The Times They Are A-Changin' For VC
One of my favorite VC blogs to follow is Mark Suster. Last week he wrote what may be his best post yet on the many changes going on in the technology venture capital industry.
I agree with the post entirely. One of the most interesting aspects within tech VC right now is the growing angel and seed fund phenomenon. Recently there has been a lot of buzz about on the subject, starting with Paul Kedrosky saying that a super-seed crash is coming. Chris Dixon then responded that the bubble in early stage investing is really due to entrepreneurs getting smarter. Fred Wilson followed with his thoughts in a great post saying the total capital needed to scale a business is still the same (~$20mm) but can now come after the business has traction:
What has changed in technology venture capital is not so much the total capital requirements, but when they are required. This is very good news for everyone involved. It means entrepreneurs that don't have to take expensive dilution early on in the development of their business. And it means that entrepreneurs can raise the big money later on when their business is worth more. It means that entrepreneurs should be able to keep more of the companies they start. That is good for everyone.
It also means that VCs don't have to take big risks early on. They can write checks in $250k and $500k sizes. It means that when the businesses develop into winners or likely winners, they can write the bigger checks like $3mm or $5mm or even $10mm. This is good for the VC business. Less writeoffs, more capital deployed into the winners and less into the losers.
Finally, Mark in his post on in the changes in the VC industry, laid out his thoughts on the seed fund phenomenon in the following points:
8. So super angel and seed funds are proliferating – As a result there has been an explosion in the number of amazing early-stage investors such as Softtech VC, Floodgate, Felicis Ventures, K9 Ventures, OATV, Lowercase Capital, Founder Collective, and many, many more. There are also super angels that are so numerous I’d rather just link to the best list out there, which is VentureHacks’ AngelList.
9. And VC’s are doing earlier stage deals – And we all know that VCs are doing earlier stage deals. The most notable is First Round Capital who built their entire fund and model around this type of investment and the notion that exit values in the future will be lower than they were 10 years ago. They are also the most innovative new fund to enter the market in the past 10 years in my opinion. There is also True Ventures that does early stage, seed investments. And of course Foundry Group, Union Square and a whole host of other firms including my own. I have written more in depth on this topic in the past.
10. This is producing a “boomlet” or a bubble in early-stage investing. That’s OK. – This massive increase in seed & angel funding caused Paul Kedrosky to predict that there is a coming seed fund crash. I don’t know whether there is a “crash” coming per se but I do believe that too much money is going into angel and seed companies too quickly. I’m OK with this – it feels fairly benign. But one problem it is causing is that early-stage deal prices are creeping up again higher than historic norms. This smells like classic froth to me. So IMHO it’s probably more of a mini “bubble” than an impending crash.
11. But it takes the same amount of money to scale a big business and this is where outsized returns are earned – If you want to build a big business you still need big bucks. Fred Wilson wrote a great piece on this. He acknowledged the importance of the growing seed fund movement in creating a new wave of cost-effective innovation. He then profiled his portfolio company FourSquare who started with a very small investment. But now that it’s time for them to scale they need a lot more capital and therefore just raised $20 million from Andreessen Horowitz. Think about it – while FourSquare has established itself as the clear market leader it is unquestionable that Facebook, Yelp, CityGrid and many more well capitalized companies will be gunning for them. Staying “lean” is not an option. If FourSquare wants to dominate it’s market it’s time to GO FAT.
Mark also talked through these points on video on the latest episode of This Week in Venture Capital. The whole video is worth watching but I've embedded it right at the point where they start talking about seed funding:
It is a fascinating time for technology VC to say the least. One thing is for sure, it is an industry that is evolving rapidly. I think Mark is right that we'll start to see more natural selection of the industry over the next couple of years where each segment – seed, super seed, A round VC, B round VC, and growth equity – is right-sized given its total market size.
As for the innovation engine, I agree with Fred Wilson that this is good news for everyone. The companies that don't work will fail faster. For the companies that do work, the entrepreneurs will be able raise more money at a later time when the business is worth more, thus they'll be better able to keep control of their company. The seed investors will fail a lot too but will get handsomely rewarded for their big risks when a few of the companies become winners. Lastly, the VCs don't have to make as many early bets so they eliminate more risks and can better deploy capital to the likely winners. Again, good news for everyone.
