Thoughts on the VC world

I have been struggling to figure out the VC world. After reading a decent amount and hearing from VCs and entrepreneurs, I’m starting to form my own opinion on the current state of the industry.

First of all, some facts:

• Overall, the returns have been less than stellar
• Good returns have been concentrated amongst a few venture firms that have had outsized success
• Too much money is chasing too few deals
• Now, we have an entrepreneur-friendly environment where capital is not enough – they are looking for more from their investors

These same trends are starting to be seen in the impact investing world as well, just on a bit of a delayed timeline in my opinion. There is this hype around being involved in the innovation space that has led to a lot of money without necessarily the quality and quantity of deal flow to justify it.

Given these trends, it makes sense that good entrepreneurs are looking for more than just money now – they are looking for investors that can increase their chances of creating a successful company. Now, whether they realize it or not, I think at least at a subconscious level, they are looking for 2 primary ways by which VCs can add value:

1. Provide the perception that their chances of being successful are high
2. Provide services that may increase their chances of being successful

While you would think the first is bullshit, I think it is actually the dominant factor. The second item has only recently become of greater importance and might come to dominate in the next decade. But, if you want access to the best deals (which is really the only chance of getting good returns), you need to provide one or both of these items.

Provide the perception that their chances of being successful are high

This is hard to fake – funds that have a track record of investing in major successes (e.g. Google, Facebook, Twitter) have a perception of being the best investors (by entrepreneurs, other investors, the general public).

This is a reinforcing psychology because the more this perception exists, the more they can cherry-pick the best deals since that perception is extremely valuable.

Right now, while there are definitely blue-chip VCs in the traditional space (e.g. Sequoia, Kleiner Perkins etc.), there aren’t many in impact investing (I would argue only Omidyar Network).

How can you create that perception? While it is hard to fake, I think there is one loophole that can be exploited. When almost all people examine the “success” of VCs, they look at the “successful” investments. Rarely is consideration given to the timing of the investment (was it seed, series A, B, C?). But each of these stages has very different odds of success as aspects of the business have been derisked, more information exists and reputations have been formed.

Therefore, I think there’s an opportunity to gain immense reputational gains by investing in later stages (B, C rounds) for companies with much higher probabilities of being major successes. This is not to say you shouldn’t invest earlier – I just think the reputational benefits of having some “winners” associated with your name are worth the potentially lower returns of getting in late on a “hot” later-stage investment.

Provide services that may increase their chances of being successful

I think this is the future of funding – VCs need to provide a lot more than capital. Two models appear to be on the cutting edge – providing a suite of services (Andreessen Horowitz) or a platform (First Round Capital).

Andreessen Horowitz has quickly built a stellar reputation, despite being a recent entrant, by focusing on the services they provide entrepreneurs. The team consists of investment folks, a team devoted to helping with the sales strategy, people devoted to finding technical and executive talent, marketing folks, finance folks, and advisors. First Round Capital has created a network amongst its portfolio companies to share learnings.

These types of tangible services I think will become more and more important to high-quality entrepreneurs who have easier access to capital. Value-added services like talent identification and operational and financial expertise will be necessities for investors seeking the best dealflow.

Overall, I remain convinced that the VC world is very overhyped and needs to be dramatically reduced in size as the ability to alternatively fund companies (e.g. AngelList) grows. They have largely lived on item number 1 as their source of deals (which is why all but a few have lousy returns – if your reputation isn’t great, your deals won’t be great). But, if VCs can start to differentiate themselves along the latter, I think they may have a promising future alongside other investment vehicles.