:

Sourcing

  • Sourcing in new, less competitive geographies (for example: US firms focusing on Europe, Brazil, etc)
  • Finding leveraged ways to tap into different founder communities (for example: General Catalyst’s Rough Draft initiative, or FRC’s Dorm Room Fund)
  • Using data and technology to identify talent

Winning (systematically finding ways to help companies be more successful and also win competitive deals)

  • Using AUM to “productize” value-add. (for example: OpenView on the growth equity side and A16Z on venture)
  • Leveraging the human capital of the portfolio to give value to the “platform” (for example: the FRC community)
  • Tuning investment models to specific kinds of investing (for example: seed funds, sector focused funds, etc)

But by far, I think the single more important thing a fund can do is to improve their selection. I’ve blogged about this before, and I continue to think that there is a big opportunity here and we just don’t know what the answer is just yet.  Getting better at sourcing and winning is important.  But I actually think that the biggest difference will be the ability to look at an opportunity, and say “yes” when others say “no”… and be non-consensus “right”.

** One fun thing about this conference is that there was someone from Collective Next who was creating a mini illustration/idea map of the talk in real-time. Pretty cool – see below!

 photo (3)

 

  • http://24x7.com/ robertdesideri

    It’s not a lack of charm and reputation when self-limiting the supply is the problem. Ten frat bros fighting over three top models will surely result in some losers. And notably, higher acquisition costs. Promising assistance to top models become more beautiful may not be the highest and best allocation of resources. Though I’ve heard sometimes throwing money can help.

    It’s totally a sourcing problem, Rob. Many VCs unwittingly have boxed themselves in. The industry has boxed itself in. That was the forgotten entry point where that pesky wedge was recently inserted. The false belief of the warm referrals myth is what’s got the VC industry confused, an assumption was made that self-isolated then sirened their ships onto the reefs. Not dissimilar to mice who self-sacrifice to cats, their brains betray them because of a virus. Exclusion of diversity killed the VC star. It could have happened to anyone really, it’s not specifically a VC deficiency, demand a referring introduction became the norm. I’m not calling ‘lazy’, I am calling blinded by a poor and now overlooked assumption.

    Look at Craig Venter for example, if you appreciate science. Gathering microbes from the ocean is for the purpose of gathering and sequencing DNA is sort of clever. How many others have taken that path? It’s too expensive some might assume. It’s a business model for heaven sakes, why do some economies end up as a decaying locale and others grow as New York, São Paulo or London? One might not make make many discoveries in the pool at the Rosewood, tough you never know what might turn up there :)) Perhaps the ocean is a better business model, even if it’s more expensive to fish there.

    From a macro perspective it’s further sub-optimal, on this most would agree. Fishing in isolated ponds will, by definition, exhaust supply. VCs like other investors are rational beings, might there be baggage, baggage that blinkers? Baggage that’s also preventing economic growth opportunities driven by folks who don’t have a golden ticket, a ticket many kids still in school, recent grads, engineers and scientists from non-hot industries can’t present because they are a degree or two away from the pond?

    A messenger that informs a friend of a friend can introduce you to XYZ may be the worst thing that’s ever been invented. Too many degrees of separation. No Rosewood. No degree from the same school. With climate change the ocean may encroach on the pond sooner than we think, such event though may precede the VC pond coming to the ocean. Science is beautiful thing, math too, let’s look at the probabilities and ask why exhausting the pond is driving valuations to levels that diminish LP returns? Can the referring introduction requirement be the cause, has the pond exhausting faster than the number of fisherman, the capital, arriving to extract the wealth?

    • robchogo

      I think the pools from which VCs source have gotten much broader, but you are right that there is a long way to go. But I see this primarily as a selection problem. If VCs had a more comprehensive selection rubric, they would see more potential in different pools of talent and start sourcing there.

  • Denniswingo

    … The Key, obviously

    …the biggest difference will be the ability to look at an opportunity, and say “yes” when others say “no”… and be non-consensus “right”……

    The problem that I see, as someone who is stepping their toes into the fund raising market in Silicon Valley is that the sales and marketing of the companies to be invested in (not the sales and marketing of the product that the companies make), have an inordinate effect on the investment community. I was recently asked by an investor why I did not team with another company that is hyping a new technology that has the appearance of a natural fit. My response was that the technology was a science project, that many of us know is a long way from the market and who’s claims are clearly as overhyped as they are sexy to those of us who are designers.

    Space is becoming sexy in Silicon Valley but the investment community is as of yet weak in the technical due diligence area. It is in all of our best interest for this to be improved in order to reduce the amount of wasted capital in the marketplace and to forestall burned investors who invested in a company marketing plan rather than a company.

    • robchogo

      I’m always surprised actually at how non-technical VC investors are.

      • Denniswingo

        Hey Rob, that subject deserves an article!

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