Are venture capitalists an endangered species?
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It’s an interesting question, as investing in private tech companies becomes increasingly competitive.
If nothing else, we’re experiencing the end of venture capital as we know it, according to Sam Lessin of Slow Ventures, who predicts in a recent column in The Information that by next year, nontraditional tech investors will invest more in private tech companies than traditional Silicon Valley VC firms will.
Our data seems to show that’s already the case.
Despite this fact, I do not agree with Lessin’s conclusion: He suggests venture capitalists need to find new ponds and focus elsewhere while leaving the more predictable SaaS startups to growth equity investors.
Some sector-focused venture funds are already investing in other ponds and providing differentiation. But the software and SaaS pond is big — and growing — and to cede this to growth equity could cripple the whole ecosystem.
And most startups still fail — even those that raise Series A and B funding.
Growth equity has a different take, gaining a stake in the best pre-IPO companies. This is a very different rationale to the messy business of building a startup.
Let’s dive a little deeper into what’s actually happening and what the future could look like.
Growth equity is upping its stake
Still, venture firms are leading three times as many investment deal counts compared with those that growth equity leads.
As we’ve reported, private equity and growth investors including Tiger Global Management and Insight Partners these days are outspending their traditional venture counterparts as they vie to invest in startups, per Crunchbase data. In fact, out of the top 15 lead or co-lead startup investors in January through July 2021, just two are traditional venture firms, my analysis of our data shows.
“Any VC firm of today that survives will look more and more like every other global financial shop,” Lessin predicts. “That means they will play in every part of the capital stack with lots of products, including public equity funds, debt funds and more.”
Silicon Valley-based Sequoia Capital has a global equities public/private crossover fund and confirmed with Crunchbase News earlier this year that it holds on to its private company investments, often years after a public debut, before dispersing capital.
Value creation continues for these companies as public entities, and can be even more dramatic, as was the case with Square, which went public in November 2015 at a valuation of $2.9 billion and now has a market capitalization of $126.5 billion after tripling its value in the last year alone.
And as we’ve reported, New York-based growth equity investor Tiger Global now manages more money in private companies than its hedge fund business.
In this future, as this asset class expands and becomes more predictable, venture capital falls away and we just have capitalists who play at increased scale, according to Lessin.
Growth firms invest at earlier stages
Funding was up by more than $100 billion for the first half of 2021 compared to the previous half-year peak global funding in the second half of 2020, Crunchbase data shows.
In this record-breaking environment, growth equity firms are not sticking to their lane in late-stage investing, but are investing at earlier stages too, based on my analysis.
Both micro and venture capitalists have lost a proportional share of the early-stage market to private equity, but it is worth noting the amount of dollars by each investor cohort has grown alongside this trend.
“What this means for investors who focus on Series A investment rounds and beyond is that the market should become more and more efficient while investing becomes less and less profitable,” Lessin argues.
Will early-stage funds get squeezed out as private company financing expands? Will investing become less profitable?
Certainly, investors at early-stage funds I’ve spoken with say they’re feeling more pressure to invest and the need to increase the amount invested per deal — if they’re able — to compete for deal flow, but also more positively to boost ownership.
Belief in fundamental opportunities is driving this change, Ben Savage of Clocktower Technology Ventures told me earlier, adding that the market opportunity is so good it can be difficult to stay on the sidelines.
Venture doubles down
Still, the venture capital industry is not unprepared for these changes.
Over the last two decades, seed has emerged as a distinct institutional asset class previously filled by angels and friends and family investors.
Lessin noted that seed is less impacted by the shake-up in venture investing, as this funding stage is highly unpredictable when it comes to success rates as “almost by definition, brand-new startups lack the instrumentation and metrics needed for efficient scale.”
Venture capital has expanded globally, with many firms building a multiple fund approach for each specific asset class, seed, early-stage venture and growth equity. Venture funds are also raising funds every two years rather than every four years, on average, and mostly raising more for each subsequent fund.
And many funds are defining themselves earlier in the stack. We have seen early-stage funds redefining themselves as leading at pre-Series A, or seed or a pre-seed lead. And seed funds are operating like multistage venture raising opportunity funds for portfolio follow on or opportunistic late-stage investing.
As Alex Wilhelm at TechCrunch said in response to the idea of the end of VC, “even if private-market investing in software has a lower risk profile than before, it’s not zero. Many software startups will fail or stall out and sell for a modest sum at best.”
I agree. To get from Series A to gaining a share of a huge market is not a slam dunk. The fact that some companies outperform early is not surprising given immediate access to a global market through the internet. New brands can be launched and grow seemingly overnight as they address a market need. Others take longer.
With changes in the venture capital landscape building over the last two decades and speeding up over the last five years, it is as though venture has been preparing for this moment all along. Venture capital will increase its allocation, even as its share of private company financing dips.
And micro VC will keep repositioning to seed, if they have not done so already.
Illustration: Dom Guzman
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