The changing nature of venture capital
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Paul Asel is managing partner of NGP Capital and a global technology investor for more than 25 years.
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SoftBank and Andreesen Horowitz (a16z) recently announced new funds that reinforce the increasing scale of the venture industry. SoftBank announced its intent to raise a second Vision Fund through a public offering, a first for any venture firm. A16z announced two new funds, an early-stage $750 million fund and a growth-stage $2 billion fund.
A16z is the latest firm to launch a family of funds, four in the past 18 months totaling $3.5 billion, including the earlier announced Bio and Crypto funds. A16z joins GGV, Lightspeed and Sequoia as firms that have raised families of funds that cover specific sectors, stages or countries. In the last 18 months, Sequoia has raised nine funds, with nearly $9 billion committed; Lightspeed four funds for nearly $3 billion; and GGV four funds with $1.8 billion.
These funds and others like them will change the nature of venture capital. Venture is no longer a cottage industry where partners sit around a conference table on Mondays meeting companies and discussing which to support. Venture no longer operates as a collection of individual practitioners like a dental clinic. Venture firms are moving from job shops to scaled organizations with an armada of specialists in human resources, marketing, finance, engineering, legal and investor relations to support their investment and fundraising activity. Once firms with just a few partners, SoftBank, Sequoia and GGV now have teams of hundreds of people working to support continual fund raising, origination and portfolio development in the United States and abroad.
Funding startups is an inherently local business.
Investment banking and private equity firms provide a road map for how the venture capital may develop. The leading investment banks and private equity firms were closely held partnerships for many decades, before increasing capital intensity required a change of corporate structure. Founded in 1914, Merrill Lynch, a securities brokerage firm, was considered an interloper in the cloistered investment banking world. But as more capital entered public securities markets, securities trading houses such as Merrill Lynch encroached on Goldman Sachs, Morgan Stanley, Lehman and Kuhn Loeb, which then dominated highly profitable investment banking.
A wave of consolidation followed as partnerships gave way to full-service investment banks armed with capital to backstop their lucrative mergers and acquisition and financing practices. Founded in 1854, Lehman acquired Kuhn Loeb in 1977, which was then acquired by American Express in 1984, combining Lehman’s banking practice with Shearson’s brokerage business. The last bulge bracket investment banking partnerships Morgan Stanley and Goldman Sachs went public in 1993 and 1999, respectively.
Private equity firms soon followed. Like investment banks, partnerships prevailed in private equity. But as their appetite for capital grew to finance ever-larger acquisitions, private equity tapped the public markets for larger, more stable capital. Today, the five largest private equity firms are all public. Apollo Global Management, a PE firm now with $250 billion under management, went public in 2004. Blackstone, the largest PE firm, with $470 billion under management, followed with an IPO in 2007. Carlyle, KKR and Ares soon followed with public offerings.
Venture capital has been insulated from the capital intensity that fueled consolidation of the investment banking and private equity industries. Funding startups is an inherently local business. Technology innovation has historically been capital-efficient as early technology leaders such as Microsoft and Oracle went public after raising less than $20 million in private funding. And venture is a risky, volatile business, where profits vary substantially, failure rate is high and returns are highly cyclical.
Innovation is costlier as entrepreneurs and investors seek to disrupt rather than enable industries.
But like the investment banking and private equity industries, venture capital is becoming more capital-intensive. Innovation is costlier as entrepreneurs and investors seek to disrupt rather than enable industries. Startups require more capital to achieve escape velocity with the ever-present, growing threat from technology incumbents. Startups are moving into new industries competing with larger incumbents. And “lean startups” that rely more on company-building services offered by their investors are not “lean” for venture firms that must build out service capacity in talent acquisition, sales, product marketing and finance to accelerate venture growth. Today, staff devoted to supporting startup development often exceeds investment professionals in large venture firms.
The venture industry is highly fragmented, with more than 200 venture firms in Silicon Valley alone. Hundreds of venture firms are starting in cities and countries that were previously considered deserts for technology innovation. The venture industry is likely to consolidate significantly in the next decade as funding confers greater advantage to large venture investors.
A few boutique investment banks and private equity firms have withstood the scale and capital advantages of bulge bracket firms. Similarly, seed and early-stage venture firms will resist SoftBank-style institutionalization. Venture firms with expertise in specific technologies, industry sectors or geographic markets will still produce superior returns. However, capital intensity is rising. The venture industry will ultimately be dominated by a few global venture firms supported by independent seed and early-stage funds with proprietary access to high-potential startups.